Business | FOCUS

Small cryptocurrency exchanges find the going hard under greater government oversight

by Kazuaki Nagata

Staff Writer

With the Financial Services Agency implementing greater oversight in the wake of the ¥58 billion Coincheck heist, many young and small cryptocurrency exchanges are finding it difficult to conduct business and looking to call it quits.

In early March, the FSA rocked the cryptocurrency exchange world with a crackdown in response to the Coincheck incident that occurred in January, issuing administrative actions for seven firms, including the suspending of two: Kanagawa-based FSHO and Nagoya-based Bit Station.

Since the FSA issued the administrative orders, six exchange operators among 16 that were unregistered have expressed their intention to drop their applications to become registered exchanges.

Those that had been running services before last April, when new regulations took effect requiring the operators to register with the government, have been allowed to keep operating on a tentative basis until they become registered.

The watchdog also last week suspended another Tokyo-based firm, Eternal Link Co., for lacking an adequate business management structure to ensure compliance.

“Compared to other industries, financial businesses are strictly monitored by regulators,” said Yasutake Okano, senior consultant at Nomura Research Institute. “Operators need high-level security systems and (proper) management and human resources, which come with quite a lot of investment.”

Coincheck Inc. lost “¥58 billion, which is a massive amount and doesn’t even compare to a simple server shutdown,” so it is natural that the FSA’s attitude has changed, he added.

He said establishing an adequate business management structure is tough for small startups.

A spokesman for one startup that decided to withdraw from the exchange business echoed this point, saying part of the reason was that his company was unable to secure workers with the skills needed to manage such systems, including cybersecurity, at the level demanded by the FSA.

“The regulation has put exchange operators under the supervision of the FSA. This means that we have become financial companies” that are supposed to meet high standards of business management, said the spokesman, who would only speak under condition of anonymity for himself and his firm.

Companies that lack employees with solid backgrounds in the financial industry need to hire such people for various positions, including administration, accounting and security. He said his firm did not have enough capital to make the necessary investment.

For its part, Japan has taken a more welcome stance to the introduction and acceptance of cryptocurrencies compared with other countries, fostering innovation using the new financial technology and cultivating the industry with its many startups.

Still, the impetus to introduce legal revisions predates the Coincheck incident, with its roots in the collapse of the Mt. Gox bitcoin exchange in 2014.

Under the new measures introduced last April, other than being required to register with the government, they are obliged to properly manage and secure their customers’ assets, submit annual reports and report suspicious transactions to the authorities.

The FSA can also conduct on-site inspections and issue business improvement orders.

“People often mention the dichotomy between regulation and innovation. While it is true that it’s difficult for the both to coexist, I think it is doable,” said Daisuke Yasaku, a researcher who monitors the cryptocurrency industry. “The FSA must be trying hard to balance that point” even after the Coincheck heist.

Yasaku said that although pressure has increased for the cryptocurrency exchange operators, the strict regulatory standards are not necessarily a bad thing.

“Regaining trust (in cryptocurrency) is essential. From that perspective, the fact that the FSA is implementing regulations more thoroughly now works positively to nurture healthy exchanges operators,” he added.

While some startups have been forced to walk away from the market, more powerful entities are looking to jump in.

Messaging app giant Line Corp., Yahoo Japan and Cyberagent Inc. are planning to become registered exchange operators.

The cryptocurrency exchange service can be highly profitable if companies are able to successfully attract users and foster large trade volume, so it is an attractive market for major firms, said Okano of Nomura Research Institute.

For instance, Coincheck, which is one of the largest exchanges in Japan, boosted its operating profit from zero in fiscal 2015 to ¥78 billion in 2016.

Last week’s announcement by Monex Group Inc., a major online brokerage, to acquire Coincheck serves as an example of the current trend with a big financial player entering the market and the inexperienced smaller one facing operational difficulty.

Monex Group CEO Oki Matsumoto said the cryptocurrency industry, led mostly by startups, is still immature, with inadequate security measures in place and a need to strengthen compliance standards. And that is where Monex can come in and offer know-how with its 19 years of online financial business experience, he said.

Coincheck was criticized for apparently neglecting security measures to protect customers’ assets, which left it vulnerable to attack.

“After the Coincheck hacking incident, I think customers are really keen on safety and security,” said Okano of Nomura Research Institute.

In that sense, they are inclined to choose exchanges that have name value, a solid business record, operating systems and capital,” he said.