Japan was the first country to establish a regulatory framework for crypto-assets. Perhaps because of this head start, blockchain technology is now being increasingly adopted in the Japanese financial industry. For example, there are 30 licensed crypto-asset exchange service providers in Japan (“exchange providers”) as of 30 April 2022.

On March 4, 2022, the “Bill for Partial Amendment to the Act on Payment Services Act, etc, for the Purpose of Establishing a Stable and Efficient Funds Settlement System” was submitted to the Diet (the “Amendment Bill”).

The Amendment Bill aims to establish a stable and efficient funds settlement system that can respond to the digitalisation of finance and other fields, against the backdrop of (i) the increasing issuance and circulation of so-called stablecoins overseas, (ii) the growing need to further improve the effectiveness of transaction monitoring by banks, etc, and (iii) the spread of prepayment instruments that enables payment by electronic means.

In addition, in response to the increasing issuance and circulation of so-called stablecoins overseas, the Amendment Bill also introduces the concept of “electronic payment instruments” (EPI), which corresponds to the concept of stablecoins (see the items in Article 2, paragraph 5 of the Amended Payment Services Act (the “Amended PSA”)).

The Amendment Bill also provides a new definition of intermediary activities in respect of the transfer and management of stablecoins that constitute EPIs. Specifically, under the Amendment Bill, such activities are defined as “electronic payment instruments transaction business” and “electronic payment handling business.” Furthermore, the Amendment Bill introduces a registration system in respect of businesses engaged in such activities.

The Amendment Bill will come into effect within a year from the date of its promulgation on a date specified by Cabinet Order.

Since 2020, security tokens, sometimes referred to as digital securities, have been in the spotlight. As a result of recent amendments to the relevant laws and regulations, an increasing number of financial institutions are entering this new market, focusing mainly on digital corporate notes and tokenised equity interests in real estate funds. For instance, on 19 April 2021, SBI Securities Co., Ltd made its first offering of digital corporate bonds in Japan. Another example is the first public offering in Japan of asset-backed security tokens by a subsidiary of Kenedix, Inc., a leading real estate company in Japan. The asset-backed security tokens are based on a beneficiary certificate issuance trust scheme utilising a blockchain platform. The platform in the offering was provided by Mitsubishi UFJ Trust and Banking Corporation and the offering was underwritten by Nomura Securities Co., Ltd. and SBI Securities Co., Ltd. Furthermore, in February 2022, Mitsui Bussan Digital Asset Management, Mitsubishi UFJ Trust and Banking Corporation (MUTB), and Nomura Securities Co., Ltd. announced their planned collaboration in the security token business area, utilising Progmat, a blockchain platform provided by MUTB, to conduct a public offering of asset-backed security tokens for real estate investments.

Furthermore, since late 2020, non-fungible token (NFT)-related businesses have been gaining traction, particularly in the online gaming and art sectors, and a number of platforms for the issuance and trading of tokenised digital artworks have also recently emerged.

These developments indicate that the application of blockchain technology to business is moving from the proof of concept stage to the stage of practical application.

There is no definition of decentralised finance (“DeFi”) under Japanese law, and there is no regulatory framework that focuses specifically on DeFi.

However, under Japanese law, if the operation of a DeFi platform conflicts with existing financial regulations, the latter will apply.

In other words, if a DeFi platform contains:

• an automated market maker (AMM) function that enables the buying, selling, and exchange of tokens that fall within the definition of crypto-assets;
• wallet aggregators;
• a decentralised synthetic investment platform;
• a decentralised prediction market;
• decentralised stablecoins; and
• a decentralised lending platform,

existing financial regulations – such as regulations in respect of crypto-asset exchange services (CAES) (as discussed in 2.1 Regulatory Overview) under the PSA; investment fund regulations and derivatives regulations under the Financial Instruments and Exchange Act (FIEA); or funds remittance transaction (kawasetorihiki) regulations under the PSA, the Banking Act or the Money Lending Business Act (MLBA), – may apply to the operator of the DeFi platform, depending on the functions of the platform.

NFTs are generally non-substitutable tokens that are issued on a blockchain, with values and attributes unique to the token itself. The issue is this context is whether NFTs constitute Type II crypto-assets (as defined in 2.1 Regulatory Overview) under the PSA, because digital assets with the characteristics of an NFT are mutually exchangeable with Type I crypto-assets (as also defined in 2.1 Regulatory Overview) among unspecified persons on a blockchain.

Based on public comments disclosed by the Financial Services Agency of Japan (JFSA) on 3 September 2019 (the “Public Comments”), the JFSA is generally understood to take the view that whether an NFT constitutes a crypto-asset should be determined on a case-by-case basis. At the same time, however, the Public Comments also suggest that the JFSA has adopted the view that even if trading cards or gaming items issued as digital assets recorded on a blockchain are mutually exchangeable with Type I crypto-assets (eg, bitcoin or ether), they do not constitute Type II crypto-assets because they serve no payment function, unlike Type I crypto-assets. In view of this, gaming items based on blockchain technology are unlikely to be deemed crypto-assets if they cannot be used as a means of payment.

Under the PSA, a person who engages in the purchase and sale of crypto-assets as a business is required to be registered as a crypto-asset exchange service provider (CAESP) (Article 63-2 of the PSA). Only CAESPs are permitted to engage in CAES. The PSA requires a person who provides CAES to be registered with the JFSA. A person who engages in CAES without registration is punishable by imprisonment for a term not exceeding three years or a fine not exceeding JPY3 million, or both (Article 107, Item 5 of the PSA).

Definition of Crypto-asset

The term “crypto-asset” is defined in the PSA as follows:

• A proprietary value (limited to that recorded on electronic devices or other objects by electronic means and excluding Japanese and other foreign currencies and currency-denominated assets; the same applies in the following bullet point) that (i) may be used to pay an unspecified person the price of any goods purchased or borrowed or any services provided, (ii) may be sold to or purchased from an unspecified person, and (iii) may be transferred using an electronic data processing system (“Type I crypto-asset”).
• A proprietary value that (i) may be exchanged reciprocally for a proprietary value specified in the preceding bullet point with an unspecified person, and (ii) may be transferred using an electronic data processing system (“Type II crypto-asset”).

“Currency-denominated assets” means assets denominated in Japanese yen or another foreign currency. Such assets do not fall within the definition of crypto-asset. For example, prepaid e-money cards are usually considered currency-denominated assets. If a coin issued by a bank is guaranteed to have a certain value vis-à-vis fiat currency, such a coin is unlikely to be deemed a crypto-asset but would instead be considered a currency-denominated asset.

Definition of Crypto-asset Exchange Service

The term “crypto-asset exchange services” (CAES) means any of the following acts carried out as a business:

• sale and purchase of crypto-assets or exchange of crypto-assets for other crypto-assets;
• intermediary, brokerage or delegation of such sale, purchase or exchange;
• management of users’ money in connection with the acts listed in the two bullet points above; or
• management of crypto-assets for the benefit of another person.

In 2017, based on the recommendations of the Financial Action Task Force (FATF) that virtual currencies could be used for money laundering, the Act on Prevention of Transfer of Criminal Proceeds (APTCP) was amended to include CAESPs as “specified business operators” and to impose an obligation on CAESPs to verify the identity of their customers.

Under the APTCP, specified business operators must verify the identity of their customers and comply with the APTCP and rules issued thereunder.

The JFSA has supervisory powers over CAESPs on the basis of the delegation of such powers to it from the Prime Minister.

As a result, the JFSA has the power, where necessary for the proper and secure provision/performance of CAES by a CAESP, to (i) order the CAESP to submit additional reports or materials, (ii) enter the office or other facilities of the CAESP to conduct inspections, and (iii) inquire about the status of the CAESP’s business or properties or inspect its books and documents.

The JFSA can also sub-delegate its supervisory powers over CAESPs to the relevant Local Finance Bureau, which are organs of the Ministry of Finance directed and supervised by the JFSA Commissioner.

For the purpose of ensuring proper provision of CAES and to protect users of CAES, the Japan Virtual and Crypto-assets Exchange Association (JVCEA) was appointed as an approved self-regulatory organisation to regulate CAESPs. The primary objectives of the JVCEA are (i) the formulation of self-governance rules, (ii) the inspection of its members to ensure their compliance with the relevant self-governance rules and (iii) the handling of user complaints.

There is an important judicial precedent of the Tokyo District Court dated 5 August 2015, which states that legal ownership or title does not apply to crypto-assets because they are intangible assets. As a consequence, the transfer of a crypto-asset does not equate to the transfer of legal ownership or title in such crypto-asset under the Civil Code of Japan (the “Civil Code”).

In 2018, as a result of the leakage of users’ crypto-assets with a value of approximately USD530 million from a cyber-attack on one of the biggest CAESPs, the JFSA conducted sweeping on-site inspections of registered and provisional CAESPs. This was followed by the JFSA’s announcement, on 8 March 2018, of the imposition of business suspension orders on two provisional CAESPs, and business improvement orders on two registered CAESPs and three provisional CAESPs. After further review, the JFSA, on 22 June 2018, also imposed business improvement orders on six additional major registered CAESPs.

In addition, on 21 June 2019, the JFSA imposed a business improvement order on a CAESP for the inadequacy of its business management, anti-money laundering and counter terrorist financing, and risk management systems, among other things.

To encourage fintech innovation, including the development and usage of blockchain technology, in June 2018, the Japan Economic Revitalisation Bureau established a cross-governmental one-stop desk for a regulatory sandbox scheme in Japan. This scheme, available to foreign as well as Japanese companies, enables applicants (once approved) to carry out, under certain conditions, a demonstration of their projects even if such activities are not yet covered under current laws and regulations. Blockchain technology, together with AI, IoT and big data, are explicitly mentioned in the basic policy of the regulatory sandbox scheme as prospective and suitable areas for exploration and development.

One of the most important issues in Japanese taxation of crypto-assets has been the treatment of consumption tax. Previously, the sale of crypto-assets was subject to consumption tax if the office of the transferor was located in Japan. However, this was overturned in 2017.

The National Tax Agency of Japan also announced that gains realised from the sale or use of crypto-assets will be treated as “miscellaneous income” (zatsu-shotoku) and that taxpayers will not be permitted to utilise losses elsewhere to offset gains realised from the sale or use of crypto-assets. Furthermore, inheritance tax will be imposed upon the crypto-assets in the estate of a deceased person.

The Japanese government has a generally positive view of the use of blockchain technology in various kinds of businesses.

For instance, in June 2019, the Japanese government published a “Growth Strategy Action Plan” discussing the importance of the use of blockchain technology, and stating that “AI, IoT, robots, big data, blockchain... are general purpose technologies (GPT) that broadly affect all industries, similar to the adoption of electric power from the 19th to 20th century and the inroads made by IT through the end of the 20th century.”

In addition, in April 2022, the Liberal Democratic Party Headquarters for the Promotion of a Digital Society Project Team regarding NFT Policies published the “NFT White Paper – Japan’s NFT Strategy for the Web 3.0 Era”. The White Paper examines regulatory barriers and other issues to the promotion of NFT and other Web 3.0 projects through a whole-of-government approach.

The legal nature of crypto-assets under Japanese civil law statutes is still unclear. According to a judicial precedent of the Tokyo District Court dated 5 August 2015, legal ownership or title does not apply to crypto-assets because they are intangible assets. As a consequence, the transfer of a crypto-asset does not equate to the transfer of legal ownership or title in that crypto-asset under the Civil Code.

Furthermore, from the perspective of the Civil Code, it is unclear when transfers of crypto-assets via a blockchain network will be considered final, because the legal characteristics of crypto-assets have not yet been firmed up.

Digital assets generated and traded on a blockchain are often classified as crypto-assets, but their legal statuses vary depending on the function of the individual digital assets and other factors. For example, if a digital asset is prepaid and can only be used by a merchant to the extent of the amount prepaid, and is prohibited in principle from being replenished, the digital asset may be classified as a prepaid payment instrument (PPI), while those that can be replenished in value may be classified as instruments for funds remittance transactions (Kawase Torihiki).

With the development of blockchain technology, so-called security tokens, or digital assets that represent shares, corporate bonds, fund interests, etc, have also emerged, and these are treated as securities, based on their nature and functions.

More specifically, if profit is distributed to the digital asset holder from the business income of the digital asset issuer, such digital asset would be classified as a security under the FIEA. If no profit is distributed, the next factor to consider is whether the digital asset is issued for consideration. Digital assets that are issued for no consideration will likely be deemed unregulated service points. Where a digital asset is issued for consideration, its legal status will depend on whether the digital asset constitutes a currency-denominated asset.

A digital asset that does not constitute a currency-denominated asset, and can be used vis-à-vis unspecified persons, and be bought, sold, or exchanged vis-à-vis unspecified persons, will in principle likely be deemed a crypto-asset or (if it can only be used for settlement with specified persons, such as merchants) a PPI. A digital asset that constitutes a currency-denominated asset but cannot be exchanged for a cash refund, will likely be deemed a PPI. If, however, such digital asset can be exchanged for a cash refund, it will likely be deemed an instrument for funds remittance transactions (Kawase Torihiki).

Furthermore, as noted in 1.1 Evolution of the Blockchain Market, in response to the increasing issuance and circulation of so-called stablecoins overseas, the Amendment Bill also introduced the concept of EPI, which corresponds to the concept of stablecoins.

As noted in 1.1 Evolution of the Blockchain Market, the Amendment Bill introduced the concept of EPI, which corresponds to the concept of stablecoins.

The Amendment Bill stipulates four categories of EPIs, as follows (Article 2, paragraph 5 of the Amended PSA):

• a currency-denominated asset that can be used as an instrument of payment for goods or services to an unspecified person, and is transferable using an electronic information processing system (Type I EPI);
• a property value exchangeable with Type I EPI with an unspecified counterparty, and transferable by means of an electronic information processing system (Type II EPI);
• specified trust beneficiary interests (Type III EPI); and
• those instruments specified by Cabinet Order as being equivalent to those listed in the preceding three items (Type IV EPI).

For the purposes of the definition of a Type I EIP, currency-denominated assets are defined as assets denominated in Japanese yen or a foreign currency, or with respect to which the performance, repayment, or any other activity equivalent thereto will be carried out in Japanese yen or a foreign currency. Based on this definition, a digital coin whose value is pegged to the Japanese yen, US dollar or any other fiat currency (such as, for example, where the price of a digital coin is always fixed at one yen or dollar, or where a digital coin is redeemable at one yen or dollar) would fall outside the definition of crypto-assets.

In view of the above, so-called algorithmic stablecoins that are not collateralised by fiat currency but whose values are linked to fiat currency through an algorithm are unlikely to qualify as currency-denominated assets. Such algorithmic stablecoins will likely fall within the category of crypto-assets if they are transferable or tradeable with unspecified parties on the blockchain.

There is in general no limitation on the use of crypto-assets for payments. Accordingly, payments are allowed to be made with crypto-assets in Japan. It should be noted, however, that under the Foreign Exchange and Foreign Trade Act, notification to the Minister of Finance is required when a payment is made or received between Japan and a foreign country, or between a resident and a non-resident, in an amount exceeding the equivalent of JPY30 million. This notification requirement is applicable both where payment in crypto-assets is made or where payment in crypto-assets is received.

Please refer to 1.4 Non-fungible Tokens.

In Japan, regardless of whether a business operator keeps the private keys to crypto-assets held by a user, the business operator is required to undergo registration as a CAESP if it engages in the sale or exchange of crypto-assets as a business. In other words, all digital asset exchanges in Japan are operated by registered CAESPs.

Decentralised exchanges (DEX) are not specifically regulated in Japan. However, as some of the services provided by DEXs may be deemed CAES (eg, sale or exchange of crypto-assets, intermediation of such sale or exchange, etc), it is high likely, where the operator of DEX is identified, that they will need to undergo registration as a CAESP.

As noted in 2.1 Regulatory Overview, under the PSA, CAES means any of the following acts carried out as a business:

• sale and purchase of crypto-assets or exchange of crypto-assets for other crypto-assets;
• intermediary, brokerage or delegation of such sale, purchase or exchange;
• management of users’ money in connection with the acts listed in the two bullet points above; or
• management of crypto-assets for the benefit of another person.

In this regard, the exchange of crypto-assets for legal tender (and vice versa) constitutes (i) “sale and purchase of crypto-assets”. Accordingly, a business operator that engages in the exchange of crypto-assets for legal currency (and vice versa) as a business will be engaging in CAES and thus will be subject to CAESP registration requirements.

As is clear from the definition of CAES, crypto-to-crypto exchanges also constitute CEAS, and business operators that engage in such exchanges as a business will also be subject to CAESP registration requirements.

Under the APTCP, specified business operators, including CAESPs, must verify their customers’ identities and comply with the requirements stipulated below.

Obligation to Identify Customers

When providing CAES to customers, specified business operators must verify the following (Article 4 of the APTCP):

• the customer’s identity;
• the purpose of the transaction;
• the customer’s occupation/lines of business;
• the identity of persons with substantial control of the customer’s business; and
• (under certain circumstances) the assets and income of the customer.

Obligation to Prepare and Maintain Verification Records

Specified business operators must, after conducting customer identification, immediately prepare customer identification records, and maintain such records for seven years from the date on which the contract for a specified transaction, etc, terminates (Article 6 of the APTCP).

Obligation to Prepare and Maintain Transaction Records

Specified business operators must, after conducting a transaction in connection with specified business affairs, immediately prepare transaction records, and maintain such records for seven years from the date on which the transaction is conducted (Article 7 of the APTCP).

Obligation to Report Suspicious Transactions to the Relevant Authority

If a property accepted through its specified business affairs is suspected to be criminal proceeds or a customer is suspected to be engaged in money laundering in connection with specified business affairs, a specified business operator must promptly report the same to the relevant authority (Article 8 of the APTCP).

Measures for Appropriate Conduct of Verification at Time of Transaction

Specified business operators must take such measures as necessary to keep matters verified at the time of transaction up-to-date, endeavour to improve the education and training of their employees in respect of verification matters, and maintain such other systems as necessary (Article 10 of the APTCP).

Under the PSA, CAESPs are required to:

• take such measures as necessary to ensure the safe management of information available to them;
• provide sufficient information to customers;
• take such measures as necessary for the protection of customers and for the proper provision of services;
• segregate the property of their customers from their own property and subject such segregation to regular audits by a certified public accountant or audit firm; and
• establish internal management systems to enable the provision of fair and appropriate responses to customer complaints, and implement measures for the resolution of disputes through financial ADR proceedings.

It should be noted that a CAESP is required under the PSA to both manage the money of users separately from its own money, and to entrust users’ money to a trust company or any other similar entity in accordance with the provisions of the relevant Cabinet Office Ordinance.

In addition, the FIEA prohibits, with penalties, unfair acts in crypto-asset trading (without limitation as to the victims of such acts) for purposes of protecting users and preventing unjust gains.

However, insider trading regulations in respect of crypto-assets have not been included within the scope of the FIEA because of the difficulties in identifying issuers of crypto-assets and undisclosed material facts pertaining to crypto-assets.

As noted in 4.4 Regulation of Markets, CAESPs are obliged to segregate the crypto-assets deposited by their customers from their own assets, and to manage customers’ assets separately from their own assets. CAESPs are also required to manage customers wallets separately from the crypto-assets held by the CAESPs themselves.

Therefore, CAESPs cannot create any security interest over the crypto-assets they manage as fiduciaries on behalf of their customers in favour of any third party without the consent of their customers.

The PSA designates “management of crypto-assets for the benefit of another person” as a type of CAES. Consequently, management of crypto-assets without the sale and purchase of such assets (“crypto-asset custody services”) is now included within the scope of CAES. This means that a person engaging in crypto-asset custody services needs to undergo registration as a CAESP.

In this context, the Guidelines on Crypto-assets issued by the JFSA provided the following clarification in respect of “management of crypto-assets for the benefit of another person”: “although each case should be determined based on its actual circumstances, it would constitute management of crypto-assets if the operator were in a position that enabled it to voluntarily transfer its users’ crypto-assets (such as, for example, when the operator owns a private key with which it may transfer its users’ crypto-assets on its own or jointly with related parties, without the involvement of its users).” Accordingly, it is generally understood that the mere provision of crypto-asset wallet services to users to enable them to manage private keys on their own would not constitute a crypto-asset custody service.

In addition, CAESPs are required to manage their users’ crypto-assets (“entrusted crypto-assets”) separately from their own crypto-assets. CAESPs are also separately required, except in exceptional circumstances, to manage entrusted crypto-assets (other than crypto-assets that are subject to requirements specified by the relevant Cabinet Office Ordinance) to ensure users’ convenience and to ensure smooth performance of crypto-asset exchange services, using the “methods specified in the relevant Cabinet Office Ordinance, being methods that are unlikely to result in insufficient protection of users.”

Furthermore, CAESPs are required to hold crypto-assets of the same kind and quantity as the crypto-assets that are subject to the aforementioned requirements (ie, the requirements that seek to ensure both users’ convenience and the smooth performance of CAES).

Based on the prevailing view and current practices, where a token issued via an initial coin offering (ICO) is already in circulation on a Japanese or foreign crypto-asset exchange, such token would be deemed a crypto-asset under the PSA, since a market of exchange for that token is already in existence.

The JVCEA published its self-regulatory rules and guidelines regarding ICOs for crypto-assets entitled “Rules for Selling New Crypto-assets” (the “ICO Rules”). Under the ICO Rules, an ICO can be legally launched in Japan as long as such launch is conducted in compliance with the ICO Rules.

The ICO Rules contemplate two types of ICOs. The first is where a CAESP issues new tokens and sells such tokens by itself. The second is where a token issuer delegates the sale of newly issued tokens to CAESPs (a so-called initial exchange offering (IEO)). As a general matter, the ICO Rules stipulate the following requirements for both types of ICO:

• maintenance of a structure for the review of a business that raises funds via an ICO;
• disclosure of information on the token, the token issuer’s purpose for the offering proceeds, and the like;
• segregated management of funds (both fiat and Crypto-assets) raised by an ICO;
• maintenance of proper accounting practices and records and financial disclosure of funds raised by an ICO;
• ensuring the security of newly issued tokens, and of the blockchain, smart contracts, wallet tools, and the like in respect of such tokens; and
• proper valuation of newly issued tokens.

Additionally, the ICO Rules require an ICO to be implemented in compliance with the following steps:

• the CAESP that will be handling the ICO token is required to assess both the feasibility of the ICO and the security of the ICO tokens;
• the CAESP that will be handling the ICO token is required to prepare and submit a report in respect of that assessment to the JVCEA for review;
• if the aforementioned report is approved by the JVCEA, the CAESP must submit a notification of change in handling crypto-assets to the JFSA; and
• upon the JFSA’s receipt of such notification, the CAESP will be permitted to make the ICO to Japan residents.

As noted in 5.1 Initial Coin Offerings, IEOs are subject to essentially the same rules as ICOs. For details of the ICO Rules, please refer to 5.1 Initial Coin Offerings.

As noted in 2.1 Regulatory Overview, CAES includes sale and purchase of crypto-assets or exchange of crypto-assets. By contrast, an airdrop of crypto-assets does not constitute a “sale and purchase” or an “exchange” for a fee, since it is an act of granting crypto-assets for free.

Based on this, the authors believe that airdrops granting crypto-assets for free do not constitute CAES.

As a result of amendments to the Regulations for Enforcement of the Act on Investment Trusts and Investment Corporations, as well as to the Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc, investment trusts and investment corporations are prohibited from investing in crypto-assets.

Accordingly, an investment fund that invests in crypto-assets has to be established in the form of a partnership-type investment fund based on a silent partnership agreement under the Commercial Code.

Digital assets that constitute crypto-assets are subject to regulation applicable to CAES; ie, regulations that relate to the exchange, intermediation, agency, and brokerage of crypto-assets (Article 2, paragraph 7, Item 2 of the PSA).

In other words, broker-dealers or other financial intermediaries that deal in crypto-assets will also be subject to regulations concerning CAES.

There is not clear definition of “smart contracts” under Japanese law, nor is there any specific regulation of smart contracts in Japan.

Assuming that smart contracts generally mean self-executing contracts containing terms that are pre-determined pursuant to specific programming codes, the use of smart contracts may raise issues of enforceability, although the costs of resolving such issues may be offset by the use of smart contracts.

For instance, a smart contract based on blockchain technology would be automatically enforced and irrevocable even if such contract is unenforceable for violating applicable law. It should be noted that there is currently no judicial precedent in Japan addressing the legal enforceability of such smart contracts.

There are no regulations in Japan that focus specifically on the responsibility of developers of blockchain-based networks or the codes that run on such networks.

In general, however, if there is any breach of contract in terms of the work performed by a contractor, the contractor will be responsible for losses arising from such breach under the Civil Code.

In respect of software bugs, where a contractor resolves an issue without delay after such issue has been brought to the attention of the contractor, or if the contractor consults with the user and takes reasonable alternative measures for the resolution of the issues, the contractor would not be deemed to have breached the software development contract.

On the other hand, if a software bug leads to significant interference with the function of the software and cannot be resolved quickly, results in significant issues, arises regularly, or causes interference with the operation of a system, then such bugs would constitute a breach of a software development contract, and the software developer would be responsible for such breach.

The issue here would be whether operators of DeFi platforms for the lending and borrowing of digital assets that constitute crypto-assets, would be deemed to be providing CAES under the PSA or conducting money lending business under the MLBA.

Applicability of CAES Regulations

As noted in 2.1 Regulatory Overview, the scope of CAES includes the sale and purchase of Crypto-assets (Article 2, paragraph 7, Item 1 of the PSA) and the “management of crypto-assets for the benefit of another person” (Article 2, paragraph 7, Item 4 of the PSA).

The lending and borrowing of crypto-assets is not caught by the PSA. More specifically, crypto-assets that are lent to or borrowed from users are considered to belong to the crypto-asset lending company. As the lending and borrowing of crypto-assets do not constitute management of crypto-assets “for the benefit of another person,” such lending and borrowing will not constitute CAES.

As a result, the operator of a DeFi platform will not constitute a CAESP (although, depending on the factual circumstances, a DeFi platform operator that manages crypto-assets held by users may be deemed to be providing crypto-asset custody services).

Applicability of Money Lending Regulations

Money lending business refers to “the business of loaning money or acting as an intermediary for the lending or borrowing of money on a regular basis” (Article 2, paragraph 1 of the MLBA). Generally, crypto-assets are not deemed to constitute legal tender or “money” as such term is referred to in the MLBA.

Accordingly, operation of a DeFi platform does not constitute the conduct of money lending business unless the platform is used to lend or borrow crypto-assets in such a manner as to effectively constitute the lending or borrowing of legal tender.

As noted in 3.1 Ownership, the concept of legal ownership of crypto-assets is not currently recognised in Japan because crypto-assets are intangible. Under Japanese law, it is considered impossible to create a security interest in an intangible object itself, it is therefore likely to be difficult to create a security interest directly over crypto-assets that are managed by a borrower at its own address.

By contrast, if a borrower has deposited its own crypto-assets with a CAESP, the lender would conceivably be able to create a pledge of or transfer security interest in the borrower’s claim for the return of the deposited crypto-assets against the CAESP.

Transfers by professional investors of digital assets in which they have invested to a custodian are not specifically regulated in Japan.

Persons wishing to act as custodians of digital assets are required to undergo registration as CAESPs because they will be offering the service of “management of crypto-assets for the benefit of another person” (ie, crypto-asset custody services).

It should be noted, however, that a trust company may be entrusted with the custody of crypto-assets pursuant to the Trust Business Act without being registered as a CAESP (Article 2, paragraph 7, Item 4 of the PSA). With that said, a trust company that is a subsidiary of a bank, a bank holding company or a trust bank is not permitted to hold crypto-assets on entrustment.

Business operators using blockchain technology may be subject to the Act on the Protection of Personal Information (APPI) if they handle personal information.

Considering that a public blockchain involves the sharing of a database among unspecified participants, where information on the blockchain will not in principle be deleted or retracted once uploaded on the blockchain, the use of blockchain technology may trigger the application of the APPI. For example, Article 19 of the APPI requires business operators who handle personal information to delete unnecessary personal information once the purpose for which such personal information is required has been achieved. However, a business operator that records the personal information of its users on a blockchain may have difficulty deleting such information, and this could result in a violation of the APPI.

Data that creatively express thoughts or sentiments, such as images and music, fall within the definition of “work” under the Copyright Act. What this means is that use of such data may be subject to the Copyrights Act. Where the Copyrights Act applies, it would be necessary to ensure non-infringement of the rights of the data’s author.

Additionally, use of data that constitutes trade secrets may be subject to the Unfair Competition Prevention Act (UCPA). Where the UCPA applies, it would be necessary to ensure that the interests of owners of such trade secrets are not infringed.

Under Japanese regulations, including the PSA, the mining of crypto-assets itself does not fall within the definition of CAES. Accordingly, mining activities are not regulated under existing Japanese regulations.

It bears noting, however, that interests in mining schemes formulated as collective investment schemes or in cloud mining schemes may be deemed securities under the FIEA, and could therefore be subject to provisions under the FIEA.

The staking of tokens itself is not regulated in Japan. Depending on the content of the staking service involved, however, it may trigger CAES regulations under the PSA or regulations in respect of collective investment schemes under the FIEA.

More specifically, if the private keys of crypto-assets held by customers in the staking service is transferred to the provider of the staking service, and such service provider is able to transfer and dispose of the crypto-assets without the involvement of the customers, then the staking service will likely constitute either (i) CAES, as it involves “the management of crypto-assets for benefit of another person”; or (ii) Type II financial instruments business, as it involves solicitation in respect of a collective investment scheme stipulated in Article 2, paragraph 2, Item 5 of the FIEA.

In contrast, if the staking service involves no transfer of the private keys of crypto-assets held by customers to the staking service provider, such that the service provider cannot transfer or dispose of such crypto-assets without the involvement of the customers, then such staking service is unlikely to constitute “management of crypto-assets for the benefit of another person” or solicitation in respect of a collective investment scheme.

Currently, there is no legal definition of decentralised autonomous organisations (DAOs) in Japan, nor is there any law that stipulates the legal treatment or composition of DAOs.

Accordingly, we believe that DAOs will likely be treated as associations, partnerships, or companies under existing laws and regulations, depending on the legal and governance structure of the relevant DAO.

For example, even if a group operating as a DAO does not have a juridical personality, it will likely be treated as an “association without rights and powers” if it has the actual substantive status of an association.

For this purpose, an “association without rights and powers” means an entity:

• made up of individuals who have been brought together for a common purpose;
• organised as an association;
• subject to the principle of majority voting;
• that continues to exist despite changes in its members; and
• in respect of which a system has been put in place for its representation, management, management of property, and other matters essential to its organisation (Supreme Court decision of 15 October 1964).

If a DAO constitutes an “association without rights and powers”, the rights and obligations of the DAO will be vested in the DAO members, who are members of the DAO, and each of these members will bear limited liability for the obligations of the association that has no juridical personality.

As noted in 10.1 General, there is no law in Japan that specifically regulates DAOs or the governance thereof.

Consequently, there are no laws regulating the method of distributing governance tokens to DAO members in DAOs, nor are there laws on whether governance tokens should be granted on or off-chain.

Additionally, there are no laws that stipulate the criteria necessary for decision-making in DAOs.

As noted in 10.1 General, there is no law in Japan that specifically regulates DAOs or the governance thereof.

As a result, if a so-called DAO in Japan tries to enter into a transaction with a non-blockchain local entity (such as a company or financial institution that adopts the legal structure of a stock company), it is unclear who in the DAO will have representative authority. Accordingly, it may be difficult as a practical matter for a DAO to conclude a contract with a local entity.

For this reason, there have been, in practice, cases in which members of so-called DAOs have considered establishing a subsidiary in Japan for purposes of entering into transactions with non-blockchain local entities through that subsidiary.