From Suppression to STOs: Crypto Regulation in South Korea from 2017 to 2023
In the past 6 years, South Korea's stance on crypto regulation has significantly transformed. We examine the principal regulatory shifts, their consequences & the unresolved issues connected to them.
South Korean regulators have undergone a meaningful shift in their stance towards digital assets based on blockchain technology. Having initially suppressed the industry, they are now starting to adapt legislation to embrace blockchain-based technologies and solutions.
The first notable declaration from South Korean regulators was made back in September 2017 when the Financial Services Commission (FSC) released a statement highlighting the difficulty of legally recognizing “virtual currencies” and set up a task force to investigate the matter further. However, after only a few weeks, the FSC released another statement announcing an outright ban on all types of Initial Coin Offerings (ICOs). The industry was quick to criticize the FSC’s sudden and disproportionate approach, especially without any supporting amendments to the Financial Investment Services and Capital Markets Act (FISCMA) or its regulations. The ban had the unfortunate effect of South Korean companies seeking refuge in more favorable jurisdictions, notably Singapore which in 2018 alone hosted 53 ICOs raising USD 1.2 billion according to a PWC report.
It was not until March 2020 that the South Korean government returned to deal with “virtual assets” when the National Assembly finally approved to amend the Act on Reporting and Use of Certain Financial Transaction Information. This amendment introduced legal definitions for “virtual assets” and “virtual asset service providers” (VASPs), aligned with the recommendations of the Financial Action Task Force. Significantly, it required VASPs to be regulated for anti-money laundering (AML) and counter-terrorist financing (CTF) risks under the supervision of the Korea Financial Intelligence Unit (KoFIU).
For VASPs with a high degree of AML and CTF risks, such as centralized exchanges and custodial wallet service providers, the amendment provided much needed clarity in terms of regulatory expectations. However, the amendment was inadequate for other service providers dealing with virtual assets but not intended to be VASPs under the AML and CTF-oriented legislation, such as blockchain game developers and decentralized platforms, since it failed to provide them with a path towards regulatory acceptance. Nevertheless, it allowed for a degree of regulation necessary for parts of the industry to operate in South Korea. By the end of 2021, KoFIU announced that 29 entities had successfully registered, and that number has since increased to 36.
In April 2022, South Korean regulators expanded the scope of the securities law to bring a larger part of the blockchain industry under its regulatory purview. After a series of consultations, the Securities and Futures Commission (SFC) within the FSC determined that the right to own fractional units in music copyrights in return for a share of the revenue, a service provided by Musicow, constituted an “investment contract'' (Section 4(6) of the FISCMA). In this first-ever application of Section 4(6), the SFC deferred sanctions so that Musicow could adjust its business practices and update its compliance program to align with standards applicable to other financial service providers under the FISCMA. Although Musicow was not a blockchain project, this seminal precedent paved the way for the FSC to exercise authority over blockchain projects dealing with investment contracts.
In February 2023, the FSC announced its ambition to amend the FISCMA and the Electronic Securities Act (ESA) to allow for “security tokens” to be issued and traded in South Korea. This move aims to expand the country’s overall securities market by allowing traditional securities and the newly acknowledged investment contracts to be tokenized. While this historic acceptance of blockchain by the FSC is welcomed, there remain significant gaps between the proposal and industry expectations.
For one, the FSC has expressly forbidden the use of blockchains that require their own tokens. Since tokens are fundamental to the overall architecture of blockchains in maintaining their security as well as enabling novel features such as smart contracts, this prohibition calls into question the FSC’s understanding of the unique features of blockchain technology. In practice, it is likely that this ban will not only deter the industry from opting into the regime, since most prefer using permissionless blockchains such as Ethereum, but also isolate South Korea from the global market since no such restriction currently exists elsewhere.
In addition, the FSC has indicated that tokens that are not “security tokens” will be regulated under the much anticipated Digital Asset Basic Act (DABA), which is currently being discussed in the National Assembly. Unfortunately, this creates further uncertainty since the FSC has not yet published a complete set of guidelines for determining whether or not a particular token will be considered a security. This is further complicated by the fact that the South Korean legal definition of an investment contract differs from that of e.g. the US, as the former requires “entitlement to profit” and the latter a mere “expectation of profit.” The lack of comity between the two nations risks creates market fragmentation by opening up for jurisdictional arbitrage.
In conclusion, in order for South Korea to harness the full potential of blockchain technology, the FSC should engage in an open dialogue with industry actors to ensure that the upcoming amendments to the FISCMA and ESA reflect market practices. More importantly, South Korea must make sure that the DABA addresses the shortcomings that have already been identified. During this legislative process, South Korea should also engage with other countries to find a common approach to regulating digital assets without compromising the innovative potential of the industry. For now, however, it must be recognized that South Korea has taken important first steps to embrace blockchain.