Japan was the first country to establish a regulatory framework for crypto assets (“Crypto Assets”). Perhaps because of this head start, adoption of blockchain technology is now fairly prevalent in the Japanese financial industry. (As of August 31, 2024, there are 29 licensed Crypto Asset exchange service providers (“CAESPs”) in Japan). Recently, a bill for amending the Payment Services Act (the “PSA”) was passed by the Diet and promulgated in June 2022, with the aim of introducing new regulations on stable coins. The amendments entered into force on June 1, 2023.

Since 2020, security tokens, sometimes referred to as digital securities, have been in the spotlight. As a result of recent amendments to the relevant laws and regulations, an increasing number of financial institutions are entering this new market, focusing mainly on digital corporate notes and tokenised equity interests in real estate funds. For instance, a subsidiary of Kenedix, one of the leading real estate companies in Japan, launched the first public offering of asset-backed security tokens in Japan in July 2021, and multiple similar projects thereafter.  Most of such asset-backed security tokens are based on a beneficiary certificate issuance trust scheme that utilises a blockchain platform. In addition, digital art and digital trading cards represented by non-fungible token (“NFTs”), which are non-replaceable digital tokens issued on a blockchain, have recently been traded for considerable amounts.  As a result, NFTs have garnered considerable attention in Japan.  NFTs are considered innovative because they involve the creation of unique, one-of-a-kind data based on blockchain technology, unlike other digital data that are inherently free and easy to copy.

Furthermore, on 16 February 2024, the ‘Bill for Partial Amendment of the Act on Strengthening Industrial Competitiveness and Other Acts to Create New Business and Encourage Investment in Industries’ was approved by the Cabinet and submitted to the Diet on the same day, with the aim of introducing measures to promote innovation and renewal by start-ups, and, in turn, encourage increased domestic investment¹. The proposals in the bill include amendments to the Act on Limited Partnership for Investment (the ‘LPS Act’). As a result, it is expected that a limited partnership for investment will be permitted to acquire and hold crypto assets in situations where the partnership itself issues crypto assets, or where it issues crypto assets through entrustment of crypto assets to a third party or through issuance jointly with a third party.

These developments demonstrate that the application of blockchain technology to business is moving from the stage of Proof of Concept (“PoC”) to the stage of practical application.

Footnote(s):

¹ https://www.meti.go.jp/english/press/2024/0216_003.html

No blockchain-specific regulatory framework currently exists in Japan, nor is such regulatory framework anticipated in the near future. Accordingly, blockchain or related businesses and services will be regulated under existing laws or regulations, depending on the legal characteristic of the token minted on a blockchain or the substance of such services.

For example:

1. if the tokens minted on a blockchain (“Blockchain-minted Tokens”) fall within the definition of “Crypto Asset” under the PSA, then a business operator who purchases or sells such tokens in the course of its business will be regulated as a CAESP;
2. a person who sells, purchases or handles the public offering of Blockchain-minted Tokens that fall within the definition of “securities” under the Financial Instruments and Exchange Act (the “FIEA”) must be registered as a Type I Financial Instruments Business Operator;
3. an issuer of Blockchain-minted Tokens that are pegged to fiat currencies (such as the JPY or USD) (i.e., stable coins), or an affiliate of such issuer who guarantees the redemption of such stable coins in fiat currencies may be required to undergo licensing as a Bank under the Banking Act, a fund remittance business operator (“FRBO”) under the PSA , or as a trust company under the Trust Business Act; ;
4. a business operator that handles the personal information of its users may be subject to the Act on the Protection of Personal Information (“APPI”); and
5. issuance of NFTs and provision of trading services in respect of NFTs are not subject to financial regulations.

The Japanese government takes a generally positive view of the use of blockchain technology in various kinds of businesses.

For instance, in June 2019, the Japanese government published an “Action Plan of the Growth Strategy”², which discussed the importance of the use of blockchain technology, stating that “AI, IoT, robots, big data, blockchain …are general purpose technology (GPT) that broadly affect all industries, similar to adoption of electric power from the 19th to 20th century and IT inroads through the end of the 20th century.”

In addition, in July 2020, the Japanese government published a “Follow-up for Growth Strategy”³, stating that “In a decentralized financial system based on blockchain technology, where there are no regulated intermediaries, the Japanese Government will lead the international discussion by actively contributing to the Blockchain Governance Initiative Network (BGIN) to achieve financial administrative objectives, such as financial system stability, user protection and prevention of money laundering, etc.”.

On June 18, 2021 the Japanese cabinet approved the “Growth Strategy (2021),” which includes facilitation of blockchain technology. The development of an eco-system surrounding NFTs and Security tokens is also specifically mentioned in the “Plans for Implementing Growth Strategy” paper published on the same date⁴.

Furthermore, it was stipulated in a paper entitled “Grand Design and Action Plan for a New Form of Capitalism 2023 Revised Version”, which was approved by the Cabinet in June 2023, that the Japanese government would foster the development of an environment for the promotion of web3, including the use of NFTs and decentralised autonomous organisations (DAOs) based on blockchain technology.

The web3 project team of the Digital Society Promotion Headquarters of the Liberal Democratic Party’s Policy Research Council also published the ‘web3 White Paper 2024’ on 21 May 2024, to address various issues related to the promotion of web3.

Footnote(s):

² https://www.kantei.go.jp/jp/singi/keizaisaisei/pdf/ap2019en.pdf

³ https://www.kantei.go.jp/jp/singi/keizaisaisei/pdf/fu2020.pdf

⁴ https://www.boj.or.jp/en/announcements/release_2021/rel210405b.pdf

The Bank of Japan (“BOJ”) commenced its PoC phase of a CBDC on April 5, 2021. The aim for phase 1 of the PoC was to develop a test environment for the CBDC system and conduct experiments on the basic functions that are central to the CBDC as a payment instrument, such as functions relating to issuance, distribution, and redemption. Phase 1 of the PoC ended in March 2022.

In “Proof-of-Concept Phase 2”, conducted from April 2022 to March 2023, the BOJ added several peripheral functions to the CBDC, in order to ascertain certain important processing performance and technical capabilities in respect of the CBDC ledger.  The BOJ also looked at the possibility of applying new technologies to data models and databases in respect of the CBDC.

Thereafter, since April 2023, the BOJ has been proceeding with a pilot program with the aim of evaluating certain technical aspects of CBDC that were not explored in the abovementioned PoCs, leveraging the expertise and insights of the private sector. The pilot program revolves around two pillars: “development of a system for the pilot program and experimentation” and the “CBDC Forum”. Under the former, performance tests are being conducted on the system developed by the BOJ, including desktop experimentation of various types on functions that have not been implemented in the system. Under the latter, the BOJ, in its capacity secretariat, holds practical discussions on a wide range of themes in respect of retail payments with the private sector.

The government of Japan has so far not decided whether to issue any CBDC in Japan, but discussions continue to be held in this regard.

One of the key issues under Japanese law in respect of cryptoassets is whether activities involving Decentralized Exchanges (“DEX”) constitute a Crypto Asset Exchange Service (“CAES”) as defined by the PSA. More specifically, the question is whether developers of DEX smart contracts, providers of user interfaces, and large holders of governance tokens are intermediating the buying or exchange of crypto assets. Based on a strict interpretation of the current provisions of the PSA, considerate is arguable that the actions of these participants do not constitute CAES.

However, the Financial Services Agency of Japan (“FSA”) has not publicly clarified its stance on this issue. Moreover, considering the perspective presented in IOSCO’s Final Report with Policy Recommendations for Decentralized Finance (“DeFi Recommendations”), which states that “Whether a person(s) or entity/entities is a Responsible Person(s) for regulatory purposes is based on whether, they in fact control or sufficiently influence the offer of financial products, provision of financial services, or engagement in financial activities, regardless of the form they use to organize and regardless how “decentralized” that organization is,” the FSA may conceivably adopt the view that the actions of DeFi participants constitute CAES.

Japanese anti-money laundering regulations are primarily found in the Act on Prevention of Transfer of Criminal Proceeds (“APTCP”). The APTCP sets forth requirements for identity verification and reporting of suspicious transactions, targeting specific business operators, including financial institutions and CAESPs. As CAESP is a concept under the PSA, whether the APTCP applies to CAESPs will depend on whether the actions of DeFi participants constitute CAES under the PSA.

Furthermore, considering that the FSA places importance on compliance with FATF standards, and that the FATF adopts a similar approach to the IOSCO’s DeFi Recommendations (cited under question 5 above) regarding the “Updated Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers”, it is possible that the FSA may adopt a similar interpretation and consider the actions of DeFi participants as constituting CAES.

In Japan, there is no particular distinction, for tax purposes, between Crypto Asset transactions using CAESP and those using DeFi.

Regarding income tax imposed on individuals, profits realised from the trading of Crypto Assets constitute “miscellaneous income” (zatsu-shotoku) for purposes of individual income tax assessment. The tax rate for miscellaneous income is progressive, ranging from 5% to 45% on profits.  In addition to this, 10% of such profits are payable to the local government as local inhabitant tax.

No consumption tax is payable on the sale or exchange of Crypto Assets.  However, consumption tax will be levied on lending fees and interest derived from Crypto Assets.

Furthermore, inheritance tax will be imposed on the estate of a deceased person in respect of the Crypto Assets held by such person.

In respect of corporate tax, corporations holding Crypto Assets with an active market (“Market Crypto Assets”) at the end of a fiscal year are, in principle, required to obtain a market valuation for such assets and include the difference between the market valuation and book value in their profit and loss accounts.  This year-end market valuation taxation on corporations applies to unrealised gains, regardless of the purpose for which the Crypto Assets are held.  This has been a significant burden on Crypto Asset-related businesses.

To a certain extent, tax reforms implemented in 2023 and 2024 for the purpose of relaxing the year-end valuation taxation have alleviated such a tax burden on corporations.  Under the tax reforms, Crypto Assets issued by a corporation that have been continuously held by that corporation itself since their issuance are excluded from market valuation taxation.  Additionally, Market Crypto Assets (other than self-issued Crypto Assets) that are subject to transfer restrictions or other conditions can be excluded from market valuation taxation.  “Crypto Assets subject to transfer restrictions or other conditions” refers to Crypto Assets:

(i) that are subject to specific transfer restrictions, such as technical specifications that prevent their transfer to others; and

(ii) the holders of which must notify or inform a CAESP that the aforementioned transfer restrictions are in place to enable information on such transfer restrictions to be published by the Japan Virtual and Crypto asset Exchange Association (“JVCEA”).

No.

According to the statistics published by the JVCEA, the total volume of Crypto Asset spot trading handled by CAESPs in Japan as of September 30, 2024, is approximately JPY 1434 billion⁵. The total volume of Crypto Asset margin trading handled by CAESPs is approximately JPY 1320 billion.

Footnote(s):

⁵ https://jvcea.or.jp/about/statistics/

The JVCEA, a self-regulatory organisation established under the PSA, has established its self-regulatory rules and guidelines regarding Initial Coin Offerings (“ICOs”) for Crypto Asset-type tokens entitled “Rules for Selling New Crypto Asset” (“ICO Rules”). Under the ICO Rules, an ICO can be legally launched in Japan as long as such launch is conducted in compliance with the ICO Rules.

According to the ICO Rules, there are two types of ICO. The first is where an CAESP issues new tokens and sells such tokens by itself. The second is where a token issuer delegates the sale of newly issued tokens to CAESPs.  As a general matter, the ICO Rules stipulates the following requirements for each type of ICO:

1. maintenance of a structure for the review of a business that raises funds via an ICO;
2. disclosure of information on the token, the token issuer’s purpose for the funds, and the like;
3. segregated management of funds (both fiat and Crypto Assets) raised by an ICO;
4. maintenance of proper accounting practices and records and financial disclosure of funds raised by an ICO;
5. ensuring the security of newly issued tokens, and of the blockchain, smart contracts, wallet tools, and the like in respect of such tokens; and
6. proper valuation of newly issued tokens.

Additionally, the ICO Rules (as well as the PSA) require an ICO to be implemented in compliance with the following steps:

1. the CAESP that will be handling the ICO token is required to assess both the feasibility of the ICO and the security of such ICO token;
2. the CAESP that will be handling the ICO token is required to prepare and submit  a report in respect of item (i) above to the JVCEA for review;
3. if the report is approved by the JVCEA, the Exchange Provider must submit a notification of change in handling Crypto Assets to the FSA; and
4. upon the FSA’s receipt of such notification, the CAESP will be permitted to make the ICO to Japanese residents.

The legal characteristics of Crypto Assets under the Civil Code of Japan is currently unclear. According to a judicial precedent of the Tokyo District Court dated August 5, 2015, legal ownership or title does not apply to Crypto Assets, as they are intangible assets. As a consequence, the transfer of a Crypto Asset does not equate to the transfer of legal ownership or title in such Crypto Asset under the Civil Code. Similarly, the grant of security over Crypto Assets would also be difficult.

However, a person who deposits Crypto Assets with an CAESP will have a claim against such CAESP for the return of the deposited Crypto Asset under the CAESP’s terms of service, or the like. In such cases, the creditors of the CAESP’s user may create a security over such users’ claim for Crypto Assets against the relevant CAESPs.

In the regulatory context, the amended Act on Prevention of Transfer of Criminal Proceeds, which came into effect on June 1, 2023, imposes the Travel Rule on the transfer of Crypto Assets and electronic payment instruments (i.e., stablecoins) (“EPI”). The Travel Rule is a system that requires CAESPs and EPI service providers (“EPIESP,” and together with CAESPs, “VASPs”), when transferring Crypto Assets or EPIs, to share certain information about originators and beneficiaries with the relevant beneficiary VASPs. This is to enable tracking of the transaction path of these assets for AML/CFT purposes, in compliance with FATF standards.

There is not clear definition of “smart contracts” under Japanese law, nor is there any specific regulation of smart contracts in Japan.

Assuming that smart contracts generally mean “self-executing contracts containing terms that are pre-determined pursuant to specific programming codes”, the use of smart contracts may raise issues of enforceability, although the costs of resolving such issues may be offset by the use of smart contracts.

For instance, a smart contract based on blockchain technology would be automatically enforced and irrevocable even if such contract is unenforceable for violating applicable law.

However, the automatic enforcement of smart contracts is only applicable where the subject of the contract are on-chain assets, such as Crypto Assets or Stablecoins. For purposes of enforcing rights against off-chain assets, a party would need to prove in court that the relevant smart contract had been validly concluded, as is the case with traditional paper contracts. Currently, there is no known judicial precedent in Japan that explores the issue of validity of smart contracts.

In April 2024, the Liberal Democratic Party, the ruling party in Japan, released a Web3 White Paper 2024, which included a summary of issues needing immediate resolution for the promotion of Web3, as well as proposals for accompanying legislative revisions.

These developments demonstrate that Japan has adopted the promotion of Web3, including NFTs and decentralised autonomous organisations (DAOs), as a national strategy.

In response to recommendations made in the Web3 White Paper, the Cabinet Office Order on Definitions under Article 2 of the Financial Instruments and Exchange Act was revised by the FSA to allow for the use of limited liability company-type DAOs.

As a result of the leakage of users’ Crypto Assets with a value of approximately USD 530 million from a cyber-attack on one of the biggest CAESPs in 2018, the FSA conducted sweeping on-site inspections on registered and provisional CAESPs. This was followed by the FSA’s announcement, on March 8, 2018, of the imposition of business suspension orders on two provisional exchanges, and business improvement orders on two registered exchanges and three provisional exchanges. After further review, the FSA on June 22, 2018, also imposed business improvement orders on six additional major registered exchanges.

In addition, on June 21, 2019, the FSA imposed a business improvement order on one of the Exchange Providers for the inadequacy of their business management, anti-money laundering and counter terrorist financing, and risk management systems, among other things.

However, on June 28, 2019, the FSA lifted the business improvement orders it had imposed on three companies, including one of the biggest CAESPs. In August 2020, the FSA also lifted a business improvement order it had imposed on another CAESP.

In November 2022, the FSA issued a business suspension order, a business improvement order, and an order for domestic retention of assets on FTX Japan KK, the Japanese subsidiary of FTX Trading Ltd., due to FTX Japan KK’s suspension of return of customer assets without clear explanation, and concerns over the creditworthiness of its parent company.

Further, on September 26, 2024, in response to the Bitcoin leakage incident that occurred at DMM Bitcoin on 31st May 2024, the FSA issued a business improvement order to DMM Bitcoin, including a specific analysis and investigation of the facts surrounding the leakage incident and the root cause thereof.

Business operators using blockchain technology may be subject to the APPI if they handle the personal information of their users.

In addition, considering that a public blockchain involves the sharing of a database among unspecified participants, where information on the blockchain will not in principle be deleted or retracted once recorded on the blockchain, the use of blockchain technology may trigger the application of the APPI. For example, Article 22 of the APPI requires business operators who handle personal information to delete unnecessary personal information once the purpose for which such personal information is required has been achieved. However, a business operator that records the personal information of its users on a blockchain may have difficulty deleting such information, and this could result in a violation of the APPI.

“Currency Denominated Assets” are excluded from the definition of Crypto Assets. “Currency Denominated Assets” is defined under Article 2, Paragraph 6 of the PSA as assets denominated in Japanese Yen or a foreign currency, or with respect to which the performance, repayment, or any other activity equivalent thereto will be carried out in Japanese Yen or a foreign currency. Based on this definition, a digital coin whose value is pegged to the JPY, USD or any other fiat currency (such as, for example, where the price of a digital coin is always fixed at one JPY or one USD, or where a digital coin is redeemable at one JPY or one USD) would fall outside the definition of “Crypto Assets”.

On March 4, 2022, the “Bill for Partial Amendment to the Act on Payment Services Act, etc. for the Purpose of Establishing a Stable and Efficient Funds Settlement System” (the “Amendment Act”) was submitted to the Diet.  The Amendment Act, which aims to introduce new regulations in respect of stable coins, was approved on June 3, 2022 and came into effect on June 1, 2023.

Under the Amendment Act:

1. EPIs (i.e., currency -denominated stable coins) would be distinguished from other currency denominated assets based on the following factors: (a) whether they can be used as payment for consideration to unspecified persons; and (b) whether they may be purchased from or sold to unspecified persons. Prepaid payment instruments and electronic currency that are issued by fund transfer service providers do not satisfy condition (a), as their issuers would centrally manage the balance of each user and the scope of member stores that accept the relevant prepaid payment instruments and electronic money.  Additionally, digital currencies, notwithstanding that they are issued on blockchains, will not satisfy condition (b) if their issuers have taken technical measures that restrict the transfer of such digital currencies only to persons who have been verified as unproblematic under know-your-customer (“KYC”) checks at the time of transaction, and if the issuers’ consent or other involvement is required for every transfer of the digital currencies.  Consequently, stable coins issued on a permissionless blockchain would typically be deemed EPIs, as new holders of such stable coins generally are not required to undergo KYC checks and transfers of such stable coins do not require the involvement of their issuers.
2. Those who are permitted to issue EPIs directly to Japanese residents are limited to banks, funds transfer service providers, trust banks or trust companies that are licensed in Japan. This is because the issuance and redemption of EPIs constitute “fund remittance transactions” (kawase-torihiki).
3. It is not possible for a CAESP to list EPIs on any exchange or manage EPIs for its users, without being registered as an EPIESP.

An EPIESP is subject to certain codes of conduct, including anti-money laundering/counter-financing of terrorism (“AML/CFT”) regulations. Among such AML/CFT regulations is the “travel” rule. Specifically, an EPIESP, when transferring EPIs to any other EPIESP, is required to provide a customer’s identification information to such other EPIESP.  Moreover, an EPIESP who sends or receives EPIs to or from overseas VASPs on a regular basis is required needs to check whether such VASPs are conducting appropriate due diligence on their users for AML/CFT purposes.