Trends and Regulations in Japan Blockchain Industry in the Last Decade

KEYTAKEAWAYS

TABLE OF CONTENTS

• KEY TAKEAWAYS
•  
• INTRODUCTION
• WHEN DID JAPAN START TO REGULATE VIRTUAL CURRENCY?
• THE LIBERAL DEMOCRATIC PARTY’S 2022 NFT WHITE PAPER
• JAPAN PROMOTES INNOVATION AND THE DEVELOPMENT OF THE BLOCKCHAIN INDUSTRY
• WHAT DOES THE 2023 WEB3 WHITE PAPER SAY?
• RECENT CHANGES IN JAPAN’S REGULATIONS AND THE DEVELOPMENT OF THE INDUSTRY
• SUMMARY
• DISCLAIMER
• WRITER’S INTRO

CONTENT

*This article was originally published in Chinese and on the Blog- Code and law.

INTRODUCTION

Japan is often shrouded in a language barrier that keeps the general public unaware of its internal industrial developments. While the global industry experienced a downturn due to the FTX exchange collapse, Japan remained relatively unaffected and even exhibited a thriving trend. Many Web2 giants have ventured into investing in this industry. What makes Japan different from others?

This can be attributed to Japan’s early history of its strict risk management of crypto exchanges (namely the closure of the Mt. Gox exchange, which later led to regulatory frameworks) and the legislation that followed. However, due to this early legislation, the industry’s development faced certain obstacles. In some cases, the premature regulations failed to adapt to subsequent changes, causing the blockchain industry to seek opportunities elsewhere.

Since 2022, there has been a significant shift in Japanese policies. As the government vigorously promotes digital transformation (DX), Japan hopes to achieve its goals by supporting startups and fostering collaboration with large companies. Blockchain is viewed as the foundational infrastructure for the future convergence of the virtual and physical worlds. With the Metaverse world seen as an inevitable future, Japan’s culture and intellectual property influence cannot be absent in the Metaverse world. Therefore, the Japanese government decided to support the blockchain industry and swap the obstacles in Japan.

In this article, the author, drawing from his legal background and practical business development experience, discusses the development and changes in Japan’s blockchain industry from 2022 to 2023, focusing on three aspects: regulatory development, policy shifts, and the industry itself.

WHEN DID JAPAN START TO REGULATE VIRTUAL CURRENCY?

Contrary to the common perception that Japan is always lagging behind in the blockchain industry, Japan has actually had regulations on crypto since 2016. Amendments were made to define what constitutes a virtual currency (now defined as “cryptoasset” in Japan, hereinafter referred to as virtual currency or cryptoassets), and regulatory systems for cryptoasset exchanges were introduced. The reason why the laws were made can be dated back to the collapse of the Mt. Gox exchange in 2014, which filed for bankruptcy in the Tokyo District Court.

Mt. Gox, founded in 2010, was a Bitcoin exchange located in Shibuya, Tokyo, Japan. However, in February 2014, it claimed to have suffered a hack resulting in the theft of Bitcoin, leading to the suspension of its operations and filing for civil rehabilitation in Japanese courts. In April of the same year, it decided to initiate bankruptcy proceedings, drawing significant attention from both society and cryptoasset investors.

This incident caused shock among Bitcoin investors at the time and prompted discussions in the Japanese government’s parliament. These discussions led to conclusions regarding the legal nature of Bitcoin, and over time, the following outcomes were reached:

In April 2014, during a response in the Cabinet to the Senate, the Japanese government acknowledged that Bitcoin is not a currency, not a foreign currency, and not a valuable security. The final conclusion was that Bitcoin would not infringe upon the nation’s monetary sovereignty.
(Japanese: 参議院議員大久保勉君提出ビットコインに関する質問に対する答弁書)

In June 2014, the ruling Liberal Democratic Party of Japan also discussed the nature of Bitcoin. Their conclusion was that Bitcoin is neither a physical entity nor a currency; instead, it should be categorized as a “value record.” This means it is considered an electromagnetic record with a certain value, neither currency nor physical item, and should be repositioned accordingly.

In December 2015, the Japanese Financial Services Agency (金融庁) also released a report regarding settlement businesses (Japanese: 決済業務等の高度化に関するワーキング・グループ 報告～決済高度化に向けた戦略的取組み～), addressing how virtual currencies should be regulated. Subsequently, in 2016, amendments were made to the Payment Services Act (Japanese:　資金決済に関する法律) and the implementation of the Financial Action Task Force (FATF) 40 Recommendations, incorporating virtual currencies into regulations, along with including exchanges. These changes were enforced starting in April 2017.

Then, in 2016, Japan incorporated regulations through its domestic payment laws and established a regulatory framework for cryptocurrency exchanges. Japan became the world’s first country to legally define “virtual currency.” These regulations included provisions that prioritize user claims over those of other creditors to ensure user rights. Operators were also required to establish self-regulatory organizations for autonomous management.

In 2018, two cryptocurrency exchanges in Japan, Coincheck and Zaif, experienced security breaches and asset losses due to hacking incidents. This prompted the Japanese Financial Services Agency (金融庁) to further amend the laws, requiring exchanges to implement risk management, enhance system security, and strengthen internal controls. These requirements laid the foundation for the regulatory framework of Japanese exchanges in the future:

1. Assets held by exchanges and user assets should be managed separately. For example, cryptoassets and fiat assets should be accounted for separately, and their ownership status should be clearly distinguished. Fiat currency should be kept in trust or through other legal means and subjected to external audits.
2. User assets should be stored in a highly secure manner. For example, user asset management should be conducted through cold wallets, although the specific proportion is not explicitly stated in the regulations. However, based on discussions with several Japanese exchanges, many choose to adopt a 100% secure storage approach.
3. Company information should be transparently disclosed. This includes informing users about what virtual currency is, highlighting its differences from legal tender, disclosing company financial information, risks associated with asset price fluctuations, and potential cybersecurity risks. If users need to assert their rights, information should be provided to help them understand where to assert their rights or resolve related disputes.
4. User claims should take precedence over those of other creditors. To ensure that users can recover their assets in the event of exchange closure or bankruptcy, their rights are legally prioritized in the order of claims ahead of other creditors. After the settlement of user claims, other creditors can be settled in their respective orders, ensuring the protection of user rights.

The clarity of regulation has made virtual currency exchanges in Japan resemble financial institutions to a certain extent. However, in order to comply with regulatory obligations, it also limits what they can do compared to foreign exchanges. This has placed certain restrictions on the development of some blockchain startups. In contrast to the rapidly changing and rapidly evolving foreign blockchain industry, Japan’s development has been relatively slower. Nevertheless, this approach has unexpectedly prevented Japan’s blockchain industry from the destructive impact of the FTX exchange collapse. As a result, both the industry and users still have confidence in it.

Image source: unsplash.com

THE LIBERAL DEMOCRATIC PARTY’S 2022 NFT WHITE PAPER

As mentioned above, due to the early regulatory emphasis on risk management and internal control systems, virtual currency exchanges and related industries in Japan had limited scope for innovative services. Listing a new cryptocurrency in Japan took more time compared to other countries. Additionally, Japan had established relevant regulations before the 2017 ICO boom, which resulted in some tax laws following the early legal perspectives and not adapting to the subsequent development of the Token Economy. For example, if a company holds crypto assets with market value, regardless of whether they dispose of the assets or gain profits at year-end, they are required to declare and be taxed on the value of those assets. This regulation led to the departure of several startups from Japan.

During the global boom in the NFT economy, many intellectual property (IP) assets were tokenized via NFTs, expanding the influence of creators. However, there were also cases of foreign entities misusing Japanese IP and selling NFTs without proper authorization. In response to the changing landscape of the global blockchain industry, as well as the limitations imposed by Japanese regulations and tax environments, the Digital Society Promotion Division of the ruling Liberal Democratic Party of Japan established the “NFT Policy Review Project Team” (Japanese:デジタル社会推進本部 NFT政策検討PT) in 2022. They sought input from private entrepreneurs and legal experts and proposed the “NFT White Paper (Japanese: NFTホワイトペーパー).” This document emphasized that Japan cannot be absent from the blockchain industry, called for the removal of obstacles to the industry, and recommended creating appropriate regulations and tax environments conducive to industry growth.

The white paper discusses Japan’s national strategic issues related to NFT development and presents six main points, along with recommendations on 24 topics, most of which pertain to assisting NFT business development, protecting IP content holders, and ensuring NFT buyer protection. Besides NFTs, it also addresses legal and tax challenges faced by Japan’s blockchain industry and suggests relaxing related regulations to foster innovative policies, ensuring the sound development of the blockchain economy ecosystem.

An interesting aspect of this white paper is that it outlines Japan’s national vision, defines what it perceives as the Web3 industry, and emphasizes the importance of not being left behind in the blockchain economy. It defines “Web3” as a digital environment created using blockchain technology that is not dependent on specific central platforms. Unlike Web2 companies that collect and control user data, Web3 tends to decentralization, profit-sharing with users, and the utilization of autonomous organization models like DAOs. Unlike Web2’s dominant GAFAM (Google, Apple, Facebook, Amazon, Microsoft) companies, there is no single dominant entity in the Web3 field, offering Japan an opportunity to compete.

Through this white paper, sorting out the problems faced by the industry and the project team made recommendations on how Japan should develop digitally. They compared past and present differences, proposed future policy goals, and advised the Prime Minister of Japan, Kishida-san during meetings. Fortunately, Prime Minister Kishida-san mentioned in May 2022 during a budget committee meeting in the House of Representatives that “the arrival of the Web 3 era, along with new digital services such as the Metaverse and NFTs, will contribute to and lead the possibility of Japan’s economic growth. It will promote future economic growth development, so we should prepare regulations and policies to attract foreign investments and Web3 startups to Japan.”

JAPAN PROMOTES INNOVATION AND THE DEVELOPMENT OF THE BLOCKCHAIN INDUSTRY

Following the strong call from the Prime Minister, several notable developments occurred:

1. In July 2022, the Ministry of Economy, Trade, and Industry (METI) established a cross-departmental organization with the aim of streamlining and coordinating different regulatory agencies involved in various aspects, including fundraising regulations and taxation. The goal was to ensure that these regulations were considered comprehensively.
2. In August, the Japanese Financial Services Agency (FSA) announced tax reforms, including those related to crypto assets. It was mentioned that regulations regarding the year-end tax assessment of crypto assets would be amended in 2023 to prevent unreasonable tax requirements.
3. In December, METI issued a report titled “Approach to Improving Web 3.0 Business Environment” which addressed domestic industries, regulations, and tax issues. The report discussed the current status of the blockchain industry in Japan and how it could effectively contribute to the concept of Society 5.0, a society characterized by the high integration of virtual space and the online world into social, economic, and interpersonal relationships. The report also explored policy development in this context.

These developments align with Prime Minister Kishida’s vision of “new capitalism,” which emphasizes the need for digital transformation (DX), support for collaboration between startups and large corporations, and recognizes the pivotal role of blockchain technology and digital services as the trust foundation in a world where virtual and real-world integration is becoming increasingly important. This approach is seen as a potential driver for Japan’s new economic growth.

Image source: unsplash.com

WHAT DOES THE 2023 WEB3 WHITE PAPER SAY?

Under the strong push from the Japanese government and the involvement of major industries such as NTT Docomo and KDDI, the future of digital development in Japan is expected to focus on individuals holding their digital assets. This means people will have their wallets containing crypto assets, NFTs, and various income securities tokens. In this context, blockchain is becoming a crucial foundational infrastructure for the digital society.

To achieve this vision, Japan needs to prepare in advance and adjust the overall industry environment. The Web3 white paper serves as a response to the challenges faced by the existing blockchain industry and provides recommendations for the next steps in Japan’s Web3 industry development. The white paper begins with the phrase “Japan is Back,” emphasizing optimism about the blockchain industry’s potential. It suggests that even in challenging environments, blockchain technology can be tested and can lead to the development of new business models or projects. Japan should strive to create a blockchain industry environment that allows anyone to use digital assets securely.

Compared to the NFT white paper published in 2022, which focused on the industry’s current challenges and adaptations, the 2023 white paper compiles the changes made by the Japanese government over the past year. Its content can be roughly divided into three parts:

1. Addressing existing bottlenecks in industry development and proposing improvements.
2. Discussing how Japan can continue to expand industry adoption and explore issues for further discussion as it aims to develop the Web3 ecosystem.
3. Providing an update on the progress of government agencies following the NFT white paper from the previous year.

Overall, the Web3 white paper symbolizes Japan’s determination to further expand its Web3 industry. It underscores their desire to combine Japanese IP with NFTs to amplify the influence of Japanese IP. In the financial market, Japan hopes to tokenize assets and leverage blockchain networks to reduce issuance and holding thresholds while facilitating unrestricted circulation. Moreover, they aim to use concepts like NFTs and DAOs generated within blockchain communities to address social issues and promote the development of local communities and nonprofit organizations.

RECENT CHANGES IN JAPAN’S REGULATIONS AND THE DEVELOPMENT OF THE INDUSTRY

In 2023, two significant regulatory changes took place in Japan: the “Corporate Crypto Asset Year-End Valuation Taxation Regulations” and the amendment and implementation of the “Stablecoin Related Legal Framework.”

The first change, related to corporate crypto asset taxation, allows startups to avoid taxation on unrealized gains from assets they have not disposed of. This change reduces barriers for companies developing blockchain token economic projects in Japan. After the tax law reform, if a company plans a specific project linked to a particular token (e.g., allocating 30% of tokens to participants and retaining the remaining 70% for future user behavior rewards), the company’s self-held portion will not be subject to additional taxation requirements. This reform encourages companies or specific blockchain projects to plan and design token economies more smoothly in Japan.

The second change involves the clear establishment of a framework for the issuance and distribution of stablecoins and how user rights should be protected. Companies involved in the distribution of stablecoins will need to obtain new licenses. This change will make Japan’s blockchain infrastructure more comprehensive, allowing businesses and the general public to easily access crypto assets through stablecoins, play blockchain games, or engage with blockchain applications, thus making Web3 more accessible.

Currently, Japan has 29 companies holding licenses for crypto asset exchanges, and many major corporations have also entered the space. Companies like SBI, Rakuten, LINE, and GMO have their exchanges. After the government’s strong push for blockchain development, we have seen companies like NTT Docomo, Square Enix, Sony, KDDI, and even Toyota dedicate resources to research and develop blockchain projects. Overall, Japan’s approach to blockchain industry applications leans more towards exploring how blockchain technology can be practically utilized and bring efficiency and real-world use cases. In Japan, blockchain companies and startups often collaborate with large corporations to jointly research and develop blockchain technology use cases and help large enterprises understand and implement relevant projects. Compared to other regions, Japanese Web2 companies show a stronger interest in investing in blockchain, often taking a long-term development perspective.

Image source: unsplash.com

SUMMARY

In summary, Japan, due to the Mt. Gox incident, established comprehensive regulatory frameworks for virtual currencies earlier than many other markets. While these regulations restrict innovation in the Japan blockchain industry, they also shield Japanese industries from excessive speculation and protect them from tremendous risks like the FTX bankruptcy.

Over time, the Japanese government has gradually recognized the necessity of blockchain technology development. To achieve its digital transformation goals and secure a prominent position in the future digital society, meaningful research into blockchain technology has become essential. Consequently, Japan has released NFT and Web3 whitepapers, with a focus on policy and tax reforms as the first step to drive related industry development. Many large Japanese enterprises are also collaborating with cryptocurrency companies on various projects, aiming to apply relevant technology to real industries and study practical use cases.

With numerous Japanese corporations, including traditional ones, currently exploring and researching blockchain applications, Japanese companies are in a three to five-year phase of long-term planning to find business partners and technology collaborators. Simultaneously, the Japanese government is actively promoting regulatory and tax reforms.

For foreign companies looking to enter the Japanese market and secure long-term cooperative benefits, these years represent an excellent opportunity to do so. However, it’s important not to overlook the need for localization when entering the Japanese market, including basic Japanese language services and collaboration with local personnel to establish long-term trust relationships and engage in enduring business cooperation with Japanese companies. If foreign companies are considering entering the Japanese market, they should be prepared for long-term commitment, with comprehensive preparations before conducting operations. Considering government support, comprehensive regulations, relaxed restrictions, and industry cooperation, Japan is one of the blockchain-friendly countries worth considering for investment in the future.

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