Introduction to the legal and regulatory framework
Japanese law does not have a unified regime applicable to tokens issued or minted on a blockchain. The legal status of tokens under Japanese law is determined in accordance with their functions and uses. For example, cryptocurrency and utility tokens such as BTC and ETH are regulated as cryptoassets under the Payment Services Act (PSA). A business operator that engages in the business of buying, selling or exchanging cryptocurrencies or intermediating these activities, or managing cryptocurrencies for the benefit of others, is required to register as a cryptoasset exchange service provider (CAESP).
In contrast, 'security tokens', which represent shares, bonds or fund interests in tokens, are regulated under the Financial Instruments and Exchange Act (FIEA) as electronically recorded transferable rights to be indicated on securities (ERTRISs). Business operators that engage in the business of offering, handling the offering, buying, selling or exchanging ERTRISs, or intermediating these activities, are required to register as a Type I financial instruments business operator (a Type I FIBO).
In addition, if tokens constitute 'stablecoins', prices of which are pegged to the value of a fiat currency, the tokens are likely to be classified as either cryptoassets or means of funds remittance transactions, depending on whether the stablecoins are redeemable in fiat currency. In this regard, on 4 March 2022, the Bill for Partial Amendment to the Act on Payment Services Act, etc. for the Purpose of Establishing a Stable and Efficient Funds Settlement System was submitted to the Diet (the national legislature), which approved it on 3 June 2022 (the Amendment Act). The Amendment Act aims to establish a stable and efficient funds settlement system that can respond to the digitalisation of finance and other fields, against the following backdrop:
- the increasing issuance and circulation of stablecoins overseas;
- the growing need to further improve the effectiveness of transaction monitoring by banks, among other institutions; and
- the spread of prepayment instruments that enables payment by electronic means.
In addition, in response to item (a) above, the Amendment Act also introduces the concept of electronic payment instruments (EPI), which corresponds to the concept of stablecoins (Article 2, Paragraph 5 of the Amended Payment Services Act (the Amended PSA)).
The Amendment Act also provides a new definition of intermediary activities in respect of the management of stablecoins that constitute EPIs. Specifically, the Amendment Act defines the management of stablecoins that constitute EPIs as 'electronic payment instruments exchange services' (EPIES). Furthermore, the Amendment Act introduces a registration system for businesses engaged in these activities. The Amendment Act came into effect on 1 June 2023.
Tokens other than those mentioned above (such as non-fungible tokens (NFTs), which serve no economic function as a means of payment because of their unique characteristics) will not be regulated under financial regulations in principle.
Securities and investment lawsi Electronically recorded transferable rights and tokenised securities
The FIEA has traditionally classified securities into: conventional securities, such as shares and bonds (Paragraph 1 Securities); and contractual rights, such as trust beneficiary interests and interests in collective investment schemes that are deemed securities (Paragraph 2 Securities). Paragraph 1 Securities, which are more liquid, have been subject to relatively more stringent disclosure and licensing (registration) requirements. Paragraph 2 Securities, being less liquid, have been subject to relatively more lenient requirements. Against this backdrop, securities issued using an electronic data processing system, such as a blockchain, are expected to be even more liquid than Paragraph 1 Securities. For this reason, under the FIEA, securities transferable by electronic data processing systems have been classified into the following three categories:
- Paragraph 1 Securities (such as shares and bonds) that are transferable through electronic data processing systems (tokenised Paragraph 1 Securities);
- contractual rights (such as trust beneficiary interests and interests in collective investment schemes) that are conventionally categorised as Paragraph 2 Securities and transferable through electronic data processing systems (also known as electronically recorded transferable rights (ERTRs)); and
- contractual rights (such as trust beneficiary interests and interests in collective investment schemes) that are conventionally categorised as Paragraph 2 Securities and are transferable through electronic data processing systems but whose negotiability is restricted to a certain extent (non-ERTR tokenised Paragraph 2 Securities).
ERTRs refer to the rights conventionally treated as Paragraph 2 Securities (such as trust beneficiary rights and interests in collective investment schemes) that 'are represented by proprietary value transferable by means of an electronic data processing system (but limited only to proprietary values recorded in electronic devices or otherwise by electronic means)', excluding 'those rights specified in the relevant Cabinet Office Ordinance in light of their negotiability and other factors'. In this connection, 'those rights specified in the relevant Cabinet Office Ordinance in light of their negotiability and other factors' are generally understood to mean rights in respect of which technical measures have been taken to prevent the transfer of the proprietary value of these rights to persons other than:
- qualified institutional investors; or
- investors eligible to conduct specially permitted businesses for qualified institutional investors (the Article 63 Exemption) such as:
- listed companies;
- corporations with capital or net assets of ¥50 million or more; and
- individuals with investment assets (including cryptoassets) of ¥100 million or more, who have maintained their securities accounts for more than one year.
Technical measures have been taken to prevent the proprietary value of these rights from being transferred without an offer from the owner and approval from the issuer for every transfer.
The key purpose of the FIEA is to subject ERTRs to the disclosure and licensing (registration) requirements applicable to Paragraph 1 Securities.Definition of tokenised securities
Tokenised securities refer to dematerialised (paperless) securities that are 'represented by proprietary value transferable by means of an electronic data processing system (but limited only to proprietary values recorded in electronic devices or otherwise by electronic means)'. Tokenised securities can be classified into the following rights:
- tokenised Paragraph 1 Securities (such as tokenised shares and bonds);
- ERTRs; and
- non-ERTR tokenised Paragraph 2 Securities.
Under the FIEA, rights under points (a) and (b) above are deemed Paragraph 1 Securities, while rights under point (c) are treated as Paragraph 2 Securities. This classification creates a significant difference in the disclosure and licensing (registration) requirements applicable to the rights.2Disclosure requirements
As a result of the application of disclosure requirements to ERTRs, issuers of ERTRs are (in principle) required, upon making a public offering or secondary distribution of ERTRs, to file a securities registration statement and issue a prospectus. A person who causes other persons to acquire ERTRs or who sells ERTRs to other persons through a public offering or secondary distribution must deliver a prospectus to the other persons in advance or at the time of the acquisition or sale.Licensing (registration) requirements
As ERTRs constitute Paragraph 1 Securities, a person acting as a broker, agent or intermediary in respect of the sale or purchase of ERTRs or the handling of an offering of ERTRs in the course of a business is required to undergo registration as a Type I FIBO under the FIEA.ii Regulations governing cryptoasset derivative transactions
Regulations governing cryptoasset derivative transactions have been introduced by the FIEA to protect users and to ensure that such transactions are appropriately conducted. More specifically, for the purposes of subjecting derivative transactions involving financial instruments or financial indicators to certain entry regulations and rules of conduct issued under the FIEA, cryptoassets have been inserted in the definition of 'financial instruments' under the FIEA. Furthermore, the prices, interest rates and other aspects of cryptoassets have been incorporated into the definition of financial indicators.
As cryptoassets are now included in the definition of financial instruments, the conduct of over-the-counter derivative transactions related to cryptoassets or intermediary or brokerage activities in relation thereto will also constitute Type I financial instruments business under the FIEA.iii Prohibitions against unfair acts in cryptoasset or cryptoasset derivative transactions
In respect of cryptoasset spot transactions and cryptoasset derivative transactions, the FIEA contains prohibitions against the following: wrongful acts; dissemination of rumours, fraudulence, assault or intimidation; and market manipulation. These prohibitions (which are without limit as to the violating party) are intended to enhance the protection of users and to prevent the obtainment of unjust benefits. Breach of these prohibitions is punishable by penalties.
Insider trading, however, is not regulated under the FIEA, owing to difficulties with both the formulation of a clear concept of cryptoasset issuers and the identification of undisclosed material facts.
Banking and money transmissioni Approach of the central bank
Cryptoassets are neither deemed money nor equated with fiat currency. The Bank of Japan (BOJ) neither supports nor prohibits the use of cryptoassets.
It has also been reported that the BOJ has no plans to issue any central bank digital currency (CBDC) at this point in time. To ensure the stability and efficiency of the entire payment and settlement system, however, the BOJ has highlighted the importance of being well prepared to respond to changes. In line with this, the BOJ conducted 'Proof-of-Concept Phase 1' from April 2021 to March 2022 to establish an experimental environment using several design patterns for the CBDC ledger, which is the foundation of the CBDC system, and to verify whether the basic functions of CBDCs could be properly executed.
In 'Proof-of-Concept Phase 2', conducted from April 2022 to March 2023, following Phase 1, the BOJ added several peripheral functions to CBDCs, and particularly to functions related to the CBDC ledger verified in Phase 1, to check certain important processing performance and technical capabilities in respect of the CBDC ledger. In Phase 2, the BOJ also looked at the possibility of applying new technologies to data models and databases in respect of CBDCs.
The government of Japan has so far not decided whether to issue CBDCs in Japan, but discussions continue to be held in this regard. On its part, the BOJ believes it important to continue preparations for any future issuance of CBDCs, including the continued conduct of technical demonstration tests, so as to be able to respond in a timely manner to future changes in the external environment.ii Money transmission
Only licensed banks or registered fund transfer business operators are permitted to engage in 'funds remittance transactions' regulated under the Banking Act or PSA as a business. The Supreme Court, in a case precedent, has defined funds remittance transactions to mean 'the planned or actual transfer of funds, as requested by customers, through utilisation of a funds transfer system without physical transportation of cash between physically distant parties'. As funds do not include cryptoassets, however, a cryptoasset remittance transaction is unlikely to be deemed a funds remittance transaction.
In addition, among the stablecoins that have been issued by private business operators, stablecoins whose prices are linked to the value of fiat currency would fall within the definition of currency denominated assets, which are excluded from the definition of cryptoassets. Accordingly, such fiat currency-backed stablecoins are unlikely to constitute cryptoassets. Conversely, the issuance of fiat currency-backed stablecoins will likely constitute a funds remittance transaction. In this connection, as noted in Section I above, under the Amendment Act, the management of stablecoins that constitute EPIs will constitute 'electronic payment instruments exchange services'.