Presto Research: Understanding the Development History of Japan's Cryptocurrency Market

Author: Rick Maeda, Presto Research; Compiler: Tao Zhu, Golden Finance

Abstract

• As the site of two of the largest cryptocurrency exchange hacks in history, Japan has had a rocky history with cryptocurrency.

• This has forced regulators to step in earlier than in other countries, thereby providing a clear regulatory framework for the industry as early as possible.

• However, strict regulations, coupled with high tax rates, have made Japan less competitive than its neighbors such as Singapore and Hong Kong.

• Amid sluggish sales and a lackluster domestic entrepreneurial environment, the challenges facing Japan in developing its Web3 industry are extensive, and a revival will require meaningful changes in policy.

Foreword

Japanese retail investors have long been known for their interest in leveraged trading due to a lack of yield and a lackluster domestic stock market. Japan’s community of retail cryptocurrency traders is so well-known for their influence on the volatile Turkish Lira/Japanese Yen forex pair that the international financial community coined the term “Mrs. Watanabe” to represent them. When Bitcoin and other cryptocurrencies entered the retail space in the early 2010s, Japanese day traders eagerly embraced this esoteric asset class. However, investors soon faced domestic challenges, including two of the most notorious exchange hacks in crypto history, which, combined with Japan’s relative lack of appeal from an entrepreneurial and investor perspective, undermined the country’s relevance in the Web3 space.

In this research article, we (1) present the history of cryptocurrency in Japan, particularly in terms of various regulatory developments, (2) look at where Japan stands today, and finally (3) explore several major players in the domestic crypto industry.

History of the Crypto Industry in Japan

Japan’s cryptocurrency journey has been marked by major events such as the Mt. Gox and Coincheck hacks, leading to the adoption of strict regulatory measures designed to protect investors and ensure the stability of the financial system. The country continues to evolve its regulatory framework to address new challenges and opportunities in the cryptocurrency space.

The Rise of Mt. Gox in the Early Years

2009:

• Bitcoin was the first cryptocurrency and was launched by an unknown person or group under the name Satoshi Nakamoto. In the early years, awareness and adoption were low in all regions, and this was no different in Japan, despite the creator using a Japanese pseudonym.

2011~2013:

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

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

Mt. Gox Hacker Attack and Aftermath

2014:

• Mt. Gox suspends trading, shuts down its website and files for bankruptcy, announcing that approximately 850,000 bitcoins were stolen due to security issues, almost 7% of all bitcoins worth around $450 million at the time (750,000 customers' bitcoins and 100,000 of their own bitcoins). The investigation showed that poor management and inadequate security measures led to the losses.

Figure 2: BTC fell by more than 40% three days after Mt. Gox stopped withdrawals.

Regulatory Development and Early Regulation

2015:

• The Financial Action Task Force (FATF), the G7 intergovernmental policymaking body, issued guidelines recommending that countries regulate virtual currency transactions 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 bills amending the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA). These amendments recognized virtual currencies ($BTC, $ETH, $XRP, $LTC, and $BCH) as a means of payment and imposed regulatory requirements on cryptocurrency exchanges, laying the foundation for the full implementation of cryptocurrency regulations.

• The Financial Services Agency (FSA) was tasked with preparing for the implementation of these regulations, focusing on registration requirements for exchanges, cybersecurity measures, and anti-money laundering (AML) protocols.

Coincheck hack and increased regulation

2017:

• The revised Payment Services Act, which will take effect in April, requires cryptocurrency exchanges to register with the FSA and comply with AML and Know Your Customer (KYC) regulations. It also classifies Bitcoin as a prepaid payment instrument.

• Bitcoin and cryptocurrencies are extremely popular in Japan, with many merchants such as Bic Camera, Japan’s largest electronics retailer, starting to accept Bitcoin as a payment method.

• The National Tax Agency (NTA) classifies cryptocurrency income as “miscellaneous income,” making it taxable.

2018:

• Coincheck, one of the largest cryptocurrency exchanges in Japan, was hacked, resulting in the theft of approximately 523 million NEM ($XEM) tokens, worth approximately $530 million at the time. Coincheck ultimately refunded customers in full. The hack remains one of the largest cryptocurrency heists in history and alerted the FSA to stricter regulatory measures. The exchange reportedly stored $XEM in hot wallets rather than multi-signature wallets. In Figure 3, the bottom chart shows that $VIEW fell more than 76% in the first 2 months after the hack. The first quarter of 2018 was a brutal start to the bear market, but even if we remove the bear market effect by plotting $XEM/$BTC in the top chart, the pair still fell more than 61%.

Figure 3: Check out the price action surrounding the Coincheck hack.

• Zaif is a smaller exchange that lost around $60 million in the hack.

• The Japan Virtual Currency Exchange Association (JVCEA), a government-approved self-regulatory body established to improve industry standards, is responsible for approving tokens to be listed on exchanges.

• FSA issues business improvement orders to multiple cryptocurrency exchanges and conducts on-site inspections to ensure compliance with new regulations.

• FSA limits leverage on cryptocurrency margin trading to 4 times the deposit amount, aiming to curb speculative trading and protect investors.

Leverage Trading Regulations and Ongoing Developments

2019:

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

• Japan’s Cabinet approves new regulations limiting leverage on cryptocurrency margin trading to 2-4 times the initial deposit.

• The revised Financial Instruments and Exchange Act (FIEA) and Payment Services Act (PSA) come into effect, further tightening regulation of cryptocurrency exchanges and security token offerings (STOs).

2020:

• FSA reduces maximum leverage for margin trading to 2x.

• Further revisions to the PSA and FIEA are implemented, focusing on strengthening user protection and market integrity.

2021:

• Japan continues to evolve its regulatory framework, focusing on strengthening investor protection, cybersecurity, and preventing money laundering.

• FSA establishes a new regulatory agency to oversee cryptocurrency exchange operators and ensure compliance with evolving regulations.

• FSA requires JVCEA to implement a self-regulatory rule called the “Crypto Travel Rule” regarding information sharing during trading.

Recent Developments

2022:

• The FSA introduced additional guidelines for exchanges custodial digital assets, emphasizing the need for strong internal controls and risk management practices.

• The JVCEA introduced the travel rule in its self-regulatory rules, while the Cabinet Secretariat amended the Act on Prevention of Transfer of Proceeds of Crime (APTCP) to implement the rule.

• The Japanese Taxation Committee amended the tax law to exempt token issuers from corporate tax on unrealized cryptocurrency gains.

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

• The Upper House passed a bill to regulate stablecoins, monitor money laundering, and combat money laundering.

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

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

• The FSA continues to lift the ban on foreign-issued stablecoins.

2023:

• The FSA continues to refine its regulatory approach, focusing on emerging trends such as DeFi and non-fungible tokens (NFTs).

• The FSA launched a public consultation on the draft order to amend the APTCP Enforcement Order to clarify the application of the travel rule to Japanese virtual asset service providers (VASPs).

• Japanese Prime Minister Fumio Kishida highlighted Web3 as a pillar of economic reform, describing it as a “new form of capitalism” and emphasizing its potential to drive growth by solving social problems.

2024:

• JVCEA plans to streamline the listing process for digital currencies, aiming to streamline the approval process for tokens already on the market.

• The lengthy pre-screening process for certain digital assets by authorized exchanges is expected to be eliminated.

• The Cabinet approved a bill that could allow venture capital firms’ investment vehicles to directly hold digital assets.

Japan’s Efforts to Adopt Web3

Japan’s weaknesses in Web3 adoption stem from regulatory restrictions, particularly in terms of exchange listings and taxation. Exchange listings are strictly regulated by the FSA, and local CEXs lack major tokens and are unable to provide stablecoin liquidity (Figure 4). Figure 4: Local CEX offerings are limited. Note: We focus on Binance and ByBit’s USDT paired tokens as neither offer USD against fiat currencies. For ByBit, $SHIB and $BONK are offered in blocks of 1000 units ($1000BONK and $SHIB1000).

Except for Bitbank, which has a slightly higher token issuance volume among Japanese exchanges, this strengthens the dominance of major exchanges among Japanese exchanges (Figure 5):

Figure 5: Trading volume market share of the top 2 assets on top Japanese and international central exchanges. Duration: 2024 to date.

Meanwhile, cryptocurrency gains are considered miscellaneous income and are therefore taxable according to the personal income tax bracket plus local taxes, with the highest tax rate being 55% (Figure 6).

Figure 6: Japan imposes excessive capital gains taxes on cryptocurrencies.

JPY trading volumes were once larger than USD trading volumes before institutional interest emerged, but the above challenges have made the situation challenging.

Figure 7: Yen market share in global fiat currency trading volumes.

The absolute dominance of the Japanese yen (at one point accounting for over 60% of all fiat currency trading volume) was short-lived and gradually became irrelevant during the COVID-19 pandemic (Figure 7). However, the total share of Asian fiat currency trading volume has remained stable over time, with trading volume shifting from the Japanese yen to the Korean won (Figure 8).

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

It is worth noting that when we rescale JPY and USD volumes to their previous all-time highs in November 2021, JPY volumes show a stronger recovery in this cycle (Figure 9).

Figure 9: JPY and USD volumes rescaled to their previous highs in November 2021 = 100.

In terms of institutions, Japan is a country rich in content intellectual property, with companies such as Sega and Kodansha, which makes it a top choice for NFT and game-driven projects. In theory, these companies bring attention, users, research capabilities and capital - the problem is that these areas are not effective in any country, and this has been touted as a bull market in Japan for many years.

Politically, recent concerns about the deregulatory ruling party losing the House of Representatives election in April 2024 have given momentum to the opposition Constitutional Democratic Party. However, given the LDP’s continued majority in both houses of parliament, and the growing international and domestic competition for Web3 adoption, we do not believe these developments are cause for concern at this time.

There are many headwinds to cryptocurrencies, but simply put, many of the issues are simply cultural, making them unquantifiable and without easy solutions. Extremely low English proficiency for a global city, an inherent lack of entrepreneurialism, stable jobs at large local companies still seen as the pinnacle of graduate employment, and the high level of corporate caution juxtaposed against the “move fast” nature of cryptocurrencies are just some of the issues. Add to that challenges around taxation and CEX product offerings, and it’s hard to imagine Japan’s adoption rates catching up to its Asian neighbors any time soon.

Major Players in Japan’s Crypto Market

i) CEXs

As explored in the previous section, Japan’s central exchanges have struggled to compete in terms of 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, where UI/UX also lags behind foreign competitors, although this is a difference observed outside of cryptocurrency exchanges.

Japan has 29 FSA-registered crypto asset trading service providers, and we explore the current situation in this chart.

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

Figure 10: Japanese CEX volume share.

• However, compared to top international exchanges, domestic Japanese exchanges are hardly competitive in terms of trading volume. Since the outbreak, Binance has left Japanese exchanges behind.
  

Figure 11: Total spot trading volume of Japanese exchanges and Binance.

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

Figure 12: 1% depth of spot BTC order books on Japanese exchanges vs. Binance.

ii) Investment Group:

SBI Digital

SBI Holdings (TYO: 8473) is a Tokyo-based financial services group established in 1999. The company was originally part of SoftBank Group and became independent in 2000. SBI Holdings operates in a variety of fields including financial services, asset management and biotechnology. The company is known for combining technology with traditional financial services to drive innovation and growth.

SBI, through its consolidated subsidiary B2C2, provides a variety of traditional financial and crypto services, including custody solutions and market making.

iii) Protocols/Projects

Astar Network

Astar Network is a decentralized application (dApp) platform built on the Polkadot ecosystem and one of the leading crypto projects in Japan (although its headquarters are not in Japan, but in Singapore, as is well known). It was founded by Sota Watanabe, a well-known figure in the Japanese 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 a variety of programming languages.

Astar is significant in Japan as it represents one of the country's leading blockchain projects, demonstrating the growing interest and investment in blockchain technology in the Japanese tech community. However, perhaps representative of Japan’s interest in Web3, activity on Astar is still in its infancy: Figure 13 shows the chain’s TVL in USD, while Figure 14 shows the growth of its native token’s TVL.

Figure 13: Astar TVL vs. larger blockchains in USD.

Figure 14: Astar TVL vs. Solana TVL, measured in terms of its native tokens ($ASTR and $SOL), rebased to 01Jan23=100.

Conclusion

Despite leading the way in retail adoption, a combination of regulatory scrutiny following exchange hacks, high taxes, limited token offerings on exchanges, and cultural resistance has left Japan lagging far behind other Asian countries in the Web3 space. The current government under LDP Kishida has been forward-thinking but has made slow progress. Activity on local exchanges reflects this struggle, and it’s hard to see what catalyst could change the tide in Japan.