Current Situation of the Japanese Cryptocurrency Market: Early Regulatory Intervention, Less Competitiveness Compared to Hong Kong and Singapore?

Author: Rick Maeda

Compiled by: Shenchao TechFlow

Summary

• Although Japan adopted cryptocurrency early on, its development has been rocky due to two major historical hacking incidents involving cryptocurrency exchanges.

• These events forced Japanese regulators to intervene earlier than in other countries, providing a clear regulatory framework for the industry.

• However, strict regulations and high tax rates have made Japan less competitive compared to neighboring countries like Singapore and Hong Kong.

• In a low trading volume and dull domestic startup environment, Japan faces numerous challenges in developing its Web3 industry, requiring significant policy changes for revitalization.

Introduction

Due to a lack of high-yield opportunities and an unattractive domestic stock market, ordinary investors in Japan have long been known for their enthusiasm for leveraged trading. Japanese retail currency traders have a significant influence on the TRY/JPY (Turkish Lira/Yen) forex trading pair, leading the international financial community to coin the term "Mrs. Watanabe" to represent them. When Bitcoin and other cryptocurrencies entered the mainstream market in the early 2010s, Japanese day traders eagerly embraced this emerging asset class. However, investors soon faced domestic challenges, including two notable exchange hacking incidents, combined with Japan's insufficient attractiveness for startups and investments, leading to a decline in the country's position in the Web3 space.

In this research paper, we will:

1. Review the history of cryptocurrency in Japan, particularly the various regulatory developments.

2. Analyze the current situation in Japan.

3. Explore some key players in the domestic industry.

History of Cryptocurrency in Japan

Japan's cryptocurrency development has experienced many significant events, such as the Mt. Gox and Coincheck hacking incidents, prompting the government to implement strict regulatory measures to protect investors and maintain the stability of the financial system. Japan continues to evolve its regulatory framework to address new challenges and opportunities in the cryptocurrency space.

Early Days and the Rise of Mt. Gox

2009:

• Bitcoin, the first cryptocurrency, was introduced by an unknown person or group using the name Satoshi Nakamoto. During these early stages, awareness and adoption of cryptocurrency were minimal worldwide, and Japan was no exception, despite the creator using a Japanese pseudonym.

2011~2013:

• Mt. Gox, a Bitcoin exchange based in Tokyo, became the largest Bitcoin exchange in the world, handling the vast majority of Bitcoin transactions at its peak (Figure 1).

Figure 1: Global CEX trading volume as of the end of 2013

The Mt. Gox Hacking Incident and Its Consequences

2014:

• Mt. Gox suspended trading, closed its website, and filed for bankruptcy, announcing that approximately 850,000 Bitcoins (equivalent to nearly 7% of all Bitcoins at the time, valued at about $450 million) were stolen. Investigations revealed that mismanagement and insufficient security measures were the causes of the loss.

Figure 2: Bitcoin price dropped over 40% within three days after Mt. Gox halted withdrawals

Regulatory Developments and Early Legislation

2015:

• The Financial Action Task Force (FATF), an intergovernmental policy-making body of the G7, issued guidelines recommending that countries regulate virtual currency exchanges 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 amendments to the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA). These amendments recognized virtual currencies (such as Bitcoin, Ethereum, Ripple, Litecoin, and Bitcoin Cash) as a means of payment and imposed regulatory requirements on cryptocurrency exchanges, laying the groundwork for comprehensive cryptocurrency regulations.

• The Financial Services Agency (FSA) was responsible for implementing these regulations, focusing on exchange registration requirements, cybersecurity measures, and anti-money laundering (AML) protocols.

The Coincheck Hacking Incident and Strengthened Regulation

2017:

• The amended Payment Services Act came into effect in April, requiring cryptocurrency exchanges to register with the FSA and comply with AML and Know Your Customer (KYC) regulations, classifying Bitcoin as a prepaid payment instrument.

• Bitcoin and cryptocurrencies gained significant popularity in Japan, with many merchants, including Japan's largest electronics retailer Bic Camera, beginning to accept Bitcoin as a payment method.

• The National Tax Agency (NTA) classified cryptocurrency gains as "miscellaneous income," making them taxable.

2018:

• Coincheck, one of Japan's largest cryptocurrency exchanges, was hacked, resulting in approximately 523 million NEM (valued at about $530 million) being stolen. Customers were ultimately fully compensated by Coincheck. This hack remains one of the largest cryptocurrency heists in history and prompted the FSA to adopt stricter regulatory measures. According to Cointelegraph, the exchange stored NEM in a hot wallet rather than a multi-signature wallet. Figure 3 shows that the price of NEM dropped over 76% in the two months following the hacking incident. The first quarter of 2018 marked the beginning of a bear market, but even excluding the effects of the bear market, the $XEM/$BTC trading pair fell by over 61%.

Figure 3: XEM price trend during the Coincheck hacking incident

• Zaif, a smaller exchange, was also hacked, resulting in a loss of approximately $60 million.

• The Japan Virtual Currency Exchange Association (JVCEA) was established as a government-approved self-regulatory organization to raise industry standards and oversee the approval of tokens listed on exchanges.

• The FSA issued business improvement orders to several cryptocurrency exchanges and conducted on-site inspections to ensure compliance with new regulations.

• The FSA limited the leverage for cryptocurrency margin trading to four times the deposit amount, aiming to curb speculative trading and protect investors.

Margin Trading Regulations and Ongoing Developments

2019:

• Coincheck has now complied with the new regulations and resumed operations.

• The Japanese Cabinet approved new regulations limiting leverage for cryptocurrency margin trading to 2-4 times the initial deposit.

• The amended Financial Instruments and Exchange Act (FIEA) and Payment Services Act (PSA) came into effect, further tightening regulations on cryptocurrency exchanges and security token offerings (STOs).

2020:

• The FSA reduced the maximum leverage for margin trading to 2 times.

• Further amendments to the PSA and FIEA were enforced, focusing on enhancing user protection and market integrity.

2021:

• Japan continued to develop its regulatory framework, focusing on enhancing investor protection, cybersecurity, and anti-money laundering measures.

• The FSA established a new regulatory body to oversee cryptocurrency exchange operators and ensure compliance with evolving regulations.

• The FSA required the JVCEA to implement self-regulatory rules regarding the "travel rule" for information sharing during transactions.

Recent Developments

2022:

• The FSA introduced additional guidelines for digital asset custody for exchanges, emphasizing the need for robust internal controls and risk management practices.

• The JVCEA introduced the travel rule in its self-regulatory rules, while the Cabinet Office revised the Act on Prevention of Transfer of Criminal Proceeds (APTCP) to enforce this rule.

• The Japanese Tax Commission revised tax laws to exempt token issuers from corporate tax on unrealized cryptocurrency gains.

• Japan explored the potential for issuing a central bank digital currency (CBDC), with the Bank of Japan conducting experiments and research.

• The House of Councillors passed a bill regulating stablecoins to monitor and combat money laundering activities.

• The Liberal Democratic Party (LDP) Digital Society Promotion Headquarters released the "NFT White Paper: Japan's NFT Strategy in the Web 3.0 Era," proposing policy recommendations for the development and protection of NFTs.

• The Ministry of Economy, Trade and Industry (METI) established a Web3 Policy Office to create a supportive business environment for Web3-related industries.

• The FSA is advancing the lifting of the ban on foreign-issued stablecoins.

2023:

• The FSA continues to refine its regulatory approach, focusing on emerging trends such as DeFi and NFTs.

• The FSA conducted a public consultation on a draft order to amend the APTCP enforcement order, clarifying the applicability of the travel rule to Japanese Virtual Asset Service Providers (VASPs).

• Japanese Prime Minister Fumio Kishida emphasized that Web3 is a pillar of economic reform, calling it "a new form of capitalism" and highlighting its potential to drive growth by addressing social issues.

2024:

• The JVCEA plans to streamline the listing process for digital currencies, aiming to simplify the approval process for existing tokens in the market.

• Certain lengthy pre-approval processes for digital assets on authorized exchanges are expected to be eliminated.

• The Cabinet approved a bill allowing venture capital investment tools to directly hold digital assets.

Where do we stand now? Japan is struggling for Web3 adoption

Japan's weaknesses in Web3 adoption primarily stem from regulatory constraints, particularly regarding exchange listings and taxation. Exchange listings are subject to strict oversight by the FSA, and local CEXs lack major cryptocurrencies, failing to provide liquidity for stablecoins (Figure 4).

Figure 4: Limited product offerings of local CEXs.

Note: We looked at the USDT pairs offered by Binance and ByBit, as they do not provide fiat currency in USD.

For ByBit, $SHIB and $BONK are offered in 1000 unit blocks ($1000BONK and $SHIB1000).

Besides Bitbank, which offers the most cryptocurrencies among Japanese exchanges, this reinforces the dominance of major cryptocurrencies on Japanese exchanges (Figure 5):

Figure 5: Market share of the top two assets on Japanese and international CEXs.

Duration: Year-to-date 2024

Meanwhile, cryptocurrency gains are classified as miscellaneous income and taxed at personal income tax rates plus local taxes, reaching up to 55% (Figure 6).

Figure 6: Japan's capital gains tax on cryptocurrency is prohibitively high

Before institutional investors intervened, there was a time when the yen trading volume exceeded that of the dollar, but the challenges mentioned above have made the situation difficult.

Figure 7: Market share of the yen in global fiat currency trading volume

The yen's absolute dominance, which once accounted for over 60% of all fiat currency trading volume, quickly disappeared during the pandemic. However, the total share of Asian fiat currency trading volume remained relatively stable as trading volume shifted from the yen to the won (Figure 8).

Figure 8: Market share of yen trading volume relative to other currencies

Interestingly, when we re-benchmark the trading volumes of the yen and dollar to the historical peak in November 2021, the yen trading volume shows a stronger recovery during this cycle (Figure 9).

Figure 9: Yen and dollar trading volumes benchmarked to the historical peak in November 2021 = 100

Institutionally, Japan is a country rich in content IP, with companies like SEGA and Kodansha, making it an ideal place for NFT and game-driven projects. In theory, these companies could bring attention, users, research capabilities, and capital, but the problem is that this strategy has shown minimal effectiveness in any country, despite being touted as Japan's bull market case for years.

Politically, the ruling party advocating for deregulation recently lost ground in the House of Representatives elections in April 2024, giving momentum to the opposition Constitutional Democratic Party, raising concerns. However, given the LDP's continued majority status in both houses of the Diet and the increasingly fierce international and domestic competition for Web3 adoption, we believe these developments are not a significant concern at this time.

Cryptocurrency faces many adverse factors, but simply put, many issues are cultural and therefore unquantifiable, with no simple solutions. As an international metropolis, the English proficiency is very low, there is a lack of inherent entrepreneurial spirit, and stable jobs at well-known local companies are still seen as the pinnacle of post-graduation employment, contrasting sharply with the "fast-moving" nature of cryptocurrency. All these factors are relative, especially compared to Asian competitors like Singapore and Hong Kong, but many of them are also absolute, making the challenges even more difficult. Coupled with challenges in taxation and CEX product offerings, it is hard to imagine that Japan's adoption rate will catch up with its Asian neighbors anytime soon.

Key Players in the Japanese Cryptocurrency Market

i) Centralized Exchanges (CEXs)

As mentioned earlier, Japan's centralized exchanges are less competitive in 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, which also lag behind foreign competitors in user interface and user experience (UI/UX).

Currently, there are 29 cryptocurrency asset trading service providers registered with the Financial Services Agency (FSA) in Japan. We present the current market landscape through charts.

• BitFlyer is the largest exchange by trading volume and has maintained its dominance in recent years.

Figure 10: Market share of trading volume among Japanese centralized exchanges

However, compared to top international exchanges, domestic exchanges in Japan have almost no competitive trading volume. Since the COVID-19 pandemic, Binance has far outpaced Japanese exchanges.

Figure 11: Comparison of total spot trading volume of Japanese exchanges with Binance

This disparity can also be observed when comparing the depth of the BTC spot order books of exchanges.

Figure 12: Comparison of 1% depth of BTC spot order books between Japanese exchanges and Binance

ii) Investment Groups:

SBI Digital

SBI Holdings (TYO: 8473) is a financial services group headquartered in Tokyo, established in 1999. Originally part of the SoftBank Group, it became independent in 2000. SBI Holdings operates in various sectors, including financial services, asset management, and biotechnology. It is known for combining technology with traditional financial services to drive innovation and growth.

SBI Digital Asset Holdings is a subsidiary of SBI Holdings, focusing on digital assets and blockchain technology, and is Japan's largest cryptocurrency investment group. Launched in 2020, SBI Digital aims to revolutionize the traditional financial industry by providing comprehensive solutions such as digital asset trading, token issuance, and custody services. They offer secure platforms for trading various digital assets and facilitate token issuance, enabling businesses to raise funds through innovative methods like security token offerings (STOs). Their custody services ensure the secure storage and management of digital assets, utilizing advanced security measures to protect investments. SBI Digital also collaborates with global financial institutions, such as establishing a crypto venture fund in Singapore in partnership with SIX Digital Exchange, aimed at enhancing liquidity and infrastructure for digital assets across Asia and Europe. Another significant initiative is the launch of the Digital Space Fund in 2023, with a funding scale of up to $660 million, focusing on Web3, the metaverse, artificial intelligence, fintech, and other emerging technologies.

SBI offers various services in both traditional finance and the crypto space, including custody solutions and market-making services through its subsidiary B2C2.

iii) Protocols/Projects:

Astar Network

Astar Network is a decentralized application (dApp) platform built on the Polkadot ecosystem and is one of Japan's most important crypto projects (notably, its headquarters is not in Japan but in Singapore). It was founded by Sota Watanabe, a prominent figure in Japan's 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 various programming languages.

Astar Network is a decentralized application (dApp) platform built on the Polkadot ecosystem. Although Astar is one of Japan's leading crypto projects, its headquarters is in Singapore. The platform was founded by Sota Watanabe, a well-known figure in Japan's blockchain space, aiming to provide developers with a scalable, interoperable, and decentralized application deployment platform. Astar supports multiple virtual machines, including the Ethereum Virtual Machine (EVM) and WebAssembly (WASM), allowing developers to write smart contracts in various programming languages.

Astar promotes the development of dApps by providing the necessary tools and infrastructure, driving innovation in decentralized finance (DeFi), non-fungible tokens (NFTs), and other blockchain applications. Astar's integration with Polkadot enhances its interoperability with other blockchains, making it an important part of the blockchain ecosystem.

Astar is significant in Japan as it is one of the country's leading blockchain projects, showcasing the interest and investment of Japan's tech community in blockchain technology. However, activity on Astar is still in its early stages: Figure 13 shows the TVL (in USD) of the chain, while Figure 14 shows the growth of its native token TVL.

Figure 13: Astar's TVL compared to larger chains in USD

Figure 14: Comparison of Astar TVL with Solana TVL, calculated in their native currencies ($ASTR and $SOL), benchmarked to January 23 = 100

Backpack

Backpack is one of the most exciting wallet providers in recent years. Their non-custodial wallet currently supports Solana, Ethereum, and Arbitrum, offering a browser extension as well as iOS and Android applications. Interestingly, the company was founded by two non-Japanese founders who chose Tokyo as their headquarters. We interviewed Backpack's co-founder Tristan Yver to discuss why they chose to establish their company in Japan:

1. Who are you, and what is Backpack ?

   I am Tristan Yver, co-founder of Backpack. Backpack is a cryptocurrency wallet designed to manage all crypto assets through a secure, user-friendly platform. I am also one of the founders of the Mad Lads NFT collection, which is a leading NFT collection on Solana and one of the most powerful communities in the crypto space.

2. Why did you choose Japan as your headquarters?

   We chose to establish our headquarters in Japan because the regulatory environment is gradually improving, and we have a local team based here. Among all countries in Asia, Japan is the place our team most wanted to set up headquarters due to its high safety and quality of life. We are also committed to promoting Japan as a thriving Web3 nation and inviting other founders and teams to visit us.

3. What changes do you think need to be made domestically to increase cryptocurrency adoption?

   To drive the adoption of cryptocurrency in Japan, more resources are needed for engineers to learn blockchain programming, and the startup sector needs to recognize the tremendous opportunities in the Web3 space. I also believe that friendlier tax policies would attract more individual investors to participate in the crypto market.

4. Can you share any upcoming updates for Backpack?

   We are excited to add more blockchain support to the Backpack wallet. We started with Solana and Ethereum, and now support Arbitrum, with plans to soon support Base, Optimism, and Polygon. These innovations aim to provide users with the best non-custodial crypto management experience.

Conclusion

Despite Japan's early start in ordinary user applications, factors such as regulatory scrutiny following exchange hacking incidents, high taxes, limited cryptocurrency offerings from exchanges, and cultural barriers have left Japan far behind its Asian peers in the Web3 space. The current government led by Kishida's LDP is looking in the right direction, but progress is slow. The activities of local exchanges reflect this struggle, and it is currently difficult to see any catalysts that could change Japan's downward trend. However, the comprehensive regulatory environment, along with lifestyle factors such as safety and quality of life mentioned by Tristan, continue to make Japan an attractive place to live, as evidenced by talented individuals potentially choosing Japan as their operational base.