In October 2008, Bitcoin’s whitepaper was published under the mysterious pseudonym, Satoshi Nakamoto. Eleven years later, the world is still guessing as to who or what was behind the creation of the first and biggest cryptocurrency. Regardless, “Satoshi Nakamoto” will go down in history for igniting a crypto revolution, which led to the birth of a US$340 billion industry. Perhaps it’s fitting, then, that some of the most exciting developments in crypto are happening in the Land of the Rising Sun.

The Road to STO Regulation is Paved with Hacked Exchanges

If Satoshi Nakamoto is indeed from Japan, then he may be elated to know of the astronomical growth in Bitcoin trading in his home country. BTC trading volume skyrocketed from US$22 million in March 2014 to US$97 billion in March 2017, according to statistics released by the country’s Financial Services Agency (FSA). 

However, Japan’s crypto journey has been anything but smooth. In 2014, the country played host to the biggest Bitcoin heist in the world when Mt. Gox was hacked, resulting in the loss of 740,000 BTC worth approximately US$450 million at that time. Three years later, yet another Japanese cryptocurrency exchange, Coincheck, was hacked in January 2018, resulting in the loss of 500 million NEM tokens, then valued at about US$530 million. 

From a regulatory perspective, it is worth noting that both Mt. Gox and Coincheck were not registered with the FSA. Regulations for crypto exchanges were introduced in Japan after the Mt. Gox heist, and the registration requirements came into effect on April 1st, 2017, long after Coincheck was formed in 2014. 

Nevertheless, the country had lost its appetite for unregulated cryptocurrency. With Security Token Offerings (STOs) coming to the fore, so too has the introduction of its regulation in Japan. The country’s legislative organ, the National Diet, amended the Financial Instruments and Exchange Act (henceforth, “the Act”) to provide for the regulation of STOs. 

Japan’s Regulatory Framework for STOs

Effective from May 31st, 2019, the Act introduced the concept of electronically recorded transferable rights (ERTRs), thereby bringing security tokens under its ambit as “interests in a collective investment scheme that are represented by tokens.” The Act defines security tokens as tokens which involve its holders making investments in the form of cash or other assets in a business in return for the right to receive dividends of profits generated by the business.

In essence, issuers of tokens whose features and functionalities are defined as security tokens under the Act would be subject to disclosure requirements. 

These requirements are more stringent than those applicable to conventional collective investment schemes. In addition to providing details about itself and its tokens, issuers are also required to disclose information relating to its token issuance, settlement, and transfer mechanisms. As a general rule, issuers of securities instruments are exempted from complying with the disclosure requirements under the Act if the issuance is undertaken on a private placement basis. However, the ease with which security tokens can be transferred through the use of blockchain networks leads to high liquidity, rendering it impractical to undertake token issuance on a private placement basis.

Aside from disclosure requirements, the Act also requires security token issuers who undertake any self-offering of their tokens to be registered as a Type II Financial Instruments Business Operator (FIBO). However, this registration requirement is similarly waived if the issuer can somehow overcome the impracticality of issuing security tokens on a private placement basis, provided that they also comply with the applicable provisions under Article 63 of the Act. Alternatively, security token issuers may choose to engage the services of a registered Type I FIBO to distribute the tokens on their behalf, saving the issuers the hassle of registration.

Japan is undoubtedly one of the forerunners of the crypto industry, with the yen constituting 11% of BTC trading in 2018, and with the legal certainty provided to investors by its STO regulations, the Land of the Rising Sun may become the undisputed leader of the global security token market.

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