Source: IFLR Compiled by: BitpushNews Yanan
Three lawyers, Seung Jae Yoo, Gye-Jeong Kim and Sung Yun Kang from Kim & Chang Law Firm, sorted out the evolving Korean crypto-asset regulatory system.
On May 3, 2022, the South Korean government issued an announcement that it plans to regulate “security-type tokens” in accordance with the “Financial Investment Services and Capital Markets Act.” At the same time, the Korean government will also promulgate the “Digital Asset Framework Law” to comprehensively supervise all matters related to virtual/digital assets, including non-security tokens.
As part of this plan, the Financial Services Commission of South Korea issued the Token Security Guideline (Translator’s Note: “Token Security” is a new proprietary technology created by the Financial Services Commission of South Korea) for the issuance and distribution of specific security tokens. vocabulary to emphasize the security nature of the token). According to this guideline, certain existing laws and regulations will be modified to allow project parties to issue and distribute token securities based on distributed ledger technology in a compliant manner. At the same time, regulatory agencies will also establish some new legal systems to manage the accounts of project parties and over-the-counter brokerage service providers. To achieve the above purposes, relevant agencies have also proposed amendments to the “Financial Investment Services and Capital Markets Law” and the “Electronic Registration of Stocks and Bonds Law”. These amendments are currently awaiting congressional approval.
In addition, in order to control the virtual asset market from the perspective of consumer/investor protection, the “Virtual Asset User Protection Law” was passed on July 18, 2023, and is scheduled to take effect on July 19, 2024. The law was enacted during the formulation of the Digital Asset Framework Law and is South Korea’s first law specifically designed to regulate virtual asset businesses. In addition, the “Virtual Asset User Protection Act” and the “Specified Financial Transaction Information Reporting and Usage Act” (i.e., South Korea’s Anti-Money Laundering Law) both stipulate the obligation of virtual asset service providers to report to the Korean Financial Commission, and also clarify the cross-border regulations. environmental applicability. Therefore, these two laws apply not only to domestic virtual asset industry participants in South Korea, but also to those groups who live outside South Korea but whose activities will affect the Korean market.
Classification of Crypto Assets
The applicability of specific regulations will depend on how cryptoassets are classified and treated. For example, if a crypto-asset is considered a “security” as defined by the Financial Investment Services and Capital Markets Act, it will be subject to that Act. If the encrypted asset is considered a “virtual asset” as defined in the Specified Financial Transaction Information Reporting and Usage Act, the dual provisions of that law and the Virtual Asset User Protection Act will apply. At the same time, after the “Virtual Asset User Protection Act” takes effect, the relevant content of the “Specified Financial Transaction Information Reporting and Usage Act” will be modified so that the definitions of “virtual assets” and “virtual asset service providers” are consistent with the “Virtual Assets Service Provider” User Protection Act remains consistent.
The Electronic Financial Transactions Law aims to regulate electronic payment and settlement businesses, and cryptoassets that meet its definition of electronic currency or pre-paid electronic payment means (PEPM) will be subject to the law. In particular, it should be noted that if a certain crypto asset is suitable for payment of goods and services, or is used for settlement payment, the issuer and payment service provider of the crypto asset need to comply with the provisions of the Electronic Financial Transaction Law before conducting business. Provide for obtaining relevant licenses or registration.
Security Crypto Asset Trading Supervision
The Specified Financial Transaction Information Reporting and Usage Act defines “virtual assets” as certificates or information that can be transferred electronically and that are recognized by the counterparty as a transaction medium or have value-added properties. However, the bill also clearly stipulates that several assets that exist in electronic form are not virtual assets. For example, “electronically registered securities” defined under the “Electronic Registration of Stocks and Bonds Act” will not be considered virtual assets. Considered “virtual assets”. Whether a crypto-asset is considered an electronic security or a virtual asset will depend on its characteristics, the terms of its transaction, and the specific provisions of the amended Electronic Registration of Stocks and Bonds Act. It can be understood that if a certain encrypted asset is an electronic security rather than a virtual asset, then it does not apply to the provisions on virtual assets and virtual asset service providers under the Specified Financial Transaction Information Reporting and Use Act.
If a certain type of crypto-assets is considered a security, the trading of such crypto-assets will be subject to unfair trading provisions under the Financial Investment Services and Capital Markets Act. There is similar content in the Virtual Asset User Protection Act. However, considering that in practice it is difficult to directly rely on court rulings based on the Financial Investment Services and Capital Markets Act to determine the regulatory scale (partly because of the differences between the Virtual Asset User Protection Act and the Financial Investment Services and Capital Markets Act There are differences in the provisions of “Virtual Asset User Protection Law”, as well as differences between crypto assets and traditional securities), we expect that there may be some gray areas in the actual application of the “Virtual Asset User Protection Act.”
Regulatory Framework for Token Securities
In February 2023, the South Korean Financial Commission released its “Improved Supervision Plan for the Issuance and Distribution of Token Securities”, which applies to the domestic issuance and distribution of token securities in South Korea (the Korean Financial Commission has not officially stated whether the plan applies to cross-border projects ). It is worth noting that the Korean Financial Commission 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 Korean Financial Commission is in order to allow security-type crypto-assets (hereinafter referred to as “token securities”) that meet specific requirements to be registered in compliance with the “Financial Investment Services and Capital Markets Act” and the “Electronic Registration of Stocks and Bonds”. It can be issued under supervision if required by the Law and other relevant regulations. As a new term introduced by the Commission, the term “token security” was proposed by the plan to specifically refer to a form of security issued through distributed ledger technology. The Financial Services Commission of Korea stated that the commission itself has not introduced new securities or adjusted the existing definition of “securities” in the Financial Investment Services and Capital Markets Act.
The plan also mentions:
- The Token Securities Guide further clarifies certain specific principles for determining whether a token is a security and the concept of token securities; and
- How regulators are preparing to amend the Financial Investment Services and Capital Markets Law and the Stock and Bond Electronic Registration Law to regulate the issuance and distribution of token securities (including issuance systems, issuer account management agencies and over-the-counter brokerage agencies) .
Under the scheme, individuals providing brokerage services for trading in token securities are required 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 meet certain strict requirements Obtained by a newly established entity (Translator’s Note: It can be understood that individuals need to provide services through a licensed institution). Before the Korean Financial Commission announced the plan, Korean financial institutions had been de facto restricted from participating in virtual asset service businesses (except for banks providing real-name verification services to local crypto asset exchanges). In this sense, allowing financial institutions to seek and obtain over-the-counter brokerage licenses to trade token securities under the program appears to be a significant development for South Korea’s financial regulators.
Additionally, the plan provides for:
- More than 51% of nodes should be operated by multiple parties, including electronic registries, financial institutions, and account management agencies not related to the project issuer.
- Separate virtual assets may not be used to record any rights holder and transaction information (i.e. cryptoassets cannot be used to settle transaction fees). Taking into account practical limitations, we expect that, according to this plan, the issuance of token securities involving international or cross-border nature on the public chain may face some difficulties.
Virtual Asset User Protection Act
According to the newly promulgated “Virtual Asset User Protection Law”, virtual asset service providers must provide consumer protection measures, including:
- Deposit or entrust the assets deposited by users to custodian institutions such as banks to keep them separate from their own assets.
- Separate one’s own virtual assets from the user’s virtual assets, and actually hold the same type and amount of virtual assets hosted by the user (Translator’s Note: to avoid asset misappropriation); and
- Take necessary steps to perform security duties in the event of a hacker attack or computer failure.
The Virtual Asset User Protection Act broadly covers unfair trading practices involving virtual assets, and violations of the Act may result in criminal penalties or administrative fines. In particular, the law prohibits:
- Virtual asset service providers, virtual asset issuers, and their respective executives, employees, agents, and major shareholders, as well as any behavior that obtains and uses undisclosed information from the above persons (Translator’s Note: It can be understood as insider trading);
- Specific unfair trading activities (such as false trading, changing or fixing prices); and
- Fraudulent trading practices
In addition, the law also prohibits virtual asset service providers from participating in the trading activities of virtual assets issued by themselves or their affiliates.
Based on the supplementary opinions to the Virtual Asset User Protection Act, Congress and the government are discussing the adoption of broader legislative improvements. This supplementary opinion requires financial regulatory agencies to take specific measures or assist market participants in dealing with the following matters before the “Virtual Asset User Protection Law” takes effect:
- Possible conflicts of interest in the process of issuing and distributing virtual assets
- Regulate stablecoins
- Supervise the business activities of virtual asset service providers
- Supervise the deposit and withdrawal account system for real-name verification in the banking industry (referring to accounts that have been verified by local banks to verify the identity of the holder)
- Listing information disclosure system; and
- Supervise the trading activities of virtual assets issued by virtual asset service providers or their affiliates
Since the “Virtual Asset User Protection Act” only covers part of the business and unfair trading activities of virtual asset service providers, and is similar to the provisions of the “Specified Financial Transaction Information Reporting and Usage Act”, other innovative encryption businesses, such as Centralized finance (DeFi), etc., still face regulatory uncertainty.
Crypto-Assets for Payments and Cross-Border Remittances
CBDC (Central Bank Digital Currency)
Given that the Virtual Asset User Protection Act explicitly 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 regulated by other separate laws and regulations. Given that the Bank for International Settlements appears 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 are also discussing the issuance of CBDC. In summary, it can be expected that the Bank of Korea will announce its CBDC plan soon.
Stablecoin
The Token Securities Guidelines stipulate that if a crypto-asset is issued for consumption of goods or services, or to maintain its stable value as a means of payment or exchange, and is not convertible, then the crypto-asset is unlikely to be are considered securities. From this perspective, stablecoins appear to be exempt from the Token Securities Guidelines. It is worth noting that the legal classification of stablecoins should be determined on a case-by-case basis. That is, unless it clearly meets the regulation’s “exclusion clause” definition of a virtual asset, the stablecoin may still be considered a virtual asset. On September 18, 2023, the South Korean Financial Commission issued a regulatory explanation, stating that under certain circumstances, stable coins may be regarded as virtual assets, and emphasized that specific issues should be analyzed on a case-by-case basis. Additionally, even if a stablecoin does not meet the provisions of the Token Securities Guidelines, it may still be deemed a security under the Financial Investment Services and Capital Markets Act. At the same time, according to the provisions of South Korean foreign exchange laws, stable coins may also be recognized as some form of foreign exchange.
While South Korea’s foreign exchange regulator has yet to express an opinion on whether foreign currency-based crypto-assets are subject to South Korea’s foreign exchange regulations, such crypto-assets could theoretically be regulated by the country’s foreign exchange system.
Payments and Cross-Border Remittances
If any cross-border remittance, payment or settlement services provided to Korean users involve crypto-assets, such services may be subject to Korean regulations related to payments, settlement and foreign exchange. In such cases, regulatory requirements may require specific licenses depending on the role of the project participants and the transaction structure (this matter has not been finalized yet).
in conclusion
Although South Korea has made some significant progress in regulating virtual assets, there are still many issues that the government and private entities need to address. For example, when preparing the Token Securities Guidelines, the South Korean Financial Commission did not appear to take into account the decentralized nature of the blockchain ecosystem. In addition, the “Virtual Asset User Protection Law” seems to only focus on the asset isolation and prohibition of unfair trading practices of virtual asset service providers, and does not consider the supervision of smart contract services, such as those based on DeFi, Decentralized Autonomous Organizations (DAO) and Web3. 0 services, etc., have not received regulatory attention. In order to solve these problems, the Korean government and industry participants must actively participate in and promote the development of the virtual asset industry and ensure that the interests of users are protected.
