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Japan shifts course to tighten grip on cryptocurrency exchanges

FSA focuses on consumer protection as sloppy management comes to light

Cryptocurrencies such as bitcoin require global regulation, a member of Germany's central bank argues.   © Reuters

TOKYO -- Japan's financial watchdog is stepping up its oversight of cryptocurrency businesses following inspections that revealed their inadequate internal controls, shifting its focus from nurturing financial technology to consumer protection.

The Financial Services Agency on Thursday ordered two cryptocurrency exchange operators, BitStation and FSHO, to suspend operations through April 7. A senior executive at the former was found to have misappropriated customer cryptocurrencies, while the latter failed to appropriately monitor large transactions.

Neither exchange was formally registered with the authorities, as both predate enforcement of the law requiring registration and so are allowed to continue operating while they apply for official recognition. Another five operators, including two registered exchanges, were ordered to improve their operations.

Since February, the FSA has conducted on-site inspections at all 16 of Japan's unregistered exchange operators and some of its 16 registered exchanges. While these inspections are in progress, the probe so far has shown that systems meant to protect customer assets and data, as well as measures to prevent crimes such as money laundering, are utterly inadequate in most cases.

More reprimands are likely as raids on the exchanges continue. Three unregistered exchanges, including BitStation, have retracted their applications for registration and are expected to shut down.

Japan's Financial Services Agency reprimanded seven cryptocurrency exchange operators Thursday over security issues.

Japan became the first country requiring exchange operators to register with regulators when a revised fund settlement law took effect last April. The registration process is a good deal less rigorous than the permitting process that upstart banks and insurers must go through, letting new players enter the industry fairly easily.

Yet while the FSA was trying to nurture cryptocurrencies into a means of payment, the market saw them as prime targets for speculation. Traders seeking a quick profit sprang into action, flooding Japan's exchange operators with more funds than they were equipped to handle.

In principle, exchange operators are expected to possess the knowledge and corporate ethics of both the technology and financial sectors. But in practice, many put profit first amid the cryptocurrency boom, neglecting to put in place the business infrastructure required of a robust financial company.

The FSA said Thursday that it would establish a research group to study how cryptocurrency businesses should be regulated. Likely questions include whether to impose a limit on how long unregistered exchanges may operate or to limit leverage used when trading cryptocurrencies on the margin. The group will also consider regulation of so-called initial coin offerings.

"We're going to crack down for a bit to rein the industry in," a senior FSA official said.

Ultimately, regulators aim to craft regulations that match the reality of the cryptocurrency sector. Rather than encouraging expansion, the FSA's new priority is to ensure that customers can trade in cryptocurrencies without worrying about the systems they are using.

Japan is not alone in this. The U.S. Securities and Exchange Commission on Wednesday warned that many companies engaging in cryptocurrency trading are not registered as exchanges as required. "Many online trading platforms appear to investors as SEC-registered and regulated marketplaces when they are not," the regulator wrote.

Joachim Wuermeling, an executive board member of Germany's central bank, called in January for global regulation of cryptocurrencies, arguing that the borderless nature of digital society makes unilateral solutions difficult. Finance ministers and central bankers from the Group of 20 major economies plan to take up cryptocurrency regulation when they meet this month in Argentina. Japan is willing to offer its own successes and challenges, the FSA has said.

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