In the decade since the original Bitcoin white paper was released, Japan has played a key role in bitcoin development—and not just because of the anonymous namesake Satoshi Nakamoto, who is not generally thought to be of Japanese origin.

As the tech capital of the world during the eighties and nineties, Japan's citizens are technologically literate, but also live under a unique financial system that relies on interest rates so low they occasionally dip into the negative. Combine this situation with a nationwide ban on gambling, and you have a potent recipe for driving people to crypto en masse—leading Japan to boast the second highest number of crypto traders in the world.

Understandable then, that countries around the world are looking to Japan for regulatory guidance. And at the G20 summit in Osaka last month, Japanese regulators delivered—issuing a handbook to fellow members that reportedly included proposals for protecting customer assets, complying with international security protocols, and dealing with hacks. All in an effort to try and help tighten regulations across the board and agree on a shared international regulatory framework.

Fostering growth

While Japan's financial and technological leanings make it predisposed to cryptocurrency, how the country became an authority is another story.

Early bitcoin evangelists Mark Karpelès and Roger Ver are often credited with helping spread the cryptocurrency word in Japan. And while their presence might have helped startups develop, it was the hack and eventual collapse of the Karpelès-headed MT Gox exchange in 2014 that put Japan on the map as the epicentre of the cryptocurrency revolution.

The Japanese Financial Services Authority—which is equivalent to the UK FCA—initially shirked responsibility for the $400 million heist of Mt Gox, but after picking up the pieces of the exchange that once served 80 percent of all bitcoin traders, started to erect a legal framework to prevent such events from happening again.

The first step was submitting a bill to Japan's legislature, the DIET, that proposed a system requiring domestic exchanges to register with the FSA and be kept under a watchful eye.

As news of the hack spread, it fostered awareness of cryptocurrency both in Japan and abroad, and the Financial Action Task Force (FATF), soon issued its Guidance for a Risk-Based Approach to Cryptocurrencies. This prompted Japan to revise its Payment Services Act to mandate that each virtual currency exchange doing business in the country must register with the FSA, keep customer assets separate from exchange assets, maintain proper bookkeeping, undergo regular audits, and comply with strict KYC and AML checks.

Reining in risks

When neighbouring China put foreign cryptocurrency exchanges behind the great firewall in 2017, traders in the country sought refuge on platforms in Singapore and Japan—fuelling further growth.

In April 2017, Japan stepped up the regulatory scrutiny and revised the Payment Services Act again to introduce a registration system for crypto-fiat brokers. Then in September, the Japanese tax authority ruled that crypto winnings should be categorised as ‘miscellaneous income’, and be subject to tax as high as 55 percent.

These rates—which exceed the taxes levied on stocks in the country—have proved too much to stomach for many investors, forcing Japan to confront another regulatory issue that the West is still grappling with: tax evasion.

Authorities estimate that 10 billion yen (£73.7 million) has been left undeclared by companies and traders in Japan, and lawmakers have called for rates to be revised out of concern they might stifle development.

At the same time, the FSA have begun pressuring exchanges to delist privacy coins, suggesting that Monero, Zcash, and Dash are favoured by criminals and belong to a "digital underground".

But the most unique aspect of cryptocurrency regulation seen in Japan comes from a different direction. Shortly after the country played host to the biggest crypto hack in history, when hackers withdraw $530 million from the Coincheck exchange in January 2018, the FSA suggested that cryptocurrency might mature faster if it was regulated by the companies themselves—ushering in a new era of bottom up grassroots regulation.

Japan's Virtual Currency Exchange Association (JVCEA), was launched in April 2018 and now consists of 21 licensed cryptocurrency exchanges. The body was granted full self-regulatory status by the FSA in October 2018, and now has the authority to advise unlicensed exchanges and set shared standards for members.

As cryptocurrency transitions from the speculative to utility phase, initiatives like this will help Japan react quickly to industry changes, and maintain its position as one of the most progressive regulatory climates.