South Korea is one of the most active countries in the world in the field of cryptocurrency and blockchain. It has a large and vibrant crypto community with millions of users, investors and traders, as well as hundreds of startups, exchanges and service providers. South Korea is also at the forefront of the world in terms of cryptocurrency adoption and trading.
However, like other regions, South Korea also faces many challenges and risks in the field of cryptocurrency, such as hacking, fraud, money laundering, tax evasion and market manipulation. These issues have prompted the South Korean government and regulators to take more active and strict cryptocurrency regulatory measures to protect users, the industry and society from potential harm.
In March 2023, the National Assembly passed the Virtual Asset User Protection Act, marking an important step for the government to establish a legal framework for crypto assets. The bill defines virtual assets as digital assets that can be traded or transferred electronically, and sets out the basic rights and obligations of users and service providers. The bill also gives the Financial Services Commission (FSC), South Korea's main financial regulator, the power to supervise and regulate the cryptocurrency industry and issue detailed implementation rules and guidelines. The Financial Supervisory Service (FSC) has been working on drafting and proposing various rules and regulations to supplement the bill and address specific issues and emerging issues in the cryptocurrency field.
However, due to the obvious differences between cryptocurrencies and traditional assets in terms of issuance and market structure, existing regulations such as the Electronic Financial Transactions Act and the Capital Markets Act have shown their limitations in comprehensively regulating the cryptocurrency crisis. In particular, the decoupling of UST and the bankruptcy of FTX in 2022 have caused great damage to the global crypto industry and increased calls for regulators to establish a safe and reliable system that is not limited to specific countries. Therefore, the United States, the European Union, Japan and other countries have also recently accelerated the formulation of cryptocurrency-related regulations to strengthen investor protection.
In South Korea, the regulatory framework for virtual assets began to take shape in 2021, and its outline became more apparent in the following years. Currently, there are three key regulations related to virtual assets in South Korea: Security Token Guidelines, Mandatory Declaration of Virtual Assets by Senior Officials, and Virtual Asset User Protection Act (Virtual Asset Act).
This article aims to explore the trend of WEB3 regulation in South Korea by introducing the legislative background, legislative content, and the current status of the above three regulations.
1. Security Token Guide
On February 5, 2023, the Financial Services Commission (FSC) issued guidelines to regulate the issuance and circulation of security tokens, with the goal of implementation by the second half of 2024.
1. Background
As information and communication technology advances, more and more people in South Korea have emphasized the need to prevent existing regulations from hindering the development of emerging financial industries such as fintech and blockchain. In response, the Financial Services Commission of South Korea began implementing a financial regulatory sandbox system in April 2019 under the Special Act on Supporting Financial Innovation.
2. Content
(1) Definition
Security tokens are defined as “digitized securities that use distributed ledger technology in accordance with the Capital Markets Act.” This analogy compares securities to food and the form in which they are issued to containers, emphasizing that despite the new “container” or token form, the essence of the security remains the same.2 Therefore, in addition to physical securities recorded on certificates and electronic securities registered in centralized accounts, security tokens recorded on distributed ledgers will also be regulated under the Capital Markets Act.
(2) Primary Market
A noteworthy aspect of the primary market for security tokens is the introduction of “issuer account managers” that can handle both the issuance and registration of securities. Under current law, when an issuer issues securities, an account manager such as a securities firm or bank registers them with a depository institution. However, for tokenized securities, the issuer account manager can perform both issuance and registration at the same time, eliminating the intermediate step and aiming to simplify the securities issuance process.
To become an Issuer Account Manager, one must meet the criteria set by the FSC. Issuers that do not meet these criteria will follow the traditional securities issuance structure, where they are solely responsible for the issuance and complete the registration through an Account Manager.
(3) Secondary Market
The secondary market can be divided into the on-exchange market and the OTC (over-the-counter) market.
On-Exchange: Introducing a digital securities market on the Korea Exchange (KRX) for trading unconventional securities.
OTC: Establish OTC brokers to allow retail investors to conduct multilateral over-the-counter transactions.
Of particular note, the Financial Services Commission announced plans to differentiate the authorization requirements for becoming an over-the-counter (OTC) intermediary based on the type of security. This includes exemptions from sales disclosure and market oversight, effectively encouraging new entrants to invest on a small scale. The move demonstrates a proactive approach to revitalizing trading in unconventional securities, which previously fell outside the scope of existing distribution systems and market regulation.
3. Current Status
At the “Public Hearing on the Legislation of the Electronic Securities and Capital Markets Act” held on July 13, People’s Power Party Representative Chang-Hyun Yoon revealed the regulatory amendments for security tokens. The amendments were proposed on July 28 and are scheduled to be reviewed by the Government Committee and the Legal Affairs Committee and finalized after a vote at the plenary session of the National Assembly. However, since it has not yet been officially enacted, the details may change after further discussion. The current amendments were submitted to the Political Affairs Committee on November 15 and have passed the bill subcommittee.
In order to formally legalize the security token guidelines, substantial amendments to the Electronic Securities Act and the Capital Markets Act are required. These two laws are being widely discussed in the industry to promote the rapid and safe growth of the security token industry in South Korea.
The key to the amendment to the Electronic Securities Law is to recognize blockchain electronic registration as an input method for official ledgers, giving it the same presumption of ownership transfer as centralized electronic registration. Therefore, defining the scope of securities that can be registered using distributed ledgers, the specific requirements for distributed ledgers as an entry method, and the management of personal information recorded on distributed ledgers are considered urgent tasks.
The amendments to the Capital Markets Act aim to expand investor choice by allowing the circulation of unconventional securities, which was previously not possible due to investor protection issues. As a result, issues such as the licensing requirements for OTC brokers, the way they operate, and the investment limits for general investors are being actively discussed.
With the guidelines released in February and the proposed amendments in July, expectations for the Korean security token market are growing. The Korean securities industry is forming various security token alliances to gain a first-mover advantage. These alliances are voluntary organizations composed of securities companies, banks, and innovative financial services (sandboxes) that aim to create a security token ecosystem by specializing in areas such as customer fund management and trading platform support.
KRX has also applied to designate the on-exchange market for security tokens as an FSC sandbox. Il-Chan Ahn, head of digital business at the Korea Exchange, expects that for listed security tokens worth more than 3 billion won, investors will be able to trade them freely through securities companies without the need for separate dedicated accounts, just like existing stocks. However, even after the on-exchange market is established, it will take about six months from the start of trading to the start of trading, as it needs to go through the same process as the current listed securities market, including preliminary review, filing securities reports, public listing, offering procedures, etc.
2. Mandatory declaration of virtual assets by senior officials
The bill, called the "Senior Officials Virtual Assets Mandatory Declaration Act" (informally known as the "Jinnangujin Prevention Act"), was passed by Congress on May 25, 2023 and took effect on December 14 of the same year. As a result, senior officials are now obliged to report any virtual assets held by themselves, their spouses, and immediate family members.
1. Background
On May 4, 2023, attention to the legislation intensified after reports surfaced that Rep. Kim Nam-guk (a former Democratic Party lawmaker) held 6 billion won worth of WEMIX in his personal virtual asset wallet. The subsequent review of the unclear source of funds and transaction flow led to Kim being referred to the National Assembly Ethics Committee under the Conflict of Interest Prevention Act. It was revealed that Rep. Kim had more assets than he had previously declared. This incident sparked public demands for transparent reporting of virtual assets by senior officials, ultimately leading to the passage of the bill.
2. Content
Under the revised Public Service Ethics Act, all members of the 21st Congress must voluntarily report the status of virtual assets acquired and held between the start of their term (May 30, 2020) and May 31, 2023, including the services used in their names and transaction details. This includes transaction dates, purchase prices, sales prices, transaction costs, and counterparties. The Anti-Corruption and Civil Rights Commission (ACRC) will oversee this process in collaboration with relevant departments such as the FSC and KRX, as well as virtual asset exchanges, to ensure the completeness of officials’ asset declarations.
3. Current Status
The registration period for the status and changes of virtual assets held by senior officials starts on June 15, 2023 and ends on June 30. According to the meeting of the National Assembly Ethics Advisory Committee on July 21, among the 299 members who submitted detailed information, 11 people including Nam-Kuk Kim have a history of holding virtual assets. However, these reports will initially be limited to assets owned by individuals, and from 2024, virtual assets held by immediate family members and spouses will be mandatory.
The Jin Nanguo incident raised awareness and accelerated the legislation of the Public Service Ethics Act. As a result, the number of suspicious transaction reports submitted by virtual asset exchanges has increased. Under the current Act on Reporting and Using Specific Financial Transaction Information, exchanges must report suspicious transactions to the FSC Financial Intelligence Unit (FIU). As of September 2023, the number of such reports for the entire year has exceeded the total for 2022, indicating an increase after the implementation of the revised bill.
3. Virtual Asset User Protection Law
On June 30, 2023, the Virtual Asset User Protection Act (Virtual Asset Act) was passed by the National Assembly and is expected to be implemented in July 2024. The Act was introduced to address the limitations of managing virtual assets solely under the provisions of the Electronic Financial Transactions Act and the Capital Markets Act. In response to these limitations, especially after the Terra incident in 2022 highlighted the challenges in preventing unfair trading practices, the Yin government listed the construction of digital asset infrastructure and regulatory systems as one of the 120 national tasks in July 2022.
1. Background
Since the current Electronic Financial Transactions Act and Capital Markets Act are not sufficient to comprehensively manage virtual assets, the South Korean government has introduced a reporting system for virtual asset service providers and various anti-money laundering and investor protection regulatory measures. In March 2021, the amendment to the Specific Financial Transaction Information Reporting and Use Act was passed. However, this amendment is mainly aimed at anti-money laundering and faces difficulties in preventing unfair trading practices, a fact highlighted by the Terra incident in 2022.
Therefore, in July 2022, the Yin government listed "35. Establish a digital asset infrastructure and regulatory framework (Financial Services Commission)" as one of the 120 national tasks, and announced the formulation of the "Digital Asset Basic Law (now the Virtual Asset Law)" specifically for virtual assets.
South Korea's ruling and opposition parties agreed to actively establish the minimum necessary regulatory framework for virtual assets and then gradually refine the details. The promulgation of the Virtual Assets Act is the first stage of this regulatory policy, focusing on the most pressing aspects: investor protection and the supervision of unfair trading practices between various sectors of the virtual asset industry.
2. Content
The Virtual Asset Act defines virtual assets and virtual asset service providers in a similar way to the Specified Financial Transaction Information Reporting and Use Act, but excludes the central bank digital currency (CBDC) issued by the Bank of Korea from the virtual asset category.
Virtual assets: transferable electronic certificates with economic value, excluding game coins, electronic currency, electronic registered stocks, etc.
Virtual asset service providers: operators of virtual asset transactions, custody, wallet services, etc.
The first phase of the law focuses on protecting the assets of virtual asset users, regulating unfair transactions, and strengthening the supervisory powers of financial regulators.
(1) Protecting User Assets
The law introduces specific regulations not found in the Specified Financial Transaction Information Reporting and Use Act, such as detailed methods and measures to ensure the safety of virtual assets held. Virtual asset service providers must separate funds deposited by users from their own funds and maintain them with reputable institutions such as banks or trusts. In addition, they must hold virtual assets of the same type and amount as deposited funds. Service providers are also required to store a certain percentage of deposits in cold wallets that are disconnected from the internet to protect users' assets from hacker risks. They must also purchase insurance or reserves to deal with events such as hacker attacks or system failures, and keep transaction records for 15 years after the transaction is completed.
(2) Supervision of unfair trade practices
The first phase of the Virtual Assets Law includes and regulates the following five unfair trading practices:
Use of non-public information: Trading activities using information that has a significant impact on investment decisions before it is disclosed to the public are prohibited.
Market Manipulation: All forms of transaction-based market manipulation are prohibited, including order matching, manipulated trading, and actual trading.
Fraudulent and Deceptive Transactions: Transactions involving false entry of material details, false pricing, or use of dishonest means are prohibited.
Trading of virtual assets issued by itself or its affiliates: Learning from the lessons of events such as FTX, trading of virtual assets issued by itself or its affiliates is prohibited, with certain exceptions.
Arbitrary blocking of deposits and withdrawals: Unjustified blocking of deposits and withdrawals is prohibited, and any unavoidable reasons must be promptly notified to users and reported to the Financial Services Commission.
* Specific exceptions: Virtual assets issued as a means of payment for specific goods or services, where a virtual asset service provider provides the promised specific goods or services to users and receives virtual assets in return (Article 10, paragraph 5, clause 1). 4
In addition, virtual asset exchanges and other market operators must monitor and report any unusual transactions that indicate unusual changes in asset prices or trading volumes to protect users. Therefore, by July 2024, exchanges must develop systems to monitor these transactions and have the resources necessary to perform the relevant tasks.
(3) Increased regulatory power
The bill also clarifies and strengthens the supervisory powers of financial regulators, prevents unfair practices, and lays the foundation for smooth law enforcement. The FSC now has the power to require virtual asset service providers to provide various documents, statements, and witnesses to appear in court when necessary. The new regulations also allow for recommendations for dismissal, suspension, or suspension of service for service provider employees who violate these regulations.
In addition, sanctions for engaging in prohibited conduct have been significantly increased. Criminal penalties include at least one year's imprisonment or a fine of three to five times the profit gained from the violation. In addition, administrative fines equal to twice the avoided losses have been introduced, and class actions for damages have been provided for.
3. Current Status
On December 11, the FSC issued a legislative notice on the implementation order and regulatory provisions for the first phase of the Virtual Assets Law, detailing the content of the first phase of the Virtual Assets Law to be implemented on July 19, 2024. The implementation order is significant because it specifies the content of the first phase of the Virtual Assets Law in detail. The current Virtual Assets Law lacks regulatory guidelines.
The implementing order of the Virtual Assets Act includes additional exclusions for virtual assets, stipulates the ratio of cold wallet storage, and defines undisclosed information, directly affecting virtual asset service providers and investors.
In particular, the "Administrative Measures for User Deposit Management Institutions" stipulate that only banks can manage user deposits. It also further requires virtual asset service providers to hold virtual assets of substantially the same type and amount as deposits, making it almost impossible for third parties to manage or operate custody and operation businesses in South Korea.
The Financial Supervisory Service (FSS) announced the establishment of a specialized agency for virtual assets, which means that the reporting and inspection process for virtual asset service providers will be strengthened. The digital asset research team responsible for legislative support and market monitoring will be divided into the "Virtual Asset Supervision Bureau" and the "Virtual Asset Investigation Bureau". The Supervision Bureau is a comprehensive department that manages and supervises service providers, and the Investigation Bureau is responsible for investigating unfair trading practices. The purpose is to prevent money laundering through virtual assets, strengthen user protection, and strictly restructure the review process of existing virtual asset service providers.
IV. Travel Rules
1. Background and content
The Travel Rule originally referred to the requirement that financial institutions must record remittance information in the format required by the Society for Worldwide Interbank Financial Telecommunication (SWIFT) when making international transfers. However, as virtual assets have increasingly become a global money laundering issue, the Financial Action Task Force (FATF) proposed in 2019 to expand the scope of the Travel Rule to virtual assets, urging countries around the world to apply it to their virtual asset service providers.
South Korea became the first country to implement the travel rule in virtual asset transactions on March 25, 2022, under the Act on Reporting and Using Specified Financial Transaction Information. The regulation stipulates that when a virtual asset service provider transfers virtual assets worth more than 1 million won, the sending service provider must provide and store relevant information to the recipient.
However, the current transfer rules only apply to transfers between domestic virtual asset service providers. The four major Korean exchanges (Upbit, Bithumb, Coinone, Korbit) are using solutions such as VerifyVASP (Upbit) and Code (Bithumb, Coinone, Korbit) to comply with the rules. However, transfers between domestic exchanges and foreign exchanges or personal wallets are not covered by the regulations. Therefore, exchanges are following the FSC's guidelines and adopting a whitelist approach on their own. 5
2. 2024 Travel Rules
On June 27, FATF released a report titled "Virtual Assets: Targeted Updates on the Implementation of FATF Standards on Virtual Assets and Virtual Asset Service Providers", announcing a roadmap for continued monitoring of criminal activities related to DeFi and private wallets as part of FATF. In addition, the EU's regulation of virtual assets, MiCA (Market for Crypto Assets), has been regulating personal wallets since June 2022, regardless of whether the transfer is domestic or international.
As South Korea is the first country in the world to implement the travel rule, the current Act on Reporting and Use of Specified Financial Transaction Information does not reflect the FATF travel rule revision recommendations. This has led to identified issues such as the rule’s limited applicability to domestic exchanges and lack of consistency with international regulations, which limits transaction transparency. There are calls for continuous revisions to the travel rule in line with international trends, especially as the virtual asset industry is not restricted by national borders and the “sunrise problem” (regulatory differences between countries) is more pronounced. By 2024, there is a growing need to expand the scope of regulation to include not only transfers between exchanges but also personal wallets, and the industry is stepping up its efforts to respond to this demand.
For example, on November 29, multi-chain infrastructure provider PiLab (Bifrost operator), the Korea Information Certificate Authority (KICA), and Travel Rule solution provider CODE signed a memorandum of understanding to develop and deploy Web3 KYC services. Bifrost has been working with KICA to develop personal wallet KYC solutions since October 2022, and plans to expand the scope of Travel Rule KYC applications currently conducted by virtual asset service providers to personal wallets.
5. Final
In 2023, the Korean virtual asset industry laid the foundation for the flexibility of the capital market by implementing the guidelines for security tokens, established trust and integrity in the market through mandatory reporting of virtual assets by senior officials, and prepared a solid foundation. The promulgation of the Virtual Assets Act laid the foundation for the industry to become a legal sector and aims to strengthen investor protection. In addition, plans for virtual asset-related accounting standards were introduced to address accounting uncertainties faced by companies holding virtual assets.
Since 2022, there has been a growing awareness of the need for comprehensive national regulation of virtual assets, and 2023 is the year to lay the foundation for such regulation. It is expected that these basic measures will be fully implemented in 2024. In South Korea in particular, regulation has received more attention due to the planned implementation of key legislative developments, especially the first phase of the Virtual Assets Act and the revision of security tokens. The latter is particularly significant, as it is expected to provide a channel for traditional financial institutions such as brokerages and banks to enter the virtual asset industry, marking a major integration of traditional finance and the emerging virtual asset sector.
The new rules proposed by the Financial Services Commission are a positive and necessary step for the cryptocurrency industry and society in South Korea, as they aim to provide a more robust and comprehensive regulatory framework that balances the interests and needs of users, service providers, and regulators. The new rules will also enhance the credibility and legitimacy of the cryptocurrency industry and promote its development and innovation by aligning with global standards and trends.
However, the general public is still generally on the sidelines, and many industry insiders also believe that the new rules are indeed not perfect enough, because they still leave some gaps and uncertainties in the crypto field, especially in emerging formats such as NFT, DeFi and metaverse. These aspects need more attention and research because they have the potential to change and subvert various fields such as culture, entertainment, education, healthcare and governance.
