South Korea's New Law Requires Exchanges to Pay Interest on Fiat Custodied by Banks, Upbit to Earn an Extra 50 Billion KRW Annually

In June last year, South Korea passed the Virtual Asset User Protection Act to introduce a regulatory mechanism for virtual assets, aiming to enhance investor protection. The law integrates 19 crypto-asset-related regulations, defining digital assets and setting penalties for illegal activities such as using non-public information, market manipulation, and unfair trading. This law is set to take effect on July 19, 2024.

Banks Must Pay Interest on Custodied Cash

Among these 19 regulations, one law could severely impact bank profits. According to South Korean media reports, under the Enforcement Decree and Supervisory Regulation of the Virtual Asset User Protection Act, banks entrusted by virtual asset exchanges must pay interest on user deposits (cash in Korean won) deposited through the exchanges.

Therefore, this law might significantly affect K-Bank, the digital bank entrusted by Upbit, South Korea's largest virtual asset exchange. Reports indicate that K-Bank currently has 5 trillion KRW (3.6 billion USD) in deposits from Upbit, accounting for over 20% of its customer balances. After the new law takes effect in July, if the interest rate is set at 1%, K-Bank will need to pay approximately 50 billion KRW (36 million USD) in interest, which is close to K-Bank's net profit for the first quarter of this year.

Note: The expected 1% interest rate is based on the current deposit interest rate paid by Korean securities companies to investors.

Additionally, K-Bank is preparing for an IPO this year, coinciding with the implementation of the new law, which might affect its valuation. Upbit, being the largest virtual asset exchange in South Korea with a large user base, leads to K-Bank holding a significant amount of virtual asset deposits, while other Korean banks do not have significant positions in virtual asset deposits.

It is reasonable to speculate that banks should be able to conduct some level of financial operations with the cash they are entrusted with under the new law; otherwise, no bank would be willing to cooperate. However, whether this is worthwhile from the bank's perspective remains to be confirmed with further information.

Contents of the Virtual Asset User Protection Act

At the end of last year, the Financial Supervisory Commission (FSC) of South Korea issued legislative notices on the enforcement ordinance of the Virtual Asset User Protection Act and the regulations for supervising the virtual asset industry, specifying details authorized by the law.

The enforcement ordinance and supervisory regulations specify authorized matters, including:

• Adding entities not subject to the Virtual Asset User Protection Act, such as deposit tokens linked to CBDCs and NFTs
• Clarifying the management institutions and operation methods for user deposits
• Requiring 80% of user virtual assets to be stored in cold wallets
• Establishing standards for insurance mutual aid or reserve accumulation to address responsibilities for incidents such as hacking or computer failures
• Defining the possible timing of non-public important information leaks and insider trading based on the characteristics of the virtual asset market
• Principally prohibiting arbitrary freezing of user virtual asset deposits and withdrawals, with exceptions specified
• Imposing obligations on virtual asset trading platforms to monitor abnormal transactions and establishing penalty procedures for unfair trading behaviors.