What impact will the "Virtual Asset User Protection Act" that will take effect in South Korea have?

Author: Weilin, PANews

Recently, South Korea’s virtual asset regulators have frequently announced new regulatory developments, and there was a "reversal" in the news. First, there were online rumors that the regulators "notified nearly 30 registered exchanges to review the more than 600 cryptocurrencies they listed therein" and "16 tokens will be delisted." Subsequently, the market fell into a panic of large-scale delisting of tokens, and the prices of related tokens fell sharply.

On June 18, the Financial Services Commission (FSC) of South Korea came forward to clarify that it would not directly participate in the inspection of cryptocurrencies listed on Korean exchanges, which was actually an industry self-inspection. In fact, in order to cooperate with the "Virtual Asset User Protection Act" that came into effect on July 19, South Korea's cryptocurrency-related regulatory agencies and self-regulatory organizations are taking the initiative to "attack."

01 Regulators establish a "suspicious" activity monitoring system and review 1,333 virtual assets in 6 months

The latest news is that on July 4, the Financial Supervisory Service (FSS) of South Korea said in a statement that it is establishing a 24-hour monitoring system to monitor abnormal cryptocurrency trading activities and recommends that exchanges enter data and information into the system to ensure compliance with the "Virtual Asset User Protection Act" that came into effect on July 19. The statement pointed out that red flags include trading volumes and prices outside the normal range, excessive trading volumes, and abnormally slow execution speeds. The Financial Supervisory Service said that one of the goals of the measure is to find accounts associated with "suspicious" activities.

This statement is one of a series of regulatory developments in South Korea recently. In mid-June, a list of "Korean won market currencies that may be delisted in June" was circulated in major Korean virtual currency communities and social media, involving 16 tokens, causing the prices of about half of the listed currencies in the Korean won market to plummet. At the same time, it is reported that regulators have notified nearly 30 registered exchanges to review more than 600 cryptocurrencies.

But on June 18, the Financial Services Commission (FSC) of South Korea clarified that it would not directly participate in the inspection of cryptocurrencies listed on Korean exchanges.

Soon after, on July 2, DAXA, an alliance of South Korea's five largest cryptocurrency exchanges, announced the launch of a six-month re-evaluation plan for 1,333 digital assets. DAXA said that in order to cooperate with the implementation of the "Virtual Asset User Protection Law", it has formulated the "Self-regulation of Virtual Asset Trading Support", which will be officially implemented on domestic exchanges together with the "Virtual Asset User Protection Law" on the 19th of this month. For more than 1,333 virtual assets, the exchanges will conduct virtual asset re-examinations within 6 months from the implementation date. The formulation of this self-regulation was carried out in accordance with the requirements of regulatory authorities such as the Financial Services Commission and the Financial Supervisory Service, and the opinions of experts were collected.

Under the influence of this re-evaluation plan, 29 cryptocurrency trading platforms including Upbit, Gopax and Bithumb will evaluate whether their listed tokens comply with the new regulations, and these regulations will also serve as a benchmark for future token listings.

In addition, for overseas virtual assets, the alliance plans to implement a more flexible "alternative review program", which will apply to relax some review conditions if they have been traded in qualified overseas virtual asset markets for more than 2 years. DAXA is currently identifying eligible foreign exchanges, including those recognized by the International Organization of Securities Commissions (IOSCO).

02 South Korea's "Virtual Asset User Protection Act" will take effect

The "Virtual Asset User Protection Act" which will take effect on July 19 aims to protect virtual asset users and establish a healthy market order. The "Virtual Asset User Protection Act" defines the definition of virtual assets and the excluded objects of virtual assets, and stipulates the obligations of virtual asset operators to safely store and manage user deposits and virtual assets.

Specific contents include: adding virtual asset exclusion objects (the "CBDC" issued by the Bank of Korea is not included in the scope of virtual assets); stipulating that virtual asset business operators should separate users' deposits from their own property and deposit or entrust them to management institutions such as banks; stipulating that virtual asset operators must keep more than 80% of user deposits in cold wallets to protect user funds, and participate in insurance plans to provide potential compensation to users in the event of security breaches. In addition, the use of undisclosed material information, manipulation of market prices, and fraudulent trading behaviors are defined as unfair trading behaviors in box trading. If violated, the liability for compensation for losses and fines may be imposed; it is prohibited to arbitrarily block users' access to virtual assets, and virtual currency exchange operators are required to monitor abnormal transactions in the virtual asset market at any time, take appropriate measures, and notify financial authorities, etc.

The strongest protection for users is that when a virtual asset enterprise goes bankrupt or its business registration is cancelled, the bank as the management agency will publish the deposit payment time and place in newspapers and websites, receive the user's deposit data, and pay the deposit directly to the user after confirmation by the virtual asset operator.

Based on these contents, the bill clarifies the establishment of the Virtual Asset Committee. On June 18, the proposal of the Financial Services Commission of South Korea to establish a new Virtual Asset Committee passed the State Council meeting. With the formal organization, a total of 12 employees have been transferred to full-time positions, and a new fifth-level civil servant responsible for artificial intelligence in the financial field has been added. The Asset Committee will operate temporarily and be responsible for the management and supervision of establishing virtual asset market order and user protection. At the same time, the Virtual Asset Committee also plans to actively respond to unfair transactions in virtual assets, and impose sanctions such as fines and criminal prosecutions.

From the background of the "Virtual Asset User Protection Act", South Korea already has the "Amendment to the Specific Financial Information Protection Act" from the perspective of anti-money laundering in 2021, which introduces a review system for virtual asset practitioners. However, in terms of protecting users, legislators believe that the law still has room for improvement, so the discussion on virtual asset legislation is very active, centered on members of Congress. In April 2023, legislators reached an agreement to formulate the "Virtual Asset User Protection Act" with a focus on the most urgent user protection. Since then, the two sides have reached an agreement on gradually and phased improvement of legislative matters.

03 Korean won Q1 becomes the world's most active cryptocurrency trading currency, and the new legislation has different market impacts

The importance of the Korean cryptocurrency market is increasing day by day. In the first quarter of 2024, the Korean won was the world's most active cryptocurrency trading currency, surpassing the US dollar. Data from research firm Kaiko shows that in the first quarter of 2024, the cumulative trading volume of the Korean won on centralized cryptocurrency exchanges was $456 billion, while the US dollar volume was $445 billion.

The growth of won-denominated transactions is partly the result of the ongoing fee war among Korean exchanges. Smaller exchanges such as Bithumb and Korbit have recently launched zero-fee trading promotions in an attempt to attract traders from Upbit, which dominates the local market with a market share of more than 80% in spot trading volume.

In South Korea, users prefer trading altcoins with smaller market capitalizations and higher volatility to more mainstream cryptocurrencies such as Bitcoin and Ethereum. On average, transactions involving smaller market capitalization tokens account for more than 80% of all activities in South Korea.

Meanwhile, crypto activities are attracting more attention from young Koreans. A recent survey showed that more and more young Koreans are looking at cryptocurrencies and stocks as alternative investment options for retirement, with more than half of respondents in the 20-39 age group distrusting the national pension system. Notably, about 7% of election candidates own digital assets in their asset disclosures.

Now, the new legislation marks a new stage in South Korea's virtual asset regulation. In response to the new legislation, Matt Younghoon Mok, senior attorney and partner at Lee&Ko Seoul Law Firm, said that the guidelines of the Financial Supervisory Service of South Korea may pose a major challenge to altcoins that cannot quickly meet regulatory requirements.

However, DAXA, an alliance of the five major exchanges mentioned above, explained: "Major exchanges have already adopted the main review items in advance, and the re-examination under the new self-regulatory management standards will be carried out in stages within 6 months, so it is unlikely that there will be a one-time large-scale delisting."

At the same time, Korean industry insiders are optimistic that the implementation of the Virtual Asset User Protection Act may enhance the competitiveness of the domestic virtual asset market. Yoon Chang-bae, a researcher at the Upbit Investor Protection Center, said: "The impact of regulatory measures must be viewed from a long-term perspective. We may not see an increase in liquidity in the short term." He added: "The core of the Virtual Asset User Protection Act is to enhance market stability. Focusing on protecting virtual asset investors and expanding market stability, it may promote business expansion and innovation in the future."

Kim Myung-woon, former director of the Seoul Eastern District Prosecutors' Office, analyzed that as the scale of cryptocurrency transactions has grown exponentially, various side effects and related crimes have also increased. For example, there are virtual asset price manipulation cases worth 90 billion won such as PICA, undeclared illegal virtual asset exchange operations worth 580 billion won, and Haru Invest deposits worth 1.4 trillion won. When handling the above cases, the provisions of the Criminal Law on fraud or violations of the Specific Financial Information Protection Act are mainly applied to convict, but it is difficult for existing laws to fully cover the transaction relationship in the special field of virtual assets, so there are some shortcomings in solving the problem. Due to this particularity, in order to prove the criminal suspicion related to virtual asset transactions, such as the existence of fraud, the causal relationship between errors and disposal behaviors, etc., the investigating authorities need to invest more efforts and time than other cases.

"Some people believe that the implementation of the new law will lead to the shrinkage of virtual asset transactions, such as the prohibition of 'Market Making' (MM), cold wallets (offline wallets isolated from the Internet), real-time monitoring of suspicious transactions and reporting to financial authorities. However, I believe that through the implementation of the new law, virtual asset transactions will be fairer and more transparent, preventing specific forces from monopolizing profits due to speculative transactions, which will make the virtual asset trading field more active."