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$530-mn Coincheck heist sheds light on Japan's rush to create crypto rules

Coincheck was among the exchanges that didn't win approval. By the time it filed its application in mid-September, bitcoin was surging towards a record high of $19,458, which it hit in December

Reuters  |  Tokyo 

Photo: Reuters
Photo: Reuters

After the exchange was stung by a half-billion-dollar theft in 2014, Japanese regulators swung into action.

Their goal was to craft rules that both protected traders and allowed a promising sector to flourish. By last April, they thought they had arrived at a set of guidelines that did just that.

Japan's national system to oversee trading was the world's first, rolled out even as policymakers elsewhere grappled with how to deal with the sector. Under the Japanese framework, some exchanges would be allowed to operate - even though they hadn't yet won regulatory approval.

One of those was Inc. Last month, hackers stole about $530 million from the Tokyo-based exchange, a theft rivalling Mt. Gox's as one of the biggest ever for the digital currency.

The heist exposed flaws in Japan's system. And for some experts, it raised questions over the country's dash to regulate the industry - a sharp contrast to clampdowns by countries like and

Interviews with a dozen government officials, lawmakers and industry leaders depict a regulator that opted for relatively loose rules to help nurture an industry largely populated by start-ups.

Japan's declined to comment.

But proponents of its regulatory approach say the system and the hack were not connected.

"It's too much to say that the FSA or institutional design was lax because there was one hack," said former vice-minister Mineyuki Fukuda, previously a supporter in the parliament of promoting and regulating cryptocurrencies.

"It's not money"

In the wake of the bankruptcy, didn't know what to make of - or even who should be in charge.

"It's not money," told reporters days after the exchange collapsed. "Does the have jurisdiction? The The The Ministry of Economy, "

Amid the vacuum of oversight, the governing Liberal Democratic Party, seeing the fin-tech sector as a way to stimulate growth, initially called for the industry to form a body to regulate itself.

That led to the formation of the Authority of Digital Assets (JADA), comprising blockchain and start-ups and entrepreneurs.

When the FSA was later tasked with creating regulations for cryptocurrencies, it turned to for help. The group lobbied for rules friendly to start-ups, like low capital requirements.

"We had constant discussions with the FSA, giving technical information and ideas," said So Saito, a founding member of and now of its successor, the Blockchain Association (JBA).

The FSA's rules required exchanges to register, operate robust and

But they left the storage of assets to a set of non-binding guidelines.

Exchanges should keep the encrypted keys needed to access digital money in "cold wallets" - for example, USB drives not connected to the internet - only if doing so didn't overly inconvenience customers, the guidelines said.

In effect, the clause left no obstacle to Coincheck's holding $530 million worth of NEM crypto-coins in an online "hot wallet" - essentially a digital folder stored on a server - from which the funds were stolen.

"The FSA was quite relaxed on protecting consumers on things like cold wallets and hot wallets," said the of a major Japanese exchange.

vs the world

Policymakers across the world have grappled with how to deal with cryptocurrencies. Most have been sceptical about trade in digital assets.

U. S. regulators may ask to legislate more oversight of digital money, the of the said this month.

In Asia, is embracing strong oversight of trading, at one point saying it might shut down local exchanges. China, concerned about financial stability, last year ordered some exchanges to close. this month vowed to stamp out the use of cryptocurrencies altogether.

Statistics on cryptocurrencies are patchy because their trading is unregulated in most countries. But accounts for between a third and half of all global trade, exchange operators say - a share of the market that has grown as other jurisdictions have cracked down.

As Japan's rules came into effect last April, exchanges were given six months to register.

But even those that registered but weren't approved could continue to operate.

was among the exchanges that didn't win approval. By the time it filed its application in mid-September, was surging towards a record high of $19,458, which it hit in December.

The exchange had grown to one of Japan's biggest amid a sharp increase in trading, moving to a new headquarters from a dingy backstreet office. Its share of domestic trades soared to 55 percent in December from only 7 percent a year earlier, data from show.

In an interview with last year, Kaga Kawabata, Coincheck's business development manager, was dismissive of the FSA's oversight, even as the exchange prepared to register.

"They have no knowledge. Every year someone moves, and it's a big pain to educate them," he said.

The FSA said last week it didn't approve partly because of worries about weaknesses in the exchange's systems, declining to give further details. It allowed to continue operating, calling for improvements without a specific timeline.

The regulator was in a bind, industry insiders said: had grown so big that the FSA couldn't reject its application.

"Consumers would be upset. It was politically difficult to close down Coincheck," said Masakazu Masujima, a to the Business Association, an industry body. "So they kept requesting it to improve its systems."

First Published: Mon, February 12 2018. 12:05 IST