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Author: Tide
Short Summary
1. The paper discusses Japan’s burgeoning Web3 market, projecting significant growth driven by gaming content, NFTs, and blockchain technology. Major players in the gaming industry, as well as financial institutions, are actively engaging with blockchain technology, indicating a promising future for Japan’s Web3 market.
2. The regulatory environment in Japan might be challenging for blockchain entrepreneurs, leading to the exodus of cryptocurrency startups to countries with more favorable regulations. The research suggests that Japan should foster responsible innovation through a balanced policy approach to encourage the next Web3 adoption.
3. Despite Japan’s strong technological foundation, the practical implementation of emerging technologies, including cryptocurrencies, presents challenges. Japan’s risk-averse culture, aging population, and preference for stability over disruptive innovation hinder the adoption of emerging technologies. The following research highlights the need to address psychological barriers and boost momentum for next-generation finance in Japan.
1.0 Introduction
Under the leadership of Chairman Gary Gensler, the SEC has faced criticism from industry leaders, regulatory authorities, and lawmakers. Their approach of ‘enforcement-based regulation’ towards digital assets has drawn attention. The SEC has filed lawsuits against cryptocurrency companies such as Coinbase, Kraken, and Ripple, and there has been no approval for physical Bitcoin exchange-traded funds (ETFs) in the United States. The U.S. is falling behind in the regulation of cryptocurrencies compared to other countries such as Australia, the United Kingdom, and Singapore, causing the cryptocurrency industry to drift away from the nation. Industry voices are suggesting a focus on prioritizing markets outside the United States, concentrating on platform growth and user adoption, and potentially returning to the U.S. market when the timing aligns.
As a result, there is a growing need to explore and harness markets beyond the U.S. In this context, Japan’s role in the crypto industry is gaining significance. With its forward-thinking government and a population of 120 million, it has emerged as an attractive market for web3 projects and practitioners. This uniquely positioned country, rich in gaming heritage and tech culture, is well poised to capitalize on the growing blockchain gaming market, offering lucrative opportunities to those eager to establish cryptocurrency businesses in the region.
A recently published “Web 3 White Paper” by Japan’s ruling Liberal Democratic Party’s Web3 project team has stated that Japan might be the first to embrace a ‘crypto spring’ having overcome numerous cryptocurrency-related challenges. This article delves into whether Japan, which had lagged behind in the adoption of Web 2.0 technologies, can successfully reform its industry and emerge as a global leader in crypto and Web 3.0 development. The discussion encompasses Japan’s history with cryptocurrencies, its regulatory landscape, and its current standing in the market.
2.0 Japan’s Experience with Digital Assets & the “Crypto Winter”
Originally at the forefront of cryptocurrency adoption, Japan gradually emerged as a significant player in the crypto industry since the early 2010s. In 2017, Japan outpaced the U.S. and China, securing an impressive 43.6% share of the global Bitcoin trading volume. However, by the late 2010s, Japan gradually became a less appealing destination for entrepreneurs, both domestic and international. The strengthening of regulations in response to a series of major hacking incidents on exchanges, coupled with the ambiguity in tax policies and rules, caused Japan’s cryptocurrency market to lose its luster. Many entrepreneurs and investors reluctantly had to leave Japan in search of a more favorable business environment.
Adding to the woes, the “crypto winter” arrived. Cryptocurrency prices and NFT trading volumes declined, triggered by factors such as interest rate hikes in the U.S. The rapid deterioration of the global business environment was exacerbated by the collapse of algorithmic stablecoins and major cryptocurrency exchanges worldwide. The era that could be described as the frenzy of web3 reached a turning point, and countries worldwide began strengthening regulations. Amid a worldwide contraction, a strong sense of crisis also gripped Japan’s cryptocurrency industry.
However, the sudden onset of winter served as an opportunity to shed light once again on the resilience of Japan’s web3 environment, which had been somewhat forgotten on the global stage. In the aftermath of the financial collapse of the cryptocurrency exchange FTX in November of last year, over a million investors worldwide found themselves unable to withdraw their funds. However, FTX’s Japanese subsidiary allowed withdrawals for all verified accounts in February, and as of April 25th, approximately 10,000 customers have withdrawn approximately 23.4 billion yen worth of cryptocurrency and cash.
3.0 A Solid Regulatory Foundation
Arguably, Japan has the most mature crypto regulations in the world, with a key stance being that “cryptocurrencies are not considered securities.” The groundbreaking legal milestone came in the form of the amended Payment Services Act in 2017, where Japan became one of the first to provide a comprehensive definition of “what cryptocurrencies are” at the national level.
Japan has weathered challenges in the industry in the past and emerged resilient. Prime Minister Kishida’s administration is confident that Japan is well-positioned to play a distinctive role in the crypto sector. They see the current moment as an opportunity for Japan to enact a national strategy to actively foster the development of a globally competitive web3 business environment. Additionally, they aim to take a leading role in international regulatory discussions. The Japanese government initiated its national strategy in January 2022 through the establishment of the Headquarters for the Promotion of a Digital Society by the ruling Liberal Democratic Party. Since then, the Web3 Project Team has consistently presented legislative and regulatory reforms to the Party, with some reforms already implemented and others still pending.
One of Japan’s competitive advantages lies in the clarity of its regulation, which stands in contrast to the U.S. In the U.S., there are various regulatory bodies, including the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) as well as a patchwork of state regulatory authorities. In contrast, Japan has a single regulatory authority for cryptocurrency, which is the Financial Services Agency (FSA). This positions Japan to become a mature market where predictability is high and businesses can venture into the Web 3 business with confidence under clear rules. Here are some recent key developments :
ICO (Initial Coin Offering)
- A new law was enacted in September 2023, to revise the limited partnership law, enabling startups to raise money from venture capital firms by selling cryptocurrency instead of stocks, providing more funding options
Stablecoin Regulatory Framework
- The Amended Payment Services Act enforced in July 2023, defines permissionless stable coins as electronic payment methods. Japanese exchanges are now able to apply for special licenses to trade stablecoins, enabling the entry of foreign stablecoins like Tether and USD coins into the Japanese market.
- Four major banks and digital lenders are already planning to issue their own stablecoins, including Mitsubishi UFJ Financial Group (MUFG), which is preparing to issue the yen-pegged Progmat Coin.
Non-Fungible Tokens (NFT)
- In March 2023, The Financial Services Agency (FSA) outlined the scope of NFTs that are exempt from cryptocurrency regulations. This is expected to further accelerate business developments related to NFTs. Specifically, two main requirements have been highlighted
- Issuers must clearly state that tokens are not intended for general payments
- Tokens should have limited attributes for settling goods or services, considering factors like high unit prices (over 1,000 yen) or limited issuance (fewer than 1 million units
Tax Reform
- The proposal to exempt corporate tax on capital gains for startups issuing their own tokens was approved in December 2022.
- The Web3 White Paper issued by the Liberal Democratic Party’s Web3 Project Team in July 2023 proposes excluding tokens issued by other companies and not intended for short-term trading from year-end taxation and only considering them taxable when they are exchanged for fiat currency
- The white paper further made two proposals regarding taxation on cryptocurrencies held by individuals
- Introduce a fixed 20% tax rate for gains and losses, addressing the high 55% maximum tax rate, which has led to asset outflows
- Consider taxing gains and losses when converting cryptocurrencies to fiat currency, rather than taxing cryptocurrency-to-cryptocurrency exchanges, simplifying tax reporting
DAO
- To address the increasing demand for clarifying the legal status of DAOs under Japanese law, the Web 3 white paper proposes that the Limited Liability Company (LLC) structure is well-suited for DAOs if they are to be granted legal personality. As a result, the most viable option is seen as the establishment of a specialized law for LLC-type DAOs, accompanied by amendments to corporate law and financial regulations concerning member equity tokens.
Security Token
- In May 2020, the amended Financial Instruments and Exchange Act established regulations for security tokens, including electronic record transferable beneficial securities. Since then, there has been a surge in real estate and corporate bond security token offerings, with major players entering the market.
- On the other hand, there is virtually no existing secondary market for security tokens, resulting in minimal trading activity. To address this issue, there are efforts underway to initiate the trading of security tokens on Private Trading Systems (PTS).
- While there are regulations emphasizing investor protection for security tokens, discussions regarding tax regulations tailored to their unique attributes need further attention. In the future, exploring tax considerations, including tax procedures, will be vital to advance the development of the security token market.
4.0 International Leadership
While the national strategy primarily focuses on Japan’s domestic progress, international leadership has always been a crucial aspect. Over the past two years, Japan has significantly advanced on the global stage, serving as both a regional leader and during its G7 Presidency. On a regional level, Japan is emerging as a leader in the digital marketplace. In May 2023, Prime Minister Kishida inaugurated the Digital Innovation Center at the Economic Research Institute for ASEAN and East Asia. Notably, the development of a regional cross-border payment system, known as the “Bakong system,” in collaboration with a Japanese startup and the National Bank of Cambodia, has connected countries across the region using Cambodia’s CBDC and stablecoins. By 2022, this system boasted over 8.5 million users, handling payments exceeding $15 billion, with plans for further expansion.
Globally, Japan took on the role of G7 President in 2023, using the opportunity to assert proactive leadership and clarify its position as a technology-neutral and responsible innovator, particularly in the context of web3. Key focuses included reinforcing consumer and investor protection, establishing uniform international laws for data and digital asset transfers, and advocating for the “travel rule” to combat money laundering and terrorist financing. The G7 Presidency witnessed alignment on the “national strategy” talking points, acknowledging the importance of regulation and oversight in managing risks related to crypto-asset activities. Central bank heads highlighted the significance of a reliable global payment system, recognizing web3 technologies like CBDCs and stablecoins. Digital and technology ministers endorsed Japan’s vision for Society 5.0 and the creation of innovative digital ecosystems. These agreements led to updates in the G7’s “inventory of rules for digital markets,” plans for a Fall 2023 summit on digital assets and security, support for the “travel rule” (formally adopted by Japan in April 2022), and a joint event by Japan and the World Bank to expedite the transition to a secure digital infrastructure.
5.0 Japan’s Economy and Web 3.0 Market
While government efforts and policies have a great impact on the development of the industry, equally or even more important are the efforts of the actual participants who drive web3: web3 firms and users. Japan, renowned for its technological finesse and gaming heritage, was once an unrivaled leader in the global technology arena. However, in recent decades, it has grappled with the ascendance of Silicon Valley and China. Following the bust of the economic bubble in the early 1990s, Japan’s economy has been characterized by a prolonged period of low growth, often referred to as the “Lost 30 years.” Despite being hailed as “Japan as No.1” during the 1980s due to its remarkable success, Japan’s economy became trapped in its past achievements, unable to diversify the economy and reduce dependence on manufacturing. Amid intensifying global digital competition, Japanese businesses face the imperative of a fundamental industrial restructuring.
In this respect, Japan’s burgeoning Web3 market shines as a beacon of hope. A recent report from AT Kearney Japan underscores that the country’s Web3 market is outpacing the global average, propelled by a powerful blend of gaming content and intellectual property-related businesses. Japan believes that “NFTs” are “the catalyst” of the “digital economy in the Web 3.0 era.” Japan’s Web 3.0 Market is projected to grow from around 0.1 trillion yen in 2021 to about 2.4 trillion yen by 2027, showing over a 20-fold increase. Japan’s cultural landscape, steeped in games like Tamagotchi and Pokemon that center around character-nurturing, aligns perfectly with the principles of blockchain gaming. These games, deeply ingrained in the Japanese psyche, have cultivated a natural affinity with blockchain games, emphasizing the enhancement of non-fungible tokens (NFTs) through gameplay.
Amid the global headwinds, new players in the Web 3.0 industry have begun to make their presence felt in Japan. Gaming behemoths have begun participating as node validators on various blockchains, acquiring crucial insights into different aspects of blockchain technology like accounting, legal, and tax perspectives(e.g. Square Enix, Sega, Sony). Since the amendment of the Payment Services Act in June of last year, major financial institutions have successively expressed their serious consideration of issuing and promoting stablecoins(e.g. Circle, SBI, MUFJ, Mizuho). Traditional large corporations, such as major telecommunications companies, which had previously had limited involvement in cryptocurrencies, have been announcing significant investments in the web3 sector(e.g. NTT Docomo). In addition to existing major companies entering the industry through joint ventures and subsidiaries, new local VCs specializing in web3 investments are also emerging(Skyland Ventures, Emote, MZ Web3 Fund). Furthermore, many local governments have shown keen interest in web3 projects, with several municipalities venturing into issuing their own NFTs as tools for regional revitalization. Creators continue to explore blockchain technology’s potential as a new avenue for expression, while citizens see it as a means to address social issues.
As the private sector, especially in emerging fields like blockchain gaming, spearheads this dynamic growth, Japan is solidifying its position as a key player in the Web 3.0 landscape. This progress highlights how a forward-thinking, well-regulated environment can serve as a catalyst for innovation and growth in this cutting-edge field.
6.0 Challenge
Despite the enthusiasm and the initiatives, the practical implementation of emerging technologies presents a formidable challenge for both the Japanese government and companies. According to a 2023 Chainalysis report, global cryptocurrency adoption is led by India, Nigeria, and Vietnam, with Japan ranking 18th. Japan’s risk-averse culture, aging population, and preference for long-term stability over disruptive innovation create concerns about the adoption of emerging technologies, despite its strong technological foundation.
Japan’s aspiration to make Web 3.0 a driver of economic growth faces practical hurdles, especially in a country that lags behind in the actual adoption of emerging technologies. A Ministry of Economy, Trade, and Industry report highlights a shortage of entrepreneurs, limited exit opportunities, and a weak domestic market for innovative products and services, posing challenges for startups and individuals venturing into the Web 3.0 realm.
Initiatives like Japan’s Digital Agency have seen limited success in changing the Japanese attitude toward innovation, with little progress reported even a year after its establishment in late 2022. An earlier report reveals that only 7.5% of the numerous national government-level procedures could be completed online, further complicating Japan’s ambitious entry into the Web 3.0 ecosystem. Japan’s push for digital payments also encounters challenges as the cash-centric culture persists, with cashless payments constituting less than 30% of all private consumption expenditure, potentially influenced by the COVID-19 pandemic. The requirement of a Japanese phone number or bank account for digital payments in Japan adds another layer of difficulty, hindering international organizations and individuals seeking to promote Japan’s participation in the borderless world of Web 3.0.
On a more individual level of cryptocurrency adoption, public interest remains limited. There seems to be a prevalent perception of cryptocurrencies as inherently risky, driven by a lack of proper understanding, a sentiment that has been exacerbated by high-profile hacking incidents. A survey conducted by SBI Financial and the Economic Research Institute in August 2022 unveils a cautious stance among Japanese individuals regarding cryptocurrency investment and usage. In a comparison with six major countries (the United States, the United Kingdom, Germany, South Korea, and China), Japan registers the lowest levels of cryptocurrency awareness and interest. A notable number of respondents in Japan reported being unfamiliar with concepts like NFTs, stablecoins, or security tokens. Even among those with comprehensive knowledge, there is a reluctance to enter the cryptocurrency market, highlighting significant challenges that businesses aiming for domestic expansion must address.
7.0 Next Steps
Under the current regulatory framework, Japan does not seem to be the most hospitable environment for blockchain entrepreneurs. Stringent regulations, along with a less-than-friendly tax system, have led to the exodus of cryptocurrency startups to countries like Singapore, which doesn’t impose capital gains tax. While the strictness of regulations in Japan has contributed to asset protection for FTX customers, it has also hindered innovation, with some comparing it to the impact of excessive regulations on industries like private lodging and ride-sharing.
In contrast, the United States exhibits a more lenient approach to innovation, but the absence of unified regulations has resulted in industry confusion and hindered the development of a national strategy. In other words, the United States leans towards a “market-driven” approach, allowing competition within the private sector and addressing issues as they arise. Meanwhile, Japan follows a “regulation-first” approach, where industries are often formed based on predetermined rules. Given the distinct advantages and disadvantages of these divergent regulatory approaches, the Japanese government may find it most advantageous to foster responsible innovation through a policy approach that strikes a harmonious balance. This balance should encompass both regulatory flexibility to encourage new ventures and the clarification of rules to broaden the scope of web3 adoption.
Moreover, the initial step in nurturing a healthy domestic cryptocurrency market is to address the significant psychological barriers preventing potential users from participating. The quest for solutions to significantly boost the momentum of next-generation finance is expected to persist, with both public and private sectors actively seeking ways to achieve this goal.
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