Akira Tokutsu is a legal scholar of financial law, corporate law, and commercial law. His research interest was the relationship between law and ownership structure, especially cross-shareholdings in Japan. In 2016, he started financial law research as a member of joint research group of fintech. He made some presentations of financial regulations relating to fintech and cryptocurrencies in international conference, especially in Chinese conferences.
The Interaction between Tokenization and Financial Law’s Framework in Japan
Abstract:
Financial Law has been made really practically and pragmatically. Various new financial phenomena require the response by financial law ad hoc. “Financial Law” contains a lot of statues and acts. It is completely different from German style Criminal Law, which is ordered systematically. Therefore, there are often some confusions in the actual legislature of financial law. This paper tries to show what confusions “tokenization” led in Japan’s financial law and how Japan’s financial law cure the confusions.
Japan launched a new rule special for cryptocurrency like Bitcoin in 2016, that was earlier than the other developed countries. Because it was too early, the rule was not ordered enough and had confusions.
In 2016, Reform of Payment Services Act introduced the special rules for cryptocurrency. This act called cryptocurrency “virtual currency” (2016 Payment Services Act, art. 2 (5) (i)). Its “virtual currency” could contain not only cryptocurrency like Bitcoin but also various other tokens dealt in the exchanges with cryptocurrency at that time (2016 Payment Services Act, art. 2 (5) (ii)).
Financial law has various fields, and token also has various financial instruments. Typically, financial tokens can be divided into three categories in theory. (i) A Payment Token, a digital token representing cryptocurrency like Bitcoin; (ii) a Utility Token, a digital token with rights to purchase the products under development after it is completed; (iii) a Security Token, a digital token with rights to receive profits sharing from the business.
At first, Japan’s Payment Services Act was thought to apply the rules relating to “virtual currency” to all (i), (ii), and (iii) tokens. As if to back it up, the term “virtual currency” was changed to the term “crypto asset” in the act (2019 Payment Services Act, art. 2 (5) (i)). However, the Payment Services Act was originally legislated for payments. In addition, there are various payment instruments. It was unreasonable to respond to all financial instruments with only one-size-fits-all regulation.
Therefore, in 2019, the rule relating to (iii) security token was changed and regulated by security law (2019 Financial Instruments Act, art. 2 (3)). As above mentioned, there is various payment methods. Cash, or legal tenders, has high finality, while check has low finality. Utility token has an issuer or a final obligator to repay the debt represented in token. On the contrary, payment token with DLT (distributed ledger, like Blockchain) does not have, or at least cannot be identified, an issuer or an obligator. In consideration of this difference, the guideline limited the target of Payments Services Act just into (i) payment token (June 2019 Working Guideline 3rd Book—Financial Companies, I-1-1 (iii)). Despite the change of term to the broad meaning “crypto assets,” its target was limited into (i) payment token.
On the contrary, (ii) utility token has not had any new regulation. However, that does not mean that (ii) utility token is not regulated by any rule. (ii) Utility token is regulated by the current rule for prepaid instruments (in Japan, telephone cards were the most popular before mobile phones were distributed. Now, the prepaid cards or instruments for train companies are really popular).
As mentioned above, tokenization led confusion in financial regulation at first. However, some time later, financial instruments from tokenization became regulated orderly based on the framework of financial law. In addition, tokenization clarified the hidden framework of financial regulation, which we had assumed. This is an interaction between tokenization and the framework of financial law.
This interaction is seen in the rule relating to Stablecoin, which has been popular in Japan. Stablecoin can be divided into two types, based on its mechanism. One is set algorithm based on computer program to control the amount in circulation in order to keep its price at specified price like $1 or 1 JPY in Stablecoin. (e.g. TerraUSD) The other is designed that an issuer or an obligator incurs a recourse debt, that mechanism keeps its price at specified price. (e.g. Tether [USDT], TrueUSD [TUSD], and USD Coin)
Japanese law regulates former with the same rule as (i) payment token. On the contrary, it regulates the latter, where the issuer incurs the debt, with different rule. The latter seems similar to (ii) utility token because the issuer has the financial obligation. However, the latter is spendable widely compared with the utility token. It has larger network effect and stronger finality than usual prepaid instruments. Therefore, the Stablecoin with issuers’ recourse debt has more strict regulation than prepaid instruments including utility token. It is regulated by settlement business regulations, which are banking regulation and fund transfer services regulation.
The example of Stablecoin teaches us that financial regulation for payment instruments with strong finality and large network effect is different from one for payment with weak finality and small network effect. It shows that financial law has different rules depending on whether the payment instruments has strong or weak finality and large or small network effect. On the contrary, financial rule is different also depending on whether it has an issuer or a financial obligator. (See, Chart 1) However, if some payment methods are same in the function of settlement, the rules applied to them should be functionally same though they are different on the surface. Therefore, it is the next issue to consider whether these rules are functionally same, or fair.