Regulatory developments concerning crypto-assets are currently taking place in many countries. Japan, on the other hand, has been ahead of the rest of the world in developing legislation, and there is a tailwind to promote Web 3.0 in light of the global situation.
Against this backdrop, a legal amendment was made in June that clarified the definition of stave coins ahead of the rest of the world. How will this change crypto assets and the payments business in Japan?
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The revised Funds Settlement Act, which came into force on 1 June 2023, clarified regulations on stable coins for the first time. In line with this, attention to stablecoins is increasing day by day.
The definition of stable coins as a result of the amendment to the law has significant implications for operators already engaged in related businesses and those considering doing so in the future.
Stablecoin is said to be effective mainly in areas of settlement, such as cross-border transactions with foreign countries and accounting procedures, which have been time-consuming in the past.
In addition, as it is now possible to issue stable coins denominated in legal tender in Japan, the legal amendment can be seen as a positive development for existing crypto asset users.
To begin with, stablecoin is written in English as ‘Stablecoin’, meaning ‘stable currency’. Crypto assets are known for their extremely high volatility, but the main feature of stablecoins is that they have backing assets and other assets to stabilise their value.
There is a wide range of types of stablecoins. The most common types are ‘legal tender-backed’, whose value is linked to legal tender such as the Japanese yen or US dollar, ‘crypto-asset-backed’, whose value is backed by a specific crypto-asset, and ‘commodity-backed’, whose value is linked to commodities such as gold, oil or platinum.
There are also ‘algorithmic’ stablecoins, which are issued in line with the supply-demand balance of the market based on algorithms and indices, but these are by no means mainstream at present.
This was triggered by the disturbances that occurred last year, also known as the ‘Terra Incident’. In this disturbance, the price of Terra USD (formerly UST), which is linked to the US dollar, diverged, resulting in the collapse of the ecosystem.
Terra USD is a stabled coin issued on the Terra blockchain. The native token of the Terra blockchain is Terra (formerly LUNA), which was closely related to Terra USD.
However, when the price of Terra USD diverged from USD, the price of Terra also collapsed, leading to a negative spiral, and the supply-demand balance completely collapsed. Since then, the price of Terra USD has never returned.
Regulators in many countries, including the US, have seen the incident as a problem and have clearly stated their intention to urgently put stablecoin regulations in place.
Japan's revised Funds Settlement Act also specifies the handling of algorithmic stablecoins. Stable coins denominated in legal tender are broadly classified into two categories: ‘digital money-like’ types, which are used as a means of electronic payment, and other ‘crypto-asset’ types.
Algorithmic, crypto asset-backed and commodity-backed stablecoins are generally not classified as digital money-like types and are treated as crypto assets or financial instruments.
Digital money-like instruments are defined as instruments that are issued with a value linked to legal tender such as the Japanese yen and promise redemption at the same amount as the issue price, or equivalent.
Issuers are also restricted to licensed persons such as banks, fund transfer operators and specified trust companies, and as part of the measures against money laundering and terrorist financing, monitoring of suspicious transactions is required, among other measures.
In addition, as mentioned above, digital money-like instruments must be used as electronic payment instruments. Electronic means of payment are defined in four categories, from No. 1 to No. 4, and crypto asset users are familiar with the US dollar-backed Tether (USDT) and USD Coin (USDC), which can be used to purchase goods and pay for them, and can also be purchased and sold between unspecified parties. The basic nature of the money is classified as No. 1, as it ‘can be used to purchase or pay for goods and can still be purchased and sold with unspecified persons’.
As can be seen from this, the revised Funds Settlement Act actually means that stable coins denominated in legal tender are not classified as crypto-assets under Japanese law.
In line with this, as well as crypto asset exchangers who broker transactions in crypto assets, in some cases it will be necessary to obtain one of the following licences to broker transactions: banking business licence, fund transfer business or electronic means of payment transaction business.
The first half of this article touched on the basic types of stable coins and how they are handled in accordance with the revised law.
In the second half, we will delve deeper into the classification of stable coins in Japan and what kind of use cases are possible.
Digital money-like stablecoins have been explained so far in line with the revised Funds Settlement Law, but they are also classified into two types: - bank deposit-type stablecoins
・Bank deposit type
・Bank deposit type
・Trust type
These can be further divided into three main types: bank deposit type, fund transfer type and trust type. Each is explained in turn.
As the name suggests, the bank deposit type is a stablecoin issued using bank deposits. Although there are no restrictions on the amount of money that can be transferred, there is the risk that money can only be transferred to addresses that are KYC-registered and that there is no guarantee that funds will be returned to users in the event of a bank failure.
In addition, the FSA's opinion in its public comments on the implementation of the revised Funds Settlement Act also states that ‘international evidence shows that this may not be compatible with the sound and proper management of banks’ business’ and that banks need to carefully consider the issuance of stable coins. The reality is that the feasibility of such a system is not yet clear at this stage.
The fund transfer type is a stable coin that can be issued by operators who have obtained a fund transfer business licence. Therefore, private companies can issue stable coins as fund transfer operators if they have this licence.
The advantages over the bank deposit type are that, although further judicial clearance is required, money can be transferred to addresses that are not KYC-registered, and customer assets are protected even if the fund transfer operator fails, as the user's deposit has to be deposited with the Legal Department until the transaction is completed. This protects customer assets even in the event of a failure of the money transfer agent.
On the other hand, private companies are considered to have a greater risk of bankruptcy than banks, and the possibility of delays in remittances, etc. and the fact that the maximum amount of remittances per transaction is limited to JPY 1 million make it difficult to use the system for business-to-business transactions, which is seen as a disadvantage. Therefore, at present, it is considered difficult to go beyond the scope of individual use.
Finally, the trust type is a stablecoin issued by a specified trust company and is defined as a No. 3 electronic means of payment. A specific trust company is an organisation that issues specific trust beneficiary rights.
The term ‘specified trust beneficiary right’ is described in the revised law as ‘property value that can be transferred using an electronic information processing system’ and is also described as ‘limited to those recorded by electronic means on electronic equipment or other objects’, so in short, it is said to refer to the stablecoin itself. ...
Trust beneficiary rights also simply refer to the right to receive profits generated from property held in trust. A clear example would be rental income from real estate.
This trust type is relatively easy to issue compared to the bank deposit and fund transfer types mentioned so far, and can in effect transfer more than one million yen.
In addition, the issuer's credit risk is also reduced, as redemption requests can be made to the trust company in the event of a contingency.
Therefore, it has been pointed out that, at present, the issuance of stablecoins in this trust type is a relatively low hurdle for operators.
No law has so far defined stablecoin to this extent, and Japan can be said to be ahead of the rest of the world. In the US, for example, moves towards legislation on stablecoins began in earnest this year and discussions are still ongoing.
The draft includes the granting of licences to issuers and the authority and conditions for intervention by regulators, and bipartisan members of Congress participating in the discussions have pointed out that stablecoins have the potential to bring about changes to the US payment system.
In fact, positive voices were heard, with Federal Reserve Chairman Jerome Powell referring to stablecoins as ‘a type of money’.
On the other hand, SEC (US Securities and Exchange Commission) Chairman Gensler, who is tightening the screws on crypto-asset-related businesses, considers altcoins, including some stablecoins, to be securities, indicating a difference in temperature among regulators. Legislation, including decisions by supervisory ministries, is therefore likely to take some time.
In Europe, the EU has passed MiCA, a comprehensive crypto-asset regulation for the EU area, and the regulation on stable coins is scheduled to come into force in 2024. The regulation has resulted in strict regulatory developments, such as requiring stablecoin issuers to hold sufficient cash and to meet security-related risk mitigation requirements.
In addition, the trading limit for stablecoins issued by private companies, such as Tether and USD Coin, is restricted to EUR 200 million (approximately USD 31 billion) per day.
Other countries and regions such as Singapore and Hong Kong, which are developing crypto-asset regulations, are also discussing stable coins, and more countries are expected to follow suit in the future.
It is thought that the use of stablecoins will continue to advance in other countries, but what exactly can be done with them? Here, we will touch on some of the situations in which stablecoins are expected to demonstrate their capabilities.
The first area that many people will have heard of is that they can be an effective tool for use in trade and cross-border transactions.
When these transactions are carried out using existing methods, very high fees are paid and it takes a lot of time from the transfer of money to the confirmation of receipt.
By using stablecoin as an alternative, the fees can be reduced and the transfer and confirmation of receipt of funds can be carried out much faster than with conventional methods.
Another advantage is the transparency of the blockchain, which allows the flow of transactions to be monitored.
In addition, smart contracts can be used to automate corporate payments, and transactions between individuals can be conducted with less risk of price fluctuations than with conventional crypto assets.
At present, based on the regulatory environment for crypto assets themselves, the benefits of using them are rather greater for corporations than for individuals.
It is also difficult to say whether stable coins backed by US dollars, such as Tether and USD Coin, can be traded on domestic crypto asset exchanges right now. Strictly speaking, the revised Funds Settlement Act allows for the handling of legal tender-denominated stablecoins issued by overseas companies, but there are very high hurdles to overcome in order to actually handle them.
First of all, the quickest way is for foreign issuers to obtain the licences required to issue stable coins in Japan.
However, this is not a good idea as it is expected to take a long time to obtain a licence.
In such a case, direct distribution through an intermediary could be considered, but in this case, fund transfer operators would be forced to deal with the risk of issuer bankruptcy and would be restricted to a maximum transfer limit of 1 million yen, so they would only be able to develop a narrowly focused business.
In this case, there could be a case for direct distribution via an intermediary, but in this case, a fund transfer agent would be forced to deal with the risk of issuer bankruptcy and would only be able to develop a narrow business because the maximum remittance limit is limited to JPY 1 million.
Given this situation, the use of trust-type schemes is currently considered effective. However, the intermediary of the foreign issuer must of course have the necessary licence to issue stable coins.
Therefore, at present it takes a certain period of time for intermediaries to obtain a licence, and the reality is that they have to wait.
There is already a growing movement in Japan to start issuing stable coins in line with the requirements of the revised Funds Settlement Act. In the future, stablecoins may first appear for circulation in an ecosystem designed for corporate use.
Subsequently, stablecoins will be issued on an infrastructure that is highly compatible with blockchain gaming, and transactions between individuals will become more active.
The activation of transactions between individuals will enable transactions on DeFi, and eventually domestic crypto asset exchanges may be able to operate lending services and the like.
The establishment of such a business model could improve the presence and value of the Japanese yen and create a virtuous circle.
As the law has not yet been amended, it may be difficult for many users to envisage using stable coins denominated in Japanese yen.
However, it is not too late to get information about the possibility of their wide use as a convenient means of payment in the not-too-distant future, and to choose the right stablecoin for each situation when using them in the days to come.
Expectations are high that the Japanese yen's presence and value will be enhanced by its use in conjunction with business situations.
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