How Japan handles crypto exchanges differently

Japan’s crypto exchanges have different rules than exchanges in other parts of the world.

Why it matters: FTX Japan, by all reports, didn’t come up short on customer funds, and that could be attributed to the more stringent laws in place for how exchanges in Japan operate.

Flashback: In 2018, Japanese crypto exchange Coincheck had hundreds of millions of dollars worth of the NEM cryptocurrency stolen.

• This followed one of the other most notorious hacks in crypto history, Mt. Gox, which was also based in Japan. A comparable amount had been stolen from that bitcoin-only exchange in 2014.

The legacy of those consumer losses made it urgent for Japan to create new rules for crypto exchanges, which are more stringent than what most other nations have done, according to the Atlantic Council’s Ananya Kumar, a part of the team behind the organization’s Crypto Regulation Tracker.

• Of note: Coincheck was later acquired by the Monex Group for about $33 million, and received a license in 2019. Monex is interested in FTX Japan now, as well.

How it works: Kumar highlighted several key rules for such businesses in Japan, which include:

• Customer assets and company assets must be held separately, with holdings verified in annual audits.
• Exchanges have to be a member of a self-regulatory body recognized by the financial regulator.
• Investors can’t trade at more than 2X margin on exchanges, which is vastly lower than elsewhere, the Japan Times reported.

Meanwhile, 95% of all customer funds must be held by the exchanges in cold wallets. That is, wallets not actively connected to the internet.

• 5% of customer funds can be made ready for withdrawal by holding them in hot wallets, but the exchange has to self-insure whatever is in hot wallets with its own funds in its own cold wallets.
• In other words, if there were a breach on the hot wallet, the exchange could cover it out of its own funds.

What they’re saying: “What’s brought about the latest scandal isn’t crypto technology itself,” Mamoru Yanase of Japan’s Financial Services Agency (FSA) told Bloomberg. “It is loose governance, lax internal controls and the absence of regulation and supervision.”

• The FSA is urging the rest of the world to match Japan’s oversight.
• “I think Coincheck was a big regulatory moment in Japan that didn’t effect other countries as much,” Kumar said.
• Of note: There’s still some concerns about whether FTX Japan customers will get all their funds back, according to reporting from the Japan Times. Not because assets aren’t there, but because of unknown legal obligations to the original company.

The other side: Not everyone is enthusiastic about Japan’s rules.

• They make it more expensive to run an operation there than elsewhere, which might be why U.S. exchanges, Kraken and Coinbase, both recently exited the country.

By the numbers: About 30 exchanges operate in the country, according to the Financial Services Agency. Some of those may include custodians, however, which are also subject to the rules.

Quick take: Customers may be better protected in Japan, but it’s also not exactly a hotbed of competitive crypto companies.