Source: IFLR
Translation: LianGuaiBitpushNews Yanan
Seung Jae Yoo, Gye-Jeong Kim, and Sung Yun Kang, lawyers from Kim & Chang Law Firm, have outlined the evolving regulatory framework for cryptocurrency assets in South Korea.
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On May 3, 2022, the South Korean government announced plans to regulate “security-type tokens” under the Financial Investment Services and Capital Markets Act. Additionally, the government will enact the Digital Asset Framework Act to comprehensively regulate all transactions related to virtual/digital assets, including non-security-type tokens.
As part of this plan, the Financial Services Commission of Korea has released the Token Security Guideline for the issuance and distribution of specific security-type tokens. Under this guideline, certain existing laws and regulations will be amended to allow project teams to issue and distribute token securities based on distributed ledger technology in compliance. Regulatory agencies will also establish new legal systems to manage project team accounts and over-the-counter broker-dealers. To achieve these goals, proposed amendments to the Financial Investment Services and Capital Markets Act and the Electronic Registration of Stocks and Bonds Act are currently awaiting parliamentary approval.
In addition, in order to regulate the virtual asset market from the perspective of consumer/investor protection, the Virtual Asset User Protection Act was passed on July 18, 2023, and is scheduled to take effect on July 19, 2024. This law was enacted in the process of formulating the Digital Asset Framework Act and is the first law in Korea specifically designed to regulate virtual asset businesses. Furthermore, both the Virtual Asset User Protection Act and the Act on Reporting and Utilizing Specific Financial Transaction Information (Korea’s Anti-Money Laundering Act) stipulate the obligation of virtual asset service providers to report to the Financial Services Commission of Korea and clarify the cross-border applicability of the regulations. Therefore, these two laws apply not only to participants in the domestic virtual asset industry in Korea but also to those residing outside Korea whose activities may affect the Korean market.
Classification of Cryptocurrency Assets
The applicability of specific regulations will depend on the classification and treatment of cryptocurrency assets. For example, if a cryptocurrency asset is considered a “security” as defined by the Financial Investment Services and Capital Markets Act, it will be subject to the provisions of that law. If the cryptocurrency asset is considered a “virtual asset” as defined by the Act on Reporting and Utilizing Specific Financial Transaction Information, it will be subject to the dual regulations of that law and the Virtual Asset User Protection Act. After the Virtual Asset User Protection Act takes effect, the relevant content of the Act on Reporting and Utilizing Specific Financial Transaction Information will be amended to align its definitions of “virtual asset” and “virtual asset service provider” with the Virtual Asset User Protection Act.
The Electronic Financial Transactions Law aims to regulate electronic payment and settlement businesses. Encrypted assets that meet the definition of electronic currency or pre-paid electronic payment means (PEPM) will be subject to the constraints of this law. It is particularly important to note that if a certain encrypted asset is applicable for payment of goods and services or used for settlement payments, the issuer of the encrypted asset and the payment service provider need to obtain relevant licenses or register according to the provisions of the Electronic Financial Transactions Law before conducting business.
Regulation of Security-type Encrypted Assets Trading
The Specific Financial Transaction Information Reporting and Use Law defines “virtual assets” as certificates or information that can be transferred electronically, and the trading parties also recognize them as transaction medium or having value-added features. However, this law also explicitly states that several assets in electronic form do not belong to virtual assets, such as “electronically registered securities” defined under the Electronic Registration Law for Stocks and Bonds, and will not be considered as “virtual assets”. Whether an encrypted asset is considered an electronic security or a virtual asset will depend on its characteristics, trading terms, and specific provisions of the amended Electronic Registration Law for Stocks and Bonds. It can be understood that if an encrypted asset belongs to electronic securities rather than virtual assets, it is not subject to the provisions of the Specific Financial Transaction Information Reporting and Use Law regarding virtual assets and virtual asset service providers.
If a certain type of encrypted asset is considered as securities, the trading of such encrypted assets will be subject to the relevant provisions of unfair trading in the Financial Investment Services and Capital Market Act. Similar content can also be found in the Virtual Asset User Protection Act. However, considering the difficulties in determining the regulatory framework directly relying on court rulings based on the Financial Investment Services and Capital Market Act in practice (partially due to the differences in the provisions of the Virtual Asset User Protection Act and the Financial Investment Services and Capital Market Act, and the differences between encrypted assets and traditional securities), we expect that there may be some gray areas in the practical application of the Virtual Asset User Protection Act.
Regulatory Framework for Token Securities
In February 2023, the Financial Services Commission of South Korea issued its “Improved Regulation Plan for Token Securities Issuance and Distribution”, which applies to the domestic issuance and distribution of token securities in South Korea (the Financial Services Commission of South Korea has not officially stated whether this plan applies to cross-border projects). It is worth noting that the Financial Services Commission of South Korea deliberately used the term “token securities” (rather than security tokens) in the plan to emphasize the classification of tokens as securities.
The launch of this plan has its specific background, that is, the Financial Services Commission of South Korea allows security-type encrypted assets that meet specific requirements (referred to as “token securities” for short) to be issued under regulated conditions in compliance with the Financial Investment Services and Capital Market Act, the Electronic Registration Law for Stocks and Bonds, and other relevant regulatory requirements. As a new term introduced by the commission, the term “token securities” refers specifically to a form of securities issued through distributed ledger technology. The Financial Services Commission of South Korea has stated that it has not introduced new types of securities or adjusted the existing definition of “securities” in the Financial Investment Services and Capital Market Act.
The plan also mentions:
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The “Token Securities Guide” further elaborates on certain specific principles for determining whether a token is a security and the concept of token securities; and
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How regulatory agencies are preparing to amend the “Financial Investment Services and Capital Markets Act” and the “Stock and Bond Electronic Registration Act” to regulate the issuance and distribution of token securities (including issuance systems, issuer account management institutions, and over-the-counter brokerage institutions).
According to the plan, individuals providing brokerage services for token securities transactions need to obtain an over-the-counter brokerage license required by the “Financial Investment Services and Capital Markets Act”, and such licenses can only be obtained by financial institutions or newly established entities that meet certain strict requirements (Translator’s note: individuals need to provide services through licensed institutions). Before the Financial Services Commission of Korea announced this plan, Korean financial institutions were effectively restricted from participating in virtual asset service businesses (excluding banks providing real-name verification services to local cryptocurrency exchanges). In this sense, allowing financial institutions to seek and obtain over-the-counter brokerage licenses for trading token securities seems to be a significant progress made by Korean financial regulatory authorities.
In addition, the plan also stipulates:
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More than 51% of the nodes should be operated by multiple parties, including electronic registrars, financial institutions, and account management institutions unrelated to project issuers.
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No separate virtual assets should be used to record any rights holders and transaction information (i.e., encrypted assets cannot be used to settle transaction fees). Considering practical limitations, we expect that issuing token securities involving international or cross-border nature on public chains may face some difficulties based on this plan.
“Virtual Asset User Protection Act”
According to the newly enacted “Virtual Asset User Protection Act”, virtual asset service providers must provide consumer protection measures, including:
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Keeping the assets deposited by users separate or entrusting them to custodian institutions such as banks, so that they are separated from their own assets.
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Keeping their own virtual assets separate from users’ virtual assets and actually holding the same type and quantity of virtual assets entrusted by users (Translator’s note: to prevent asset misappropriation); and
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Taking necessary measures to fulfill security responsibilities in the event of hacking attacks or computer failures.
The “Virtual Asset User Protection Act” extensively covers unfair trading practices involving virtual assets, and violations of this law may result in criminal penalties or administrative fines. It is particularly noteworthy that this law prohibits:
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Acts of obtaining and using undisclosed information by virtual asset service providers, virtual asset issuers, and their respective executives, employees, agents, and major shareholders (Translator’s note: this can be understood as insider trading);
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Specific unfair trading activities (such as false transactions, price manipulation, or fixing); and
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Fraudulent trading activities
In addition, the law also prohibits virtual asset service providers from participating in virtual asset trading activities issued by themselves or their affiliates.
According to the supplementary opinions of the “Virtual Asset User Protection Law,” the Congress and the government are discussing broader legislative improvement measures. This supplementary opinion requires financial regulatory agencies to take specific measures or assist market participants in dealing with the following issues before the “Virtual Asset User Protection Law” takes effect:
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Conflicts of interest that may arise in the process of issuing and distributing virtual assets
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Regulating stablecoins
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Regulating the business activities of virtual asset service providers
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Regulating the bank’s real-name verification deposit and withdrawal account system (referring to accounts verified by local banks as being held by the account holder)
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Listing information disclosure system; and
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Regulating virtual asset trading activities issued by virtual asset service providers or their affiliates
Since the “Virtual Asset User Protection Law” only covers part of the business of virtual asset service providers and unfair trading activities, and is similar to the provisions of the “Specific Financial Transaction Information Reporting and Use Law,” other innovative encrypted businesses, such as decentralized finance (DeFi), still face regulatory uncertainty.
Encrypted assets for payment and cross-border remittances
CBDC (Central Bank Digital Currency)
In view of the fact that the “Virtual Asset User Protection Law” clearly excludes Central Bank Digital Currency (CBDC) from the definition of virtual assets, if South Korea also launches CBDC services, we expect that its issuance and distribution will be subject to separate legal and regulatory supervision. As the Bank for International Settlements seems to be considering building a CBDC ecosystem involving tokenized deposits, a unified ledger, and a single currency, the Bank of Korea and domestic commercial banks in South Korea are also discussing CBDC issuance. Based on the above, it can be expected that the Bank of Korea will soon announce its CBDC plan.
Stablecoins
The “Token Securities Guidelines” stipulate that if the issuance of a certain encrypted asset is used for the consumption of goods or services, or to maintain its stable value as a means of payment or exchange, and cannot be redeemed, then this encrypted asset is unlikely to be considered a security. Therefore, stablecoins seem to be exempt from the constraints of the “Token Securities Guidelines.” It should be noted that the legal classification of stablecoins should be determined based on specific circumstances. In other words, unless it clearly meets the “exclusionary clause” definition of virtual assets prescribed by regulations, the stablecoin may still be considered a virtual asset. On September 18, 2023, the Financial Services Commission of South Korea issued a regulatory interpretation stating that stablecoins may be considered virtual assets in specific circumstances, and emphasized that specific analysis should be conducted for specific issues. In addition, even if stablecoins do not meet the requirements of the “Token Securities Guidelines,” they may still be considered securities under the “Financial Investment Services and Capital Markets Act.” At the same time, based on the provisions of South Korean foreign exchange laws, stablecoins may also be recognized as a form of foreign exchange.
Although the South Korean foreign exchange regulatory agency has not expressed its opinion on whether foreign currency-based cryptographic assets are subject to South Korean foreign exchange regulations, in theory, such cryptographic assets may be subject to regulation by the South Korean foreign exchange system.
Payments and Cross-border Remittances
If any cross-border remittance, payment, or settlement services provided to South Korean users involve cryptographic assets, such services may be subject to South Korean regulations related to payments, settlements, and foreign exchange. In this case, depending on the roles of the project participants and the transaction structure, regulators may require them to obtain specific licenses (this matter is still undecided).
Conclusion
Although South Korea has made significant progress in the regulation of virtual assets, the government and private entities still need to address many issues. For example, when preparing the “Token Securities Guidelines,” the South Korean Financial Services Commission does not seem to have considered the decentralized nature of the blockchain ecosystem. In addition, the “Virtual Assets User Protection Act” seems to only focus on asset segregation and the prohibition of unfair trading practices by virtual asset service providers, without considering the regulation of smart contract services, such as those based on DeFi, decentralized autonomous organizations (DAOs), and Web3.0, which have not received regulatory attention. To address these issues, the South Korean government and industry participants must actively engage in and promote the development of the virtual asset industry and ensure the protection of user interests.
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