Author: Rick Maeda, Presto Research; Translated by: Tao Zhu, Golden Finance
Summary
As the site of two of the largest cryptocurrency exchange hacks in history, Japan has a rocky history with cryptocurrency.
This forced regulators to step in earlier than in other countries, thereby providing a clear regulatory framework for the industry at the earliest opportunity.
However, strict regulations, coupled with high tax rates, make Japan less competitive than its neighbors such as Singapore and Hong Kong.
The challenges Japan faces in developing its Web3 industry amid sluggish sales and a lackluster domestic startup environment are extensive, and revival will require meaningful changes in policy.
Preface
Japanese retail investors have long been known for their appetite for leveraged trading due to a lack of yield and a lackluster domestic stock market. Japan’s community of retail crypto traders is so well known for their influence on the volatile Turkish Lira/Japanese Yen forex pair that the international financial community coined the term “Mrs. Watanabe” to represent them. When Bitcoin and other cryptocurrencies entered the retail space in the early 2010s, Japanese day traders eagerly embraced the esoteric asset class. However, investors soon faced domestic challenges, including two of the most notorious exchange hacks in crypto history, which, combined with Japan’s relative lack of appeal from an entrepreneur and investor perspective, undermined the country’s relevance in the Web3 space.
In this research article, we (1) present the history of cryptocurrency in Japan, particularly with regard to various regulatory developments, (2) look at the situation in Japan today, and finally (3) explore several major players in the domestic crypto industry.
History of the Japanese Crypto Industry
Major events such as the Mt. Gox and Coincheck hacks marked Japan's cryptocurrency journey, leading to the adoption of strict regulatory measures aimed at protecting investors and ensuring the stability of the financial system. The country continues to evolve its regulatory framework to address new challenges and opportunities in the cryptocurrency space.
The rise of Mt. Gox in the early years
Year 2009:
Bitcoin is the first cryptocurrency, launched by an unknown person or group under the name Satoshi Nakamoto. In the early years, awareness and adoption were low in all regions, and this was no different in Japan, despite the creator using a Japanese pseudonym.
2011~2013:
Mt. Gox was a Tokyo-based bitcoin exchange that was the largest bitcoin exchange in the world at the time, processing the vast majority of bitcoin transactions at its peak (Figure 1).
Figure 1: Global CEX trading volume as of the end of 2013.
Mt. Gox hack and aftermath
2014:
Mt. Gox halted trading, shut down its website, and filed for bankruptcy, announcing that approximately 850,000 bitcoins had been stolen due to security issues, nearly 7% of all bitcoins at the time (750,000 customers’ bitcoins and 100,000 of their own bitcoins) worth around $450 million. Investigations revealed that poor management and inadequate security measures led to the losses.
Figure 2: BTC fell more than 40% three days after Mt. Gox stopped withdrawals.
Regulatory development and early regulation
2015:
The Financial Action Task Force (FATF), the G7’s intergovernmental policymaking body, has issued guidelines recommending that countries regulate virtual currency transactions to combat money laundering and terrorist financing.
The Japanese government began drafting legislation aimed at regulating exchanges to protect consumers and ensure financial stability.
2016:
The Japanese Cabinet and Diet passed bills amending the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA). These amendments recognize virtual currencies ($BTC, $ETH, $XRP, $LTC, and $BCH) as a means of payment and impose regulatory requirements on cryptocurrency exchanges, laying the foundation for the full implementation of cryptocurrency regulations.
The Financial Services Agency (FSA) has been tasked with preparing for the implementation of these regulations, focusing on registration requirements, cybersecurity measures and anti-money laundering (AML) protocols for exchanges.
Coincheck hacked and regulation tightened
2017:
The revised Payment Services Act, which will come into effect in April, requires cryptocurrency exchanges to register with the FSA and comply with AML and Know Your Customer (KYC) regulations. It also classifies Bitcoin as a prepaid payment instrument.
Bitcoin and cryptocurrencies are extremely popular in Japan, with many merchants, such as Bic Camera, Japan's largest electronics retailer, starting to accept Bitcoin as a payment method.
The National Tax Agency (NTA) classifies cryptocurrency income as “miscellaneous income,” making it taxable.
2018:
One of Japan’s largest cryptocurrency exchanges, Coincheck, was hacked, resulting in the theft of approximately 523 million NEM ($XEM) tokens, worth approximately $530 million at the time. Coincheck ultimately refunded customers in full. The hack remains one of the largest cryptocurrency heists in history and alerted the FSA to stricter regulatory measures. The exchange reportedly stored $XEM in hot wallets, rather than multi-signature wallets. In Figure 3, the bottom chart shows that $VIEW fell by over 76% in the first 2 months after the hack. The first quarter of 2018 was a brutal start to the bear market, but even if we remove the bear market effect by plotting $XEM/$BTC in the top chart, the pair still fell by over 61%.
Figure 3: Check out the price action surrounding the Coincheck hack.
Zaif is a smaller exchange that lost around $60 million in a hack.
The Japan Virtual Currency Exchange Association (JVCEA), a government-approved self-regulatory body established to improve industry standards, is responsible for approving tokens for listing on exchanges.
The FSA issued business improvement orders to several cryptocurrency exchanges and conducted on-site inspections to ensure compliance with the new regulations.
The FSA has limited leverage on cryptocurrency margin trading to four times the deposit amount, in an effort to curb speculative trading and protect investors.
Leveraged Trading Regulations and Continuing Development
2019:
Coincheck has now complied with the new regulations and resumed operations.
Japan’s Cabinet approved new regulations that will limit leverage on cryptocurrency margin trading to 2-4 times the initial deposit.
The revised Financial Instruments and Exchange Act (FIEA) and Payment Services Act (PSA) came into effect, further tightening regulation on cryptocurrency exchanges and security token offerings (STOs).
2020:
The FSA has reduced the maximum leverage for margin trading to 2x.
Further amendments to the PSA and FIEA were implemented, focusing on strengthening user protection and market integrity.
2021:
Japan continues to develop its regulatory framework, with a focus on strengthening investor protection, cybersecurity and preventing money laundering.
The FSA has established a new regulator to oversee cryptocurrency exchange operators and ensure compliance with changing regulations.
The FSA asked the JVCEA to implement a self-regulatory rule called the “Cryptocurrency Travel Rule” regarding information sharing during transactions.
Recent Developments
2022:
The FSA has introduced additional guidance for exchanges custodying digital assets, highlighting the need for strong internal controls and risk management practices.
The JVCEA introduced the travel rule in its self-regulatory rules, while the Cabinet Secretariat amended the Act on Prevention of Transfer of Proceeds of Crime (APTCP) to implement the rule.
Japan’s Tax Commission has amended its tax code to exempt token issuers from paying corporate taxes on unrealized cryptocurrency gains.
Japan is exploring the possibility of issuing a central bank digital currency (CBDC), with the Bank of Japan conducting experiments and research.
The House of Lords passed a bill to regulate stablecoins, monitor money laundering and combat money laundering.
The Liberal Democratic Party's Digital Society Promotion Headquarters released the "NFT White Paper: Japan's NFT Strategy in the Web 3.0 Era", which reflects policy recommendations for the development and protection of NFTs.
The Ministry of Economy, Trade and Industry (METI) has established a Web3 Policy Office to create a supportive business environment for Web3-related industries.
The FSA continues to lift its ban on foreign-issued stablecoins.
2023:
The FSA continues to refine its regulatory approach, focusing on emerging trends such as DeFi and non-fungible tokens (NFTs).
The FSA has launched a public consultation on a draft order to amend the APTCP Enforcement Order to clarify the application of the Travel Rule to Japanese Virtual Asset Service Providers (VASPs).
Japanese Prime Minister Fumio Kishida has highlighted Web3 as a pillar of economic reform, describing it as a “new form of capitalism” and emphasizing its potential to drive growth by solving social problems.
2024:
The JVCEA plans to simplify the listing process for digital currencies, aiming to streamline the approval process for tokens already on the market.
It is expected to eliminate the lengthy pre-screening process for certain digital assets by authorized exchanges.
The cabinet approved a bill that could allow venture capital firms’ investment vehicles to directly hold digital assets.
Japan’s Efforts to Adopt Web3
Japan’s weakness in Web3 adoption stems from regulatory restrictions, especially in terms of exchange listings and taxation. Exchange listings are strictly regulated by the FSA, and local CEXs lack major tokens and are unable to provide stablecoin liquidity (Figure 4).
Figure 4: Local CEX offerings are limited. Note: We focus on Binance and ByBit’s USDT paired tokens as neither offer USD against fiat currencies. For ByBit, $SHIB and $BONK are offered in blocks of 1000 units ($1000BONK and $SHIB1000).
With the exception of Bitbank, which has a slightly higher token issuance volume among Japanese exchanges, this strengthens the dominance of major exchanges among Japanese exchanges (Figure 5):
Figure 5: Trading volume market share of the top 2 assets on top Japanese and international central exchanges. Duration: 2024-Present.
Meanwhile, cryptocurrency gains are considered miscellaneous income and are therefore taxable at the individual income tax bracket plus local taxes, with the highest rate being 55% (Figure 6).
Figure 6: Japan imposes excessive capital gains taxes on cryptocurrencies.
Before the emergence of institutional interest, yen trading volumes were once larger than dollar trading volumes, but the above challenges have made the situation challenging.
Figure 7: Japanese Yen’s market share in global fiat currency trading volume.
The absolute dominance of the Japanese yen (at one point accounting for over 60% of all fiat currency trading volume) was short-lived and faded into insignificance during the COVID-19 pandemic (Chart 7). However, the overall share of Asian fiat currency trading volume has remained stable over time, with trading volume shifting from the Japanese yen to the Korean won (Chart 8).
Figure 8: Market share of Japanese Yen trading volume relative to other currencies.
Notably, when we adjust JPY and USD volumes to their all-time highs prior to November 2021, JPY volumes show a stronger recovery in this cycle (Figure 9).
Figure 9: JPY and USD volumes rebased to previous high in November 2021 = 100.
On the institutional side, Japan is a country rich in content IP, with companies like Sega and Kodansha, making it a prime candidate for NFT and game-driven projects. In theory, these companies bring attention, users, research capabilities, and capital - the problem is, these areas are not effective in any country, and this has been touted as a bull market in Japan for many years.
Politically, recent concerns about the deregulatory ruling party losing the House of Representatives election in April 2024 have given momentum to the opposition Constitutional Democratic Party. However, given the LDP’s continued majority in both houses of the Diet, and the growing international and domestic competition for Web3 adoption, we do not believe these developments are cause for concern at this time.
There are many headwinds to cryptocurrencies, but to put it simply, many of the issues are simply cultural, making them unquantifiable and without easy solutions. Extremely low English proficiency for a global city, an inherent lack of entrepreneurialism, stable jobs at large local companies still seen as the pinnacle of graduate employment, and the high level of corporate caution juxtaposed against the “move fast” nature of cryptocurrencies. Add to that challenges with taxation and CEX product offerings, and it’s hard to imagine Japan’s adoption rate catching up to its Asian neighbors any time soon.
Major players in the Japanese cryptocurrency market
i) CEXs
As explored in the previous section, Japanese central exchanges have struggled to compete in terms of product offerings compared to their international counterparts, while high capital gains taxes make cryptocurrency trading unattractive. These challenges are reflected in the trading volumes of domestic exchanges, and while this is a difference observed outside of cryptocurrency exchanges, the UI/UX of these exchanges also lags behind foreign competitors.
There are 29 crypto asset trading service providers registered with the FSA in Japan, and we explore the current situation through a chart.
BitFlyer is the largest exchange by trading volume and has maintained its dominance in recent years.
Figure 10: Japanese CEX volume share.
However, compared with top international exchanges, domestic Japanese exchanges are barely competitive in terms of trading volume, and since the pandemic, Binance has left Japanese exchanges behind.
Figure 11: Total spot volume across Japanese exchanges and Binance.
This difference can also be observed when comparing the depth of exchanges’ spot BTC order books.
Figure 12: 1% depth of spot BTC order books on Japanese exchanges and Binance.
ii) Investor Group:
SBI Digital
SBI Holdings (TYO: 8473) is a Tokyo-based financial services group founded in 1999. The company was originally part of SoftBank Group and became independent in 2000. SBI Holdings operates in a variety of fields including financial services, asset management and biotechnology. The company is known for combining technology with traditional financial services to drive innovation and growth.
SBI, through its consolidated subsidiary B2C2, provides a variety of traditional financial and crypto services, including custody solutions and market making.
iii) Agreement/Project
Astar Network
Astar Network is a decentralized application (dApp) platform built on the Polkadot ecosystem and one of the leading crypto projects in Japan (although its headquarters are not in Japan, but in Singapore, as we all know). It was founded by Sota Watanabe, a well-known figure in the Japanese blockchain space. Astar aims to provide developers with a scalable, interoperable and decentralized network to deploy their applications. The network supports multiple virtual machines, including the Ethereum Virtual Machine (EVM) and WebAssembly (WASM), allowing developers to write smart contracts in a variety of programming languages.
Astar is significant in Japan as it represents one of the country’s leading blockchain projects, demonstrating the growing interest and investment in blockchain technology within the Japanese tech community. However, perhaps representative of Japan’s interest in Web3, activity on Astar is still in its infancy: Figure 13 shows the chain’s TVL (in USD), while Figure 14 shows the growth of its native token’s TVL.
Figure 13: Astar TVL vs. large blockchains in USD.
Figure 14: Astar TVL compared to Solana TVL, measured in their native tokens ($ASTR and $SOL), rebased to 01Jan23=100.
Summarize
Despite leading the way in retail adoption, a combination of regulatory scrutiny following exchange hacks, high taxes, limited token offerings on exchanges, and cultural resistance has left Japan lagging far behind other Asian countries in the Web3 space. The current government, led by LDP’s Kishida, has been forward-looking but has made slow progress. Activity on local exchanges reflects this struggle, and it’s hard to see what catalyst could change the tide in Japan.