Japan publishes draft report on new cryptocurrency regulation

The report provides solutions to problems that are not currently covered by existing laws. Namely: hacking, self-regulation, purported dealers, privacy and margin trading.

Japan's leading financial regulator, the Financial Services Agency (FSA), published a draft report on Friday outlining the country's new regulatory framework for cryptocurrencies and initial coin offerings (ICOs). 

One of the main aspects of the report is the prevention of incidents such as hacks of two large Japanese cryptocurrency exchanges - Coincheck in January and Zaif in September. The FSA will require cryptocurrency exchanges to strengthen the “management and maintenance of client assets,” in particular the management of private keys. To protect consumers, the FSA says exchanges need to have net assets "equal to or greater than the equivalent of currency and redemption funds" in the event of a hack. The document also sets out measures to prevent the failure of cryptocurrency exchanges.

The FSA recognizes rapidly changing technological innovations and sees the importance of cooperation with accredited self-regulatory organizations. “For this reason, we encourage members to join a certified [self-regulatory] association” and develop systems in accordance with its rules. In October, the Japan Association of Cryptocurrency Exchanges (Jvcea) received FSA accreditation to be able to legally enforce self-regulatory rules.

The document also explains that the FSA considers it appropriate to refuse or cancel the registration of exchanges that do not enter into an “accredited association and do not comply with self-regulatory principles.”

The report looks at “deemed dealers,” that is, companies that were allowed to operate the exchange while their application was being considered. There are currently three of them: Coincheck, Lastroots and Everybody's Bitcoin. The report found that some have advertised heavily and grown their businesses rapidly, but many of their clients are unaware that they are not registered.

The FSA has a number of measures in place for them. First, they cannot expand their business or pursue additional listings until they are registered. Moreover, they can neither attract new clients nor advertise their services to attract new clients. They must also post a notice on their websites regarding the status of their registration.. Among other measures, the report includes restrictions on anonymous cryptocurrency listings, derivatives transactions, and margin trading.

The report also discusses regulation of ICOs. ICOs “may be subject to securities laws.” Depending on their structure, tokens may be subject to regulation under the Financial Instruments and Exchanges Act or the Settlement Act.