The Journal The Authority on Global Business in Japan

Late last year, US-based blockchain startup BitClave raised the equivalent of $25.5 million in 30 seconds following its initial coin offering (ICO). An ICO, or token sale, is a relatively new crowdfunding mechanism that entrepreneurs use to raise money for product development or to fund operations.

ICOs present a new liquidity mechanism and opportunities for innovation, but their meteoric rise has raised eyebrows and the regulatory hammer in a number of jurisdictions.

Apart from ICOs, cryptocurrencies and platforms such as blockchain—the technology underlying this new ecosystem—have come into the cross hairs of regulators following the loss in January of some $530 million in cryptocurrencies that were under the management of Tokyo-based cryptocurrency exchange Coincheck.

For experts who spoke to The ACCJ Journal, innovation via ICOs offer a great number of opportunities for disruption across all sectors. But with foundational issues still outstanding in blockchain, it remains to be seen if the technology is ready for widespread use.

SELF-REGULATION
Companies issue ICOs in the form of tokens, which investors buy using cryptocurrencies such as Bitcoin or fiat currencies—money recognized by a government as legal tender.

Investors, in turn, receive dividends when the token appreciates in value. They can also exchange their tokens for other tokens or currencies in the ecosystem, buy more tokens, or receive benefits such as early access to a proposed product or service.

In Japan, blockchain and cryptocurrencies first came under scrutiny following the 2014 heist of 850,000 Bitcoins (then worth $450 million) from Tokyo-based Mt. Gox cryptocurrency exchange. This resulted in prioritization of consumer protection, Mineyuki Fukuda said.

“At the time, there were no regulations covering block­chain and cryptocurrencies. I took charge of the government’s crypto­currencies and Bitcoin portfolio shortly thereafter,” Fukuda, a former lawmaker of Japan’s ruling Liberal Democratic Party, and a founding member of the Japan Blockchain Association (JBA), explained to the The ACCJ Journal.

“We made it a rule that, if people wanted to start an exchange, they had to join the association to be in compliance with the guidelines. And while there was no enforcement mechanism for the guidelines, members could comply with them via self-regulation.”

Now a visiting professor at Tama University, where his work includes looking into the future effect of blockchain, Fukuda helped establish the JBA so that business owners, politicians, and the government could come together to discuss guidelines for the industry. The JBA also has lobbied for the enactment of laws around virtual currencies, and helped fashion Japan’s legislative landscape in the block­­chain ecosystem, including the Virtual Currencies Act of 2015.

When the lobbying process began, virtual currencies were a thing of novelty for many stakeholders, and issues around security were almost an afterthought.

At the time, Virtual currencies were called kachikiroku, or value record, because there was no legal terminology for them.

In Japan, virtual or cryptocurrencies have subsequently been defined under the Payment Services Act (PSA), promul­gated on June 3, 2016. That said, “Virtual currency is thought of as a payment method rather than a financial asset. It is something close to money, without being a fiat currency,” explained Ken Kawai, a partner and financial regulations expert at Tokyo-headquartered global law firm Anderson Mori & Tomotsune.

KNOW YOUR CUSTOMER
A consequence of the PSA is that exchanges which handle fiat and cryptocurrencies must be registered or licensed. This is in line with the Financial Action Task Force on Money Laundering, a Paris-based international organization that made a declaration in 2015 on know-your-customer (KYC) and anti-money laundering (AML) compliance. Japan followed those instructions, Kawai said.

“One of the main aspects of the registration is the segregation requirement of customers’ money or assets from that of the exchange. In the Mt. Gox example, there was no separation between the two. Under the most-recent regulations, an exchange must check daily to ensure that there is sufficient segregation between their own and the consumer’s assets.”

After the PSA went into effect on April 1, 2017, a lot has happened. There has been a boom in ICOs and a massive expansion of cryptocurrency classes, as well as fluctuations in the value of cryptocurrencies on exchanges.

Prior to 2016, only very early adopters were involved in the market for cryptocurrencies. After the implementation of the PSA, Kawai explained, lay investors rushed in and began trading on the forex market, thereby transforming cryptocurrencies into something akin to an asset rather than a payment method.

With exchanges becoming places for speculative trades, concerns over things such as insider trading and currency manipulation have led to a clamor for more regulations.

ICOs, meanwhile, came under greater regulatory scrutiny when, in early April, the government-backed research entity ICO Business Group set guidelines for their legalization. Japan’s financial regulator, the Financial Services Authority (FSA), was set to consider their proposals later that month.

As of this writing, there are no specific rules on ICOs in Japan. ICOs have been banned outright in China and South Korea, allowed to wander in a regulatory wilderness in the United States, or kicked into the regulatory long grass in the European Union.

THE NEW LIQUIDITY
While ICOs linger in a kind of regulatory no-man’s-land in many regions, this has not stopped innovators from seeking them out, most having been enticed by the relative ease and speed with which they can be tapped for liquidity.

The mechanism is seen in the startup world as a viable alternative to traditional funding vehicles, such as angel investment, venture capital funding, or initial public offerings (IPOs).

When BitClave issued its ICO late last year, investors from more than 100 countries stepped up, allowing the startup to raise tens of millions of dollars in seconds.

With those funds, the company is presently rolling out the DeSearch platform, which incentivizes users via micro cryptocurrency or token payments to share their data with product and service providers if they desire to do so.

The company’s CEO, Alex Bessonov, said that BitClave seeks to do for blockchain what Google Inc. is doing for the internet: create a search engine to beat all others. But there is a difference: while Google’s search seeks to gather your data, BitClave’s engine allows users to keep their data private.

Tokyo-based Equadex, a blockchain-based crypto-index startup, is tapping into the community with its public ICO sale running from May 1 to June 30. Speaking to The ACCJ Journal, Mike Hadas and Theo Gauthier from the company said their investors-first platform will seek to disrupt the way people play the crypto­currency markets.

“Our crypto-index fund tracks the top-10 cryptocurrencies by market cap as represented by our index token. We give people full control over their investment, and share all information related to the fund on our website, which is a blockchain principle of transparency,” they explained.

The fund also pledges to provide a portion of its profits to non-government organizations, and to implement best practice for security.

Having spent the better part of a year bootstrapping the company’s development, Hadas and Gauthier hope their token sale, which has a $5 million minimum requirement to raise funds, will allow them to hit the ground running while maximizing returns for investors.

BitClave and Equadex are not alone in the ICO multiverse. Myriad ventures hit the news in 2017 with their ICO events, with some $8 billion worth of capital being raised that year—the year ICOs had their Big Bang moment.

CRYPTO ALLEY
Startups such as Equadex and BitClave, which has a Japan office, have found Japan to be something of a haven for the blockchain ecosystem. And, corporates are taking the technology seriously, too.

Giants such as Line and Rakuten are launching blockchain platforms or research and development divisions, and that’s not to mention moves in the same direction by legacy institutions such as Japan’s megabanks: Mitsubishi UFJ Financial Group, Inc., Mizuho Financial Group, Inc., and Sumitomo Mitsui Financial Group, Inc.

There is even talk within the community of a “crypto alley”—an area encompassing Tokyo’s fashionable districts of Harajuku and Shibuya. Both areas are known for their concentration of fintech and other tech startups. So, it comes as no surprise that the world has its focus on Japan’s crypto-scene.

As Kawai from Anderson Mori & Tomotsune notes: “What I see is that some countries would like to create legislative structures for cryptocurrencies that are similar to those in Japan, perhaps as part of their e-government system. They are studying the rules in Japan so that they can create their own rules.”

BUYER BEWARE
That being said, ICOs—as with all new financing vehicles—have fallen prey to hustlers wishing to take the uninitiated for a ride. There are a lot of scammers issuing coins that have no value.

To try and mitigate this, the FSA has decided that, to issue an ICO to Japanese residents, you need a virtual currencies license. However, as most ICOs targeting Japan residents don’t fulfill the criteria, they may, in fact, be acting illegally.

Scammers are not the only concern. In Japan, for instance, there is a severe shortage of experts in blockchain technology, including at the FSA.

“The biggest issue for regulators is that, until now, they don’t have enough background in the technology. This makes it difficult for them to perform due diligence,” cryptographer Shin’ichiro Matsuo said.

Matsuo is a research professor at Georgetown University, where he is establishing a blockchain research institute. He has also been a member of the FSA’s study group on blockchain.

As of this writing, some 170 applications had been made in Japan for a crypto­currency license. Yet only 16 had been granted. While Japan remains a world leader in blockchain, it is unclear if the ecosystem here is ready for primetime.

John Amari is a writer and editor from the UK who specializes in articles on startups, entrepreneurs, science, tech, and business.
Innovation via ICOs offer a great number of opportunities for disruption across all sectors.