Currently, Web3 is gaining momentum in the world and has a huge impact on the economic market. The Japanese government is very optimistic about the development potential of Web3. Since taking office in 2021, Japanese Prime Minister Fumio Kishida has been seeking to establish "a new form of capitalism" in Japan. The core of this is the intention to develop Japan's national strategy of "digital economy in the Web3 era" - that is, the Japanese government believes that "realizing a digital society" is the "key" to Japan's economic future. In today's "fierce competition" in the world, Japan hopes to seize the momentum of blockchain development in East Asia by "opening up the future of Web3."
1. Background of Web3 Development in Japan
Back in the early days of the Web, Japan was “leading the world in cryptocurrency.” But then, large-scale hacking incidents occurred frequently and regulators reacted strongly. This reputation and regulatory burden, coupled with high taxes and a lack of regulatory transparency, has put Japan’s once-booming crypto industry in trouble.
In 2014 and 2017, the Japanese crypto industry suffered two serious hacking incidents. MtGox was hacked and about 850,000 Bitcoins (BTC) were stolen, and Coincheck was hacked and caused a loss of US$500 million, which severely hit the market consumer confidence. In order to avoid such major losses from happening again, the Japanese government has since actively formulated regulations to protect consumers and investors in its crypto industry.
Since then, regulators have further required that cryptocurrency exchanges operating in Japan separate customers’ legal tender and crypto assets from the exchange’s own assets, entrust customer currencies to third-party Japanese banks or trust companies managed by trustees, with customers identified as beneficiaries. At least 95% of customer currencies must be stored in non-Internet-connected “cold wallets” and all Internet-connected currencies must be supported by crypto assets held in their own cold wallets that are owned through independent exchanges.
Thanks to its strict consumer protection regulations, Japan has been able to effectively mitigate the negative impact of the collapse of some of the world's most prominent cryptocurrency exchanges in recent years. The Chief Financial Technology Officer of the Financial Services Agency (FSA) of Japan once said that although the FTX exchange "faces a global bankruptcy crisis", all "Japanese customers' assets affected by FTX are likely to be compensated because they are protected."
2. The path of reform of Japan’s Web3 policy
Today, the Japanese Prime Minister Kishida's government believes that "Japan plays a unique role in the cryptocurrency industry" and emphasizes that Japan now has the opportunity to implement a "national strategy" to vigorously promote the development of an internationally competitive Web3 business environment and an international regulatory environment.
In January 2022, the Japanese government launched its "National Strategy" and the ruling Liberal Democratic Party established the Digital Society Promotion Headquarters. Since then, its Web3 project team has directly proposed legislative and regulatory reforms to the ruling party. Many of these reforms have been adopted.
1. Japan’s tax reform
The most basic component of the "national strategy" launched by Japan this time is to create "a development environment and tax system that is attractive to entrepreneurs and engineers" - to promote investment.
Currently, these tax reforms mainly focus on two parts of tax policies: corporate year-end tax and personal tax rates.
1. Corporate year-end tax. In theory, all crypto assets held by a company (if there is an active market for these assets) need to be valued at the market. In other words, regardless of whether these assets can be actively traded by the company or even whether they lose value during the year, the company holding these assets must pay taxes based on their fair market value, which can sometimes be as high as 35%. Therefore, in order to promote a "token financing-friendly environment" for companies, the Japanese Web3 policy team has also proposed two other reform policies.
First, the government exempts “tokens that are continuously held by the issuing company” and “the year-end market-to-market tax on corporate income tax.” Second, the government exempts “tokens issued by other companies, held by third parties, and not for short-term trading purposes.”
The first reform is due to take effect in June 2023. The second reform was proposed by the FSA to Japan’s 2024 legislative agenda and approved by METI. The adoption of these two measures could ease the long-standing disadvantage that domestic corporate investors in Japan have been at compared to overseas investors who can rely on more favorable tax treatment.
2. Personal tax rate. Currently, income from crypto asset transactions is taxed as "miscellaneous income" in Japan, and when "income tax and resident tax" are combined, its "minimum tax rate is 55%." And this tax is levied "not only when the crypto assets held are converted into legal tender," but also "when they are converted into other crypto assets." This tax system is more severe than most other countries, resulting in a large outflow of taxpayers or obstacles to taxpayers filing taxes, so the Web3 policy team proposed four reforms.
First, impose a flat 20% tax on crypto asset transactions. Second, tax “gains and losses” only when converted to fiat currency, thereby exempting “crypto asset exchanges” from tax. Third, allow individuals to carry forward losses for up to three years. Fourth, apply the same tax rate to “crypto asset derivative transactions.”
Although Japan’s Digital Society Promotion Headquarters made emergency proposals in November 2022, these reforms were excluded from the 2023 agenda and it is unclear whether these proposals will become part of the 2024 legislative agenda1.
2. Stablecoin Regulatory Framework
Another pillar of Japan’s “national strategy” is to promote the issuance and circulation of permissionless stablecoins. As of this year, “the market value of stablecoins totals $129.5 billion.” Creating a market environment where stablecoins “can be used safely and publicly” is necessary to influence and occupy part of the market and promote digital asset transactions and other Web3 industries.
In June 2022, Japan became one of the first major economies in the world to provide a regulatory framework for stablecoins. Japan's newly revised Payment Services Act defines stablecoins as "electronic payment instruments" and establishes a new regulated "electronic payment instrument intermediary" business category. The amendment will take effect on June 1, 2023.
Under the bill, trust companies and money transfer operators are authorized to issue and trade stablecoins in accordance with existing capital maintenance requirements. This enables them to enter the "1 trillion yen per year" corporate payment settlement market. Four of the major banks and digital lenders have already planned to issue their own stablecoins, including Mitsubishi UFJ Financial Group (MUFG), which is preparing to issue Progmat Coin pegged to the yen. In addition, other traditional companies that previously "seldom involved in crypto assets" are also making major investments in the Web3 field.
3. Non-fungible tokens (NFT)
In April 2022, the Web3 Policy Team (then called the NFT Policy Project Team) released the team’s first white paper, outlining a “national strategy for developing the (Japanese) digital economy in the Web3 era,” which included “NFT,” the starting point for Japan’s “national strategy” for digital assets.
Japan believes that NFT is a catalyst for the "digital economy in the Web 3 era". So far, the NFT market has grown from "40 billion yen in 2020" to "more than 4.7 trillion yen in 2021". 2 Japan has rich and high-quality intellectual property rights. It believes that animation and games are internationally competitive, which gives Japan great potential to lead the world in the field of NFT and even WEB3.
In order to take advantage of the growth of its intellectual property and NFT markets, Japan has been looking to promote the development of the Japanese NFT industry. One of the measures it has taken is to relax the regulation of some NFTs as crypto assets.
But NFT businesses and content creators still "face significant obstacles." Because on the one hand, regulatory ambiguity has made companies rush to adopt the popular NFT model, which is a combination of "random sales model of NFT" and "secondary circulation market", which is common in fantasy sports in the United States and Europe. Companies are worried that this may violate Japan's anti-gambling laws, and these laws also make it unclear whether Japanese companies can legally license their intellectual property for overseas NFT business. The inability of Japanese companies to enter the market has raised concerns about other companies "free riding" and their valuable intellectual property.
In addition to protecting the rights of content holders and safeguarding their data, clarifying and updating these legal barriers is necessary for the “further development of Japan’s content industry in the Web3 era.”
(IV) Investment
Another aspect of Japan’s “national strategy” is to reform existing corporate forms to promote investment in “public and private funds in blockchain-related businesses.” Globally, Web3 startups “raised $15.1 billion” in 2022, a 15-fold increase from 2018. Japan believes that it can capitalize on this momentum and encourage investors to “gather in Japan” if it “establishes an appropriate legal and tax framework”3.
Part of establishing an appropriate legal framework is opening up new financing channels for partnerships through digital assets and recognizing a new form of company based on Web3 technologies: Decentralized Autonomous Organizations (DAOs).
Currently, Japan restricts investment business limited partnerships to raising capital only through traditional means (stocks, stock options, and security tokens). These partnerships are also required to invest more than half of their capital domestically, and Japan's Ministry of Economy, Trade and Industry is considering removing both restrictions in 2024. This would allow startups to raise funds through the sale of digital assets and provide more investment opportunities to maximize capital growth, allowing for more reinvestment in domestic startups.
Another impetus is the recognition of DAOs. DAOs are entities that operate by granting governance voting capabilities to owners through security tokens. This makes membership and operation fluid and fast. However, currently “there is no clear legal framework for DAOs to ensure limited liability for their members”, pushing for a corporate form that is flexible enough for them to operate. Even the limited liability company model has certain rules, such as requiring the LLC to list all members and their personal information in the articles of incorporation, which creates an unbearable administrative burden. While the Web3 policy team has often suggested reforms in this area, it is unclear when such reforms will take place. However, the Ministry of Digital has created its own DAO to promote research.
5. International Leadership
While the National Strategy focuses on Japan’s domestic development, a key goal has always been to gain international leadership in this area.
From a regional perspective, Japan has begun to emerge as one of the leaders in the digital market. In May 2023, Prime Minister Kishida launched the Digital Innovation Center at the Economic Research Institute for ASEAN and East Asia. He also highlighted the regional cross-border payment system developed in collaboration with Japanese startups and the National Bank of Cambodia, called the “Bakong System,” which connects cross-border payments across the region by using Cambodia’s CBDC and stablecoins.
Globally, Japan holds the 2023 G7 presidency and seeks to use its presidency to “play an active leadership role” in the field. In particular, it seeks to highlight its history of strong “consumer and investor protection,” establish harmonization of private international law on the transfer of data and digital assets, and promote the adoption of a “travel rule” for digital assets to combat money laundering and terrorism.
Japan has made the most of its G7 presidency, and other members appear to agree with Japan’s “national strategy” talking points. G7 leaders agreed that regulation and oversight are essential to address the risks posed by crypto-asset activities and avoid regulatory arbitrage while supporting responsible innovation. Central bank governors agreed that “a reliable, stable and transparent global payment system is a key foundation for their economies” and that Web3 technologies such as CBDCs and stablecoins can “play a significant role.” Digital and technology ministers agreed to “Japan’s vision for Society 5.0” and proposals to develop “an innovative and competitive digital ecosystem.”
3. Japan’s Expectations for New Web3 Policies
Japanese lawmakers Masaaki Taira and Hideto Kawasaki said in an interview with CoinDesk Japan on January 24, 2024 that they hope to develop a formal Web3 policy for Japan.
The country has been looking for different ways to regulate Web3, and in April 2023, the Liberal Democratic Party Web3 Project Team (Web3PT) released a white paper calling for the use of blockchain technology to develop various Web3 projects.
At the end of 2023, Japan also held a decentralized autonomous organization (DAO) rule-making hackathon, where stakeholders could express their expectations of policymakers. "Through the hackathon, both short-term issues and medium- and long-term issues became clear," added Kawasaki, who is also the executive director of Web3PT.
Another area of concern is the need for more clarity on DAOs and whether a company needs to implement smart contracts to be classified as a DAO, something Web3PT chair Taira believes will narrow over time.
Kawaski also said: “The next step will be to clearly reflect this in the next white paper.” He added that they need to develop regulations for DAOs, “In addition, we hope to grasp the current situation in areas other than DAOs and identify new policy points within Web3PT.”
IV. Other Regulations and Regulatory Policies
(I) Cryptocurrency exchange services
The Crypto-Assets Regulation came into force on April 1, 2017. The PSA was amended to introduce a registration requirement for “crypto-asset trading service providers”. In June 2019, the PSA was further amended to strengthen customer protection by introducing stricter regulations applicable to crypto-assets, and the amended PSA came into force on May 1, 2020.
For purposes of the PSA, “crypto-assets” are defined as:
Proprietary value may be used to pay to an unspecified person the price of any goods purchased or borrowed or any services rendered, where the proprietary value may be (a) sold to or purchased from an unspecified person, provided that such sales and purchases are recorded on an electronic device or other device by electronic means, and (b) transmitted through an electronic data processing system;
Alternatively, the proprietary value specified in the preceding paragraph may be exchanged with unspecified persons, and the proprietary value may be transferred through an electronic data processing system.
Most so-called payment tokens and utility tokens fall within the definition of crypto assets.
Crypto-asset exchange services (“CAES”) are defined as including any of the following activities carried out as a business:
Sell/buy crypto assets or exchange them for other crypto assets;
i. Providing intermediary, agency or entrustment services for the listed activities, or managing user funds related to the activities listed in i.
ii. or manage crypto assets for the benefit of others.
According to this definition, not only typical crypto asset exchanges, but also so-called over-the-counter ("OTC") brokers are regulated by the PSA as CAES providers. In addition, most initial coin offerings ("ICOs") or token sales fall within the definition of CAES. Therefore, as a general rule, if the token sale (i.e., ICO) is targeted at residents of Japan, the token issuer must register as a CAES provider. Notwithstanding the above, if the issuer has fully outsourced its token issuance to a reliable ICO platform provider that is registered as a CAES provider, the token issuer does not need to register as a CAES provider.
It is worth noting that under the 2019 revision of the PSA, managing a client’s crypto assets and transferring such crypto assets to an address specified by the client constitutes CAES, as “managing crypto assets for the benefit of others” has been included. Therefore, if a custodial wallet service provider provides wallet services to Japanese residents, it must register as a CAES provider.
CAES providers must manage their clients’ funds separately from their own funds and entrust their clients’ funds to a trust company or any other similar entity. CAES providers should manage their clients’ crypto assets (“trusted CA”) separately from their own crypto assets. In addition, CAES providers are also required to manage 95% or more of the total value of the entrusted CA through fully offline wallets or other technical measures with the same security level as fully offline wallets.
2. Cryptoasset derivatives
The revised Financial Instruments and Exchange Act (“FIEA”), which came into effect on May 1, 2020, contains specific provisions for crypto-asset derivatives. By including “crypto-assets” and crypto-asset standardized instruments created by financial instrument exchanges in the definition of financial instruments, and crypto-asset prices, interest rates, etc. in the definition of financial indicators, crypto-asset derivative transactions are now subject to the provisions of the FIEA, regardless of the type of derivative transaction involved. For example, providing over-the-counter crypto-asset derivative transactions or acting as an intermediary or broker in related transactions constitutes a Category 1 financial instrument business under the revised Foreign Investment Act. Therefore, companies engaged in these transactions need to register as Category 1 Financial Instrument Business Operators (“Category 1 FIBOs”).
In addition to the various conduct rules applicable to Category 1 FIBOs that provide crypto-asset derivatives services under the FIEA, it is noteworthy that the revised FIEA introduces strict leverage ratio requirements. If a Category 1 FIBO engages in crypto-asset derivatives trading, the margin amount deposited by the client must be: (i) if the client is an individual, not less than 50% of the amount of the crypto-asset derivatives transaction (i.e. the leverage ratio is limited to two times); (ii) if the client is a company, not less than 50% of the amount of the crypto-asset derivatives transaction or a crypto-asset risk exposure ratio based on historical crypto-asset volatility as specified in the announcement published by the FSA entitled "Establishing a method for calculating the crypto-asset risk exposure ratio in leveraged crypto-asset trading".
3. Digital Securities
The FIEA conventionally divides securities into: (i) traditional securities such as shares and bonds (“Section 1 securities”); and (ii) contractual rights such as interests in trust beneficiaries and interests in collective investment schemes (“Section 2 securities”).
Due to their higher liquidity, Section 1 securities are subject to relatively strict requirements in terms of disclosure and licensing/registration, while Section 2 securities are subject to relatively loose requirements in terms of disclosure and licensing/registration due to their lower liquidity. However, if securities are issued using an electronic data processing system such as blockchain, it is expected that such securities may have higher liquidity than securities issued using traditional methods, regardless of whether they are Section 1 or Section 2 securities. Therefore, the revised FIEA introduces a new regulatory framework for securities that can be transferred using an electronic data processing system. Under the revised FIEA, securities that can be transferred through an electronic data processing system are classified into the following three categories:
Section 1 securities, such as shares and bonds that are transferable through an electronic data processing system (tokenized Section 1 securities).
Contractual rights such as interests in trust beneficiaries and interests in collective investment schemes, which are generally classified as Section 2 securities, are transferable through electronic data processing systems (electronically recorded transferable rights (“ERTRs”)).
Contractual rights such as interests in trust beneficiaries and interests in collective investment schemes are generally classified as Section 2 securities and are transferable through electronic data processing systems, but their negotiability is subject to certain restrictions (non-ERTR tokenized Section 2 securities).
In principle, issuers of tokenized Section 1 securities or ERTRs must file a securities registration statement like traditional Section 1 securities before conducting a public or secondary offering. Any person engaged in the business of selling, buying, or dealing in the issuance of tokenized Section 1 securities or ERTRs must register as a Type I FIBO. Given the greater freedom in designing tokenized Section 1 securities or ERTRs, as well as the higher liquidity of these securities, Type 1 FIBOs dealing with these digital securities are needed to control the risks associated with digital networks.
(IV) Electronic payment intermediary services
On June 1, 2018, amendments to the Banking Act came into effect to regulate electronic payment intermediary service providers to promote open APIs. The definition of electronic payment intermediary service providers is broad and includes intermediaries between financial institutions and customers, such as entities that use information technology to communicate payment instructions to banks based on customer entrustment, or entities that use information technology to provide customers with information about their financial accounts. Entities that provide financial account aggregation services are also classified as electronic payment intermediary service providers. They must register with the FSA to provide these services.
The following are the main regulations applicable to registered electronic payment intermediary service providers:
Electronic payment intermediary service providers who intend to carry out services that constitute electronic payment intermediary business must, in principle, disclose certain matters in advance. Such matters include the name or address of the business, authority, compensation, and contact information of the office that handles complaints.
For electronic payment intermediation services, electronic payment intermediation service providers must (a) provide information to prevent misunderstandings; (b) ensure the correct handling of user information; (c) maintain security management measures; and (d) take measures to manage outsourced contractors.
Before an electronic payment intermediary service provider provides electronic payment intermediary services, it shall sign an electronic payment intermediary service contract with a bank.
The contract must clearly specify (a) the allocation of liability for compensation in the event of damage to the user; (b) measures for the proper handling of user information; and (c) security management measures. Banks and electronic payment intermediary service providers must promptly disclose the above items (a) to (c) when signing a contract.
(V) Financial services intermediary business
In June 2020, the Financial Instruments Sales, etc. Act was amended to establish an industry suitable for financial services intermediaries, which seek to provide a convenient one-stop service that allows users to obtain a variety of financial services. The amendment came into effect in November 2021, and the name of the Act was changed to the Financial Services Provision Act.
Under Japan’s previous regulatory framework, financial intermediary services were divided by “function”, such as banking agents and electronic payment service providers under the Banking Act, financial instrument intermediary service providers under the FIEA, and insurance agents and insurance brokers under the Insurance Act. Therefore, operators who handle products and services across multiple “functions” will need to apply for multiple licenses.
Under the new framework, operators will be allowed to act as intermediaries in cross-sector financial services by re-registering as “Financial Services Intermediary Business Operators” (“FSIBOs”).
at last
Japan's WEB3 regulatory policy will continue to be updated and implemented in the next few years, and the government will propose new reforms and track progress. Japan is taking the future of the digital economy seriously, but as the head of the Japanese Digital Agency said, their work has just begun.