How can Japan lead stablecoin regulation Do issuers really have asset backing them?

Japan's Role in Stablecoin Regulation Ensuring Authenticity of Asset-Backed Issuers

Author: Emily LianGuairker, CoinDesk; Translation: Song Xue, LianGuai

Most major countries have yet to regulate stablecoins. One exception is Japan, which is a pioneer in this field.

The stablecoin law came into effect in June in the world’s third-largest economy. The example of Japan is important because it shows that regulating stablecoins is indeed possible. This may seem obvious, but it is not the case. For example, in the United States, Congress is still debating this issue, and no stablecoin bill has been enacted into law. The European Union’s stablecoin regulations will come into effect next year, but gray areas still remain.

Japan also shows that regulating stablecoins is not easy. Until recently, these types of cryptocurrencies, which are designed to maintain their value against real assets such as the US dollar or the Japanese yen, were essentially prohibited in Japan. Now issuers need to start from scratch. In addition to regulatory barriers, there are also business challenges: how to create a system that is both secure and profitable for issuing stablecoins?

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The stakes are high. The total market value of stablecoins is estimated to be over $124 billion. Big players are involved: LianGuai recently issued its own stablecoin. There are various use cases. Investors in countries plagued by currency devaluation and high inflation use USD stablecoins as a store of value. Other investors simply use them to trade other cryptocurrencies.

Meanwhile, the prominent position of stablecoins in the crypto industry has raised widespread concerns about their so-called stability. In May 2022, the algorithmic stablecoin project Terra Luna collapsed, resulting in billions of dollars in losses. There have long been concerns about Tether, the world’s dominant stablecoin, which The New York Times described as “a currency that could undermine cryptocurrencies.” People worry about a bank run scenario, where investors attempt to exchange their stablecoins for USD on a large scale and then find there are not enough USD to redeem their full value.

Japan’s stablecoin regulation attempts to address some of the biggest concerns people have with major stablecoins: do the issuers really have assets backing them? And even if they do, how do you ensure that the assets are easily accessible and not tied up in opaque and high-risk investments?

Now, we wait

These are not easy problems to solve, which means that launching stablecoins in Japan won’t happen quickly. In fact, Tatsuya Saito, the founder and CEO of Progmat, a software platform for issuing and managing digital assets, said that Japan’s first stablecoin may not be launched until June next year at the earliest. Saito said that fulfilling license requirements and obtaining approval from Japanese regulators could take at least a year.

In September, Binance Japan (the local branch of the world’s largest cryptocurrency exchange), Mitsubishi UFJ Trust and Progmat announced a partnership to explore creating new stablecoins.

Saito pointed out that he is currently in talks with ten different projects that want to launch stablecoins in Japan. These ten projects all want to issue stablecoins based on the US dollar and stablecoins based on the Japanese yen. He said that several of the projects he is consulting are overseas companies. Saito stated that these projects have not yet formally started the licensing process. They are still in the exploratory stage.

Circle, the issuer of the second-largest stablecoin, USDC, openly stated that they are considering the Japanese market.

In Japan, only banks, trust companies, and fund transfer service providers are allowed to issue stablecoins. Stablecoin issuers may establish a trust within Japan and issue stablecoins through that vehicle. The assets supporting stablecoin trading on Japanese exchanges must be held by that trust.

For foreign stablecoin issuers, this seems like an exceptionally strict requirement. However, Saito suggests that there is a more practical way to comply with the regulations.

By partnering with Japanese trust banks, issuers can issue their own branded stablecoins without the need for special permission in Japan.

Issuers can outsource the custody and management of the underlying assets within Japan to the trust institutions, as specified in the regulations.

Saito stated that cryptocurrency exchanges wishing to list stablecoins must also apply for licenses, but currently, no exchange has officially initiated this process. “They are still preparing.”

Business Challenges

Japan’s regulations have some strict provisions to protect the underlying assets of stablecoins. If domestic stablecoins are issued under a trust structure (expected to become a common method of issuing stablecoins), “the fiat currency (such as the US dollar or Japanese yen) supporting the stablecoin must be 100% stored in trust institutions within Japan and can only be invested in domestic bank deposits” as stated by Keisuke Hatano, a partner at Anderson Mori & Tomotsune law firm.

However, while this requirement may help ensure the safety of the assets, it can make it more challenging for stablecoin issuers to make a profit. “This poses a challenge for domestically-based stablecoins denominated in Japanese yen since the interest rates for Japanese bank deposits are currently very low (usually below 0.1%),” noted Hatano.

Hatano pointed out that the situation is slightly better for domestically-based stablecoins denominated in the US dollar. “You still have to keep all the US dollars in bank deposits in Japan, but US dollar deposits can earn higher interest rates.”

Other individuals in the Japanese stablecoin space also acknowledge that issuers face real business challenges.

“Will stablecoins succeed in Japan? It’s hard to say,” said Fumiaki Sano, a partner at Kataoka and Kobayashi LPC law firm. “You can’t invest in underlying assets, and if transaction costs are too high, nobody will use them. So what is the business model? Compliance costs are also high, meaning you have to find a way to monetize it.”

Sano also listed other aspects of the new regulations that could pose business challenges. “For exchanges handling foreign stablecoins, the transaction limit for each stablecoin is 1 million Japanese yen,” he explained.

“For example, if a foreign stablecoin issuer wants to establish their own entity in Japan through a trust, then they wouldn’t have this restriction. However, stablecoins issued in Japan will be different from globally circulating stablecoins. For instance, if Circle issues USDCJ instead of USDC, it won’t have the same liquidity.”

Finding the right balance between security and profitability is just one of the reasons why stablecoin regulation takes time, which also helps explain why other jurisdictions have not yet incorporated stablecoin regulation into law. Japan is worth paying attention to because it is actively addressing these challenges.

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