In a significant move to strengthen investor protection in the digital asset space, Japan’s revised Payment Service Act (PSA) and Financial Instruments and Exchange Act (FIEA) took effect on May 1, 2020. These amendments mark a pivotal shift in how the Financial Services Agency (FSA) regulates cryptocurrency-related businesses—including custodial service providers and derivatives trading platforms—signaling Japan’s intent to build a more transparent, secure, and compliant crypto ecosystem.
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The regulatory overhaul was first proposed by the FSA in March 2019, passed by Japan’s Diet on May 31, 2019, and officially promulgated on June 3, 2019. Final revisions and responses to public feedback were released on April 3, 2020. The groundwork for these changes began earlier, with the FSA establishing a Virtual Currency Exchange Services Study Group in March 2018. This group published its recommendations in December 2018, which largely shaped the final form of the proposed amendments.
At the time of implementation, Japan had 23 FSA-licensed cryptocurrency exchanges. As compliance requirements tightened, several unlicensed platforms chose to exit the Japanese market. For example, BitMEX announced it would cease services for Japanese residents effective April 30, 2020. To support self-regulation within the industry, the FSA also recognized two new self-regulatory organizations (SROs): the Japan STO Association and the Japan Virtual and Crypto-Asset Exchange Association (JVCEA). These bodies work closely with the FSA to enforce high operational standards across the sector.
Pre-Amendment Regulatory Landscape: A Gaps-Filled Framework
Before the 2020 amendments, entities offering virtual currency exchange services in Japan were required to register under the PSA as Virtual Currency Exchange Service Providers (VCESPs). Eligible applicants included Japanese joint-stock companies or foreign firms with equivalent licensing in their home jurisdictions, provided they maintained a registered branch in Japan with sufficient capital and a local representative.
However, while registration was mandatory, the criteria for being deemed “proper and sound” in operations—key to approval—were not clearly defined in law. Guidance emerged indirectly through an 86-page questionnaire issued by the FSA in October 2018, which outlined expectations around corporate governance, cybersecurity, and anti-money laundering (AML) compliance.
Additional obligations for VCESPs included:
- Segregating customer assets from company funds
- Conducting regular audits by certified public accountants (CPAs)
- Maintaining accurate financial records
- Submitting annual business reports to the FSA
- Establishing dispute resolution mechanisms
- Complying with AML/CFT regulations, including KYC procedures under the Act on Prevention of Transfer of Criminal Proceeds
Despite these measures, critical gaps remained. There were no specific rules governing Initial Coin Offerings (ICOs), cash-settled cryptocurrency derivatives, or margin trading. While the FSA issued warnings that some ICOs might constitute securities offerings under the FIEA—or that token sales might require PSA registration—no formal framework existed.
Key Changes Introduced by the 2020 Amendments
The revised PSA and FIEA now provide a comprehensive regulatory framework covering previously unregulated areas such as crypto custody, derivatives trading, and stablecoins.
Expansion of PSA Oversight: Who Must Register?
Under the updated PSA, the definition of a Crypto Asset Exchange Service Provider now includes any entity that:
- Buys or sells crypto assets
- Acts as an intermediary in such transactions
- Provides crypto asset custody services
This is a major change: prior to May 2020, pure custodians who did not facilitate trades were outside the PSA’s scope. Now, any service holding private keys or capable of transferring client assets without user consent falls under regulation—unless it uses multi-signature systems where no single party controls all key fragments.
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Enhanced Registration Requirements
Entities seeking registration must now disclose shareholders holding 10% or more voting rights. Financially, if a provider holds customer assets, its net assets must equal or exceed the total value of crypto held in hot wallets—a stricter standard than the previous minimum capital requirement of ¥10 million and positive net worth.
Strengthened Investor Protections
1. Trust-Based Handling of Customer Cash
Customer fiat deposits must now be held in trust accounts managed by licensed trustees, with clients named as beneficiaries. At least one designated agent overseeing the trust must be a qualified professional (e.g., lawyer, CPA, tax accountant). Trust assets can only be invested in low-risk instruments and must be reconciled daily. Any shortfall must be corrected within two business days.
2. Cold Storage Mandate for Crypto Assets
Customer crypto holdings must be stored in cold wallets or equivalent secure environments, with no more than 5% allowed in hot wallets for operational needs. Even this small portion must be isolated. For every unit of client crypto kept online, the exchange must hold an equal amount of its own crypto in cold storage—ensuring clients have priority in case of insolvency.
According to FSA guidelines, “cold wallet equivalents” include any system that stores private keys offline using electronic devices, electromagnetic media, paper records, or other methods with equivalent security controls.
3. Mandatory Annual Audits
Registered providers must undergo annual audits by CPAs or accounting firms to verify compliance with asset segregation and storage rules.
4. Emergency Preparedness Plans
Exchanges must establish and implement contingency plans for scenarios such as system failures or inability to deliver assets to customers.
Best Execution and Fair Trading Practices
Similar to obligations for securities brokers under FIEA, crypto exchanges must now:
- Disclose recent execution prices and benchmark rates from self-regulatory bodies like JVCEA
- Implement policies to achieve best execution and disclose them publicly
- Notify clients when acting as counterparty in trades
- Monitor and manage conflicts of interest
- Detect and halt manipulative or fraudulent activities
- Avoid excessive leverage and manage material non-public information responsibly
Prohibited Activities
The amendments prohibit misleading marketing, failure to disclose data collection practices, facilitating illicit transactions, market manipulation, and spreading unsubstantiated claims about asset performance.
Margin Trading and Derivatives Regulation
Margin trading is now subject to stricter rules akin to forex trading:
- Clear disclosure of terms and risks
- Mandatory collateral deposits (minimum 50% of position value)
- Implementation of automatic loss-cutting mechanisms
Crypto derivatives are now regulated under the FIEA, not the PSA—even if settled in crypto. This means platforms offering futures, options, or swaps on crypto assets must register as Type I Financial Instruments Business Operators.
Advertising Restrictions
Marketing materials must include:
- Company name
- Confirmation of FSA registration
- A clear statement that crypto assets are not legal tender
- Warnings about price volatility and potential losses
- Disclosure that crypto payments depend on merchant acceptance
Promotions emphasizing speculative gains over utility as payment methods are prohibited.
Stablecoins and Fund Management: Gray Areas Clarified
While the FSA has not definitively ruled on whether stablecoins qualify as crypto assets under the PSA, they are likely to fall under regulation if used in exchange services. Investment funds dealing in crypto may require their managers to register as exchange providers if they actively trade underlying assets.
FAQs
Q: What triggered Japan’s cryptocurrency regulation update?
A: Following high-profile exchange hacks and rising investor concerns, Japan sought to strengthen oversight. The 2018 Coincheck hack ($530M loss) highlighted vulnerabilities in custody and compliance.
Q: Do foreign exchanges need to comply?
A: Yes. Any platform serving Japanese users must meet FSA standards or restrict access, as seen with BitMEX and others exiting the market.
Q: Are all crypto custody services regulated?
A: Only those controlling private keys or able to move funds unilaterally. Decentralized or non-custodial wallets are exempt.
Q: How does Japan classify crypto derivatives?
A: They’re treated as financial instruments under FIEA, requiring registration similar to stock or forex derivatives.
Q: Can individuals invest in crypto freely under these rules?
A: Yes—regulations target service providers, not end users. However, exchanges must ensure suitability and risk awareness.
Q: What role do SROs like JVCEA play?
A: They assist the FSA in monitoring member exchanges, setting technical standards, conducting audits, and promoting ethical practices.
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Conclusion
Japan’s 2020 cryptocurrency regulatory amendments represent a mature approach to balancing innovation with investor protection. By expanding oversight to custody and derivatives, enforcing strict asset safeguarding rules, and empowering self-regulatory bodies, Japan has set a benchmark for responsible digital asset regulation. As global regulators look for models to emulate, Japan’s framework offers valuable lessons in clarity, enforcement, and adaptability.
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