Japanese Blockchain Law: ZeLo’s Six-Part Series (2 of 6)

Contents

Part 2: Legal Characteristics and Issues of Virtual Currency

I. What are virtual currencies such as Bitcoin?

A. What are virtual currencies?

Starting with Bitcoin, virtual currencies were introduced on or around November 1, 2008. Satoshi Nakamoto sent out a paper called “Bitcoin: A Peer-to-Peer Electronic Cash System” to a closed mailing list. Bitcoin was then created on January 2009.

Other well-known services include Ripple, which run a global payment processing system, and Ethereum, which is a fragmented computing platform.

The value of virtual currencies lies in peer networks (“P2P”). A P2P network is similar to a network system like Skype, where users (terminals) communicate with one another as if you are running around messages. Virtual currencies share transaction data via P2P networks and blockchain technologies to computers around the world in a fragmented manner.

B. Is virtual currency legally considered money in Japan?

However, legal scholars generally say that currency should be defined as: (1) “something that can be used to settle an account without some other form of payment wherever, and (2) has “mandatory recognition.” “(Mandatory recognition)” means: (1) the amount of is displayed on a bill or coin will be legally recognized as that amount; ) the national government guarantees that the value of the bill or coin as indicated on its face can not be disputed.

The “yen” is something that can be used in Hokkaido or Okinawa by someone who is old, young, male or female; and can be used to buy ramen or a house. It is Japan’s “currency” – a nationally recognized method to settle transactions.

Let us see whether this definition applies to virtual currencies. Bitcoin may be used at some major stores such as Bic Camera and “can be used by whoever” and “can be used to settle an account without some other form of payment.” However, it is not something that can be used “whenever” or “for whatever” and the national government does not guarantee that recipients will not dispute its value. Accordingly, virtual currencies cannot be considered “currency” from a Japanese legal perspective.

C. Consequences of virtual currencies not being legal “currency”

The following legal issues arise from virtual currencies not legally being “currency.”

1. Can Bitcoin be used to repay debts?

Let us assume that your company is providing a web service. Your customer says that “I made a lot of Bitcoin lately and will be providing payment in Bitcoin.” Can your company deny the customer this method of payment?

To start with the answer, it is possible to refuse. Civil Law Section 402(1) states that, if the subject of a claim is money, the obligor may, at his/her choice, make payment in currency of any kind unless the claim specifies that payment must be made in a certain kind of currency. The Civil Law does not take into account the principle of repayment of debts with virtual currencies that are not legally “currency.” Under Japanese law, if the parties agree, it is possible for an obligor to repay its debt under the principle of accord and satisfaction. Accordingly, in order to use Bitcoin or Ethers as a form of payment, it is necessary to include this payment concept in a binding contract to establish that there was an agreement between the parties for such accord and satisfaction. In other words, if Bitcoin or Ethereum will be used as a form of payment on a platform, it is necessary to include this in the website’s terms of use.

2. Can you pay wages in Bitcoin?

Your company’s president says: “employees will receive Bitcoin given that there are no transfer fees required.” Is this possible?

To start with the answer, generally speaking, it is not possible to pay wages with virtual currency. According to Article 24(1) of the Labor Standards Act, wages must be paid with “currency.” However, an exception is if the company and the employees (or labor unions) execute a contract that allows for this (supplementary provision to Article 24(1) of the Labor Standards Act). Accordingly, if you would like to pay wages with Bitcoin, a labor agreement is needed.

D. Definition of Virtual Currencies under the Amended Payment Services Act

Because there is an expectation that virtual currency will serve a similar function as currency even though it does not fall under the recognized legal definition of the concept, the amended Payment Services Act provides a definition for “virtual currency.” Because this definition is critical for blockchain and virtual currency businesses, we will cite the entire section of the law here.

Article 2(5)
(i) property value (limited to that which is recorded on an electronic device or any other object by electronic means, and excluding the Japanese currency, foreign currencies, and Currency-Denominated Assets; the same applies in the following item) which can be used in relation to unspecified persons for the purpose of paying consideration for the purchase or leasing of goods or the receipt of provision of services and can also be purchased from and sold to unspecified persons acting as counterparties, and which can be transferred by means of an electronic data processing system; and
(ii) property value which can be mutually exchanged with what is set forth in the preceding item with unspecified persons acting as counterparties, and which can be transferred by means of an electronic data processing system.

The only laws that use this definition are the Payment Services Act and the Criminal Proceeds Act.

II. Regulation of Virtual Currency

A. Introduction

Lately, the use of virtual currencies has expanded. Given that the value of virtual currencies has started to become recognized, some have begun to hold virtual currencies as assets. There is no doubt any more that virtual currencies have some sort of asset value. However, it is unclear what the legal consequences are of holding virtual currency. Also, if a debtor does not have any assets other than virtual currency, it is unclear to what extent a creditor can recover virtual currency from the debtor and to what degree the collection of virtual currency is legally enforceable. 555). 

This section will look at the legal characteristics of virtual currency and to what extent they can be subject to attachment by law.

B. Legal Characteristics of Virtual Currency

With regard to the definition of virtual currency in the Payment Services Act, it becomes clear that property value is a vital legal characteristic of this currency. Indeed, the Act defines virtual currency by its “property value.” However, this definition comes from public law and it may not apply for all instances of private law.

1. Categorization of Property under Japanese Civil Law

Under the Civil Law, the following are considered assets: tangible things (Civil Law article 85), real property rights (Civil Law article 175), claims (e.g. as a creditor) (Civil Law article 399), money/currency (Civil Law article 402) and other property rights (Civil Law sections 362 (1), 555).  

2. Is virtual currency a “tangible thing” under Japanese Civil Law?

If virtual currencies can be considered “tangible things,” the currency’s owners will have property rights to control the “tangible thing” and will have the right to seize back the property.

In the Mt. Gox Case at the Tokyo District Court , a company called Mt. Gox filed for bankruptcy. Under Article 62 of the Bankruptcy Act, in order to be able to recover assets, ownership of such assets needs to be established. During the bankruptcy proceedings, given that one of the alleged assets to be recovered was Bitcoin, the ownership rights of Bitcoin were litigated. The court held that Bitcoin is not a “tangible thing” because it lacks “tangibility” and “exclusive controllability.”

i. Tangibility

Bitcoin is a digital currency or cryptocurrency and was defined by the court as “an internet commodity” given how it is used. Because Bitcoin is something that is used on the internet, it does not fit the definition of “tangibility,” which the court defined as something that occupies space.

ii. Controllability

Even if there is no tangibility, there is precedent that something may be considered a “tangible thing” if there is “exclusive controllability” such as electricity and air conditioning. However, the court held that there was no exclusive controllability for Bitcoin. In order for Bitcoin to be transferred, the parties do not only rely on electronic records but also on other factors related to mining. Also, electronic records of how much Bitcoin an owner has remaining do not exist given that the number is calculated based on all Bitcoin transactions at a given time. Accordingly, it cannot be said that the manager of a Bitcoin address’s secret key has control over the amount of Bitcoin it holds.

3. Is virtual currency a “tangible thing” under Japanese Civil Law?

The “Law of Obligations” (saiken) under Japanese law is a body of law regarding the right to have a claim against another party under certain circumstances. For the purpose of this section, the party that has the claim will be called the “obligee” and the party who owes the debt to fulfill the claim will be called the “obligor.” Is it possible for virtual currencies to be the subject of a claim under the Law of Obligations?

Virtual currency’s blockchains are computer algorithms that determine how much virtual currency should be allocated to participants. Given that there is no meeting of minds between transacting parties, it cannot be said that a party has a right to claim another’s currency.

Another Mt. Gox case proves to be instructive on this issue. In the 2018 Mt. Gox case , the court stated that any claims where customers seek to recover Bitcoin from Mt. Gox can be deemed to be “claims that do not require payment of currency” (Bankruptcy Act article 103(2)(1)).

C. Enforcing Claims regarding Virtual Currency

1. Property subject to compulsory execution (injunction)

Let us assume that holders of claims (obligees) sue the obligors and obtain a judgment or settlement. If the obligor does not comply with its payment obligations pursuant to the judgment, the obligee generally must request that the court issue an order for compulsory execution of the payment, which then results in a court order for the obligor’s assets to be seized.

Japan’s Civil Execution Act establishes the methods by which obligees can recover claims by seizing the assets of the obligor via compulsory execution. The main methods are compulsory auction of real estate (Civil Execution Act 43(1)), transferring control of movable property to the obligor (Civil Execution Act 123(1)), having a third party that has a claim to the obligor retain control directly of the obligor’s rights (Civil Execution Act 155(1)) and other property rights (real estate, vessels, movable property and other claims other than assets (Civil Execution Act 167(1)). 

Assuming that the obligor does not have any assets to pay the obligee other than virtual currency, we will take a look at at the process that occurs when an obligee attempts to recover a claim by seizing movable assets, enforce its claims against a third party recipient, or go after other property rights in the following two situations: (1) the obligor manages its own secret key for virtual currency it carries (use of a client wallet); and (2) when a third party manages the secret key for virtual currency that an obligor carriers.

2. When an obligor manages its own secret key for virtual currencies (“client wallet model”)

i. Recovering a claim by seizing movable property

a. Seizing virtual currency itself

As discussed above, as long as virtual currencies are not considered “tangible things,” it also cannot be defined as a “movable” under the Civil Execution Act. Accordingly, virtual currency itself cannot be considered property that can be seized.

b. Seizing computer terminals

Given that virtual currency itself cannot be seized as movable property, let us now examine whether it is possible to target the terminals that handle the transactions such as computers or smart phones that install the wallets and have the ability to control the transfer of the virtual currency. Generally speaking, it is not contested that terminals such as computers can be considered movable assets under the Civil Execution Act.

In the case where the manager of the secret key of the virtual currency is using a client wallet and passwords or third parties are unnecessary for that manager to transfer the virtual currency, the terminals can be seized, and the claim can be recovered.

However, for injunctions targeting movable property, it is necessary to (1) seize the movable property at issue (Civil Execution Act article 122), (2) convert the movable property to funds at an arms’ length price (Civil Execution Act article 134); and (3) deliver it to the obligee (Civil Execution Act article 139). In other words, movable assets can be the subject of an injunction only when they can be sold and converted into money. In other words, even if the obligee can seize the obligor’s computer terminals as movable assets, the obligee can only recover the value of the computer terminals and cannot transfer the value of the virtual currency that the obligor carries.

Accordingly, even in cases of client wallets where the carrier of virtual currency directly manages the secret key, injunctions of movable property do not seem like an effective way for an obligee to recover its claims.

ii. Enforcing an obligee’s claim against a third party that received the virtual currency from the obligor

Even for client wallet models where the carrier of virtual currency directly manages the secret key, the carrier does not have the right to claim the return of virtual currency from a third party that received it after it had been transferred. Accordingly, an obligor’s claim against a third party recipient of the virtual currency cannot be enforced.

iii. Enforcement by Recovery of Other Asset-Value Rights

Given that virtual currency most likely can be given an asset value, it will most likely fall under “other asset-value rights” under the Civil Execution Act (Article 167(1)).

When enforcing the recovery of other asset-value rights, for instances where the carrier of virtual currency directly manages the client wallet, an attachment order may be enforced against the owner of the virtual currency assuming that there are no other third party obligors. The value of the currency would be the time at which the order was issued. 

a. Conversion Methods as a result of Assignment Order

When “other asset-value rights” are to be converted into money, it would most likely be after an assignment order or a sale order by the court. (Civil Execution Act article 161(1)). If using the conversion method, the prosecutor must show that recovering the subject of the attachment is going to be difficult. In cases where virtual currency is managed by client wallets, the recovery of claims and distributions by third party obligors is not possible. Accordingly, the recovery of the subject of the attachment is difficult and assignment or sale orders are warranted.

However, even if assignment or sale orders are issued, the obligee will not be satisfied unless the owner of the virtual currency cooperates voluntarily, making this a limited solution.

b. Possibility of indirect enforcement

In the case that an obligor does not seek to cooperate and convert virtual currency, an obligee will have to rely on monetary penalties that the court issues for not complying with assignment or sale orders.

3. When a third party manages the secret key for virtual currencies that the obligor owns (“server wallet model”)

i. Recovering a claim by seizing movable assets

a. Seizing Virtual currency itself

The same analysis as the client wallet model applies.

b. Seizing computer terminals

Similar to client wallets, it is true that only the sale proceeds of the computer terminal can be recovered for server wallets as well. However, there is an additional problem when there is no relationship with the third party that is managing the secret key given that the obligor is not able to transfer the virtual currency, which prevents the obligee from being able to seize any movable assets.

ii. Enforcing an obligee’s claim

Is it possible to enforce an obligee’s claim when a third party controls the secret key for a server wallet by ordering that the virtual currency be transferred back to the obligee? The owner of the virtual currency may be able to contractually enforce its claim against the third party using the Terms of Service/Terms of Use of the virtual currency in order to enforce either (a) reimbursement of virtual currency in Japanese yen; or (b) remittance of the virtual currency to a specified address.

Regarding this issue, for example, if there is a specified issuer or a central manager of electronic money, if that issuer or manager is the obligor and its cooperation can be obtained, it will also be possible to have electronic money transferred to the obligee. Also, issuing an attachment order to the appropriate institution that manages electronic money would make an injunction to seize those assets enforceable (Electronic Record Obligation Act article 49, Civil Execution Act Enforcement Regulations article 150(10)).

iii. Enforcement by Recovery of Other Property Rights

The same analysis as the client wallet model applies.

D. Methods of Compulsory Execution

As discussed above, if the secret key is managed by a third party, the owner of the virtual currency has a right to request reimbursement or the right to return the virtual currency.

1. Regarding the right to request reimbursement

The right to request reimbursement gives the owner of virtual currency the right to have it converted to Japanese yen so that the obligor can fulfill its debts (Civil Execution Act article 143). If this is possible, the obligor has the right to request a third party to convert the virtual currency into money and the court can attach a reimbursement claim and demand the reimbursement be sent to the obligor (Civil Execution Act article 155(1)). If the third party does not voluntarily abide by the demand, it is possible for the obligee to file suit to enforce its attached claim for reimbursement right (Civil Execution Act article 157(1)).

Furthermore, the obligee can file a motion to have the court order the obligor to transfer its right to attach the face value of the claim from the third party to the obligee. However, determining the time period in which to calculate the face value of the virtual currency will become an issue.

2. Whether virtual currency can be forced to be returned

Because virtual currency cannot be defined as “money,” the right to have the virtual currency returned is not a monetary claim. Accordingly, it will fall under “other property rights” under Article 167(1) of the Civil Execution Act. These rights cannot be transferred. Accordingly, some form of an assignment order or sale order by the court will be required. (Civil Execution Act Article 161(1)).

In order to obtain an assignment order or sale order, the conditions or period of the attachment claim or counterclaim must be such that collection of the proceeds will be difficult. The issue then becomes whether collection of virtual currency in the server wallet model would be difficult. In a case where a contractual reimbursement right from the terms of use is being exercised, it is unlikely that a court will find that the collection of proceeds will be difficult. Accordingly, it does not seem as though a conversion through an assignment order or sale order would pass muster.

III. Payment Services Act

The amended Payment Services Act was passed on June 3, 2016 and made effective on April 1, 2017. On this date, virtual exchange companies became subject to regulations within Chapter 3(2) of this act.

There are many ways that virtual currencies can be used in business. However, with regard to virtual currency exchange services, registration becomes necessary under the Payment Services Act. Also, given that the definition of virtual currency is still in a grey area, it also becomes necessary to determine whether a given business model will fall under the ambit of the Payment Services Act’s definition of “virtual currency.”

Article 2(7) of the Payment Services Act defines “Virtual Currency Exchange Service” as carrying out any of the following services:

(i)  purchase and sale of a Virtual Currency or exchange with another Virtual Currency;
(ii)  intermediary, brokerage or agency services for the act set forth in the preceding item; and
(iii)  management of users’ money or Virtual Currency, carried out by persons in connection with their acts set forth in the preceding two items.

A. Acts that fall under the definition of “Virtual Currency Exchange Service”

1. Purchase and sale of a Virtual Currency or exchange with another Virtual Currency

The “purchase and sale” of virtual currency means transactions regarding virtual currency and money (legal currency). For example, virtual currency platforms that sell virtual currency would fall under this definition. In contrast, the “exchange” of virtual currency means transactions between those who own virtual currency.

It becomes necessary to determine whether a transaction actually involves the purchase and sale of virtual currency or whether it merely promises the purchase and sale of virtual currency at a future point in time (“Leveraged Transaction”). There are two types of Leveraged Transactions. First, if the virtual currency itself is transferred, the Leveraged Transaction will essentially be a “purchase and sale.” In contrast, the second type is a transaction where the virtual currency itself is not actually delivered but, rather, the future profits that derive from advantageous positioning of buying and selling the currency are used as payment. Regarding the second type of transaction, the fact that virtual currency itself is not exchanged precludes it from being subject to the Payment Services Act (Payment Services Guideline I-1-2).

As of October 2018, because virtual currency is not considered a “security” under the Financial Instruments and Exchange Act (“FIEA”), FIEA will also not apply to options relating to virtual currency and Leveraged Transactions.

Meanwhile, it is possible that an ICO involving exchanging a new token with virtual currency may be considered as “purchase and sale” of virtual currency. This exchange of new tokens with existing tokens would be subject to the Payment Services Act.

2. Intermediaries, brokerages or agency services

Intermediaries related to the purchase and sale of virtual currency are third parties that act between parties to execute a legal action. “Brokerages” are those who engage in legal actions on their own name for others’ financial situations. Finally, agents are those who step into the shoes of a party and legally act on their behalf.

Virtual currency exchange services that match the purchase and sale orders of users do not necessarily act as entities that purchase and sell virtual currencies. However, an exchange service most likely becomes an “intermediary” and is subject to the Payment Services Act. Also, if services act in the place of users, they could act as either a “brokerage” or “agent” that would be subject to the Payment Services Act.

3. Managing users’ money and virtual currency with regard to the services in (a), (b) above

Regarding the matters involved in (a) and (b) above, managing money and virtual currency also falls under the definition of virtual currency exchange services. If a service does not actually exchange money or other virtual currencies, registration is not necessary under the Payment Services Act.

B. Definition of “Services”

“Services” means engaging in acts “to the public” that have “continuity” (Virtual currency guideline I-1-2). This can be interpreted as services to the public that have continuity and a continuous service to the public.

C. Capital Transfer Services

When using a method to transfer virtual currency, it may become necessary for the transferor to register as a Capital Transfer Service (Capital Settlements Act article 37).

A “Capital Transfer Service” is a transferor that engages in exchange transactions other than banks and financial institutions (Capital Settlements Act article 2(2)). For transactions under 1 million yen, it will become necessary to determine whether it is a capital transfer service; but, for transactions over 1 million yen, a license under the Banking Act will be required.

“Exchange transactions” do not have a definition but case law under the Banking Act shows that it means remote parties that do not directly deliver money but rather accept and/or undergo a capital transfer transaction.

Virtual currency can be exchanged for money but, given that the value changes, it cannot be considered “capital” and it does not seem likely that the transfer of virtual currency will be considered an exchange transaction. If an exchanger of virtual currency accepts a transfer of funds in a manner that falls within the definition of exchange transactions, registration as a Capital Transfer Service will be necessary. For example, if a company accepts a request to transfer funds and, if this is converted to virtual currency and sent to a wallet within or outside the company, this will be considered a transfer of “capital” and the definition of exchange transaction is likely to apply” (Virtual currency guideline I-1-2).

D. Money Lending Services

Given that virtual currency is not considered money, the Money Lending Service Act does not apply.

However, if a virtual currency exchange service ends up lending money to a user, it needs to register as a Money Lending Service. (Money Lending Service Act article 3(1)). For example, if a virtual currency service agency receives funds as a security and credit transactions are enacted by lending some virtual currency, registration as a Money Lending Service may be necessary (Virtual currency guideline I-1-2).

IV. Act on Prevention of Transfer of Criminal Proceeds; Anti-Money Laundering Act

Anti-money laundering is the act of using a false identity or the identity of another to process transactions so that criminal profits look as if they are legitimate transactions in order to hide the origin and beneficiary of the crime. Virtual currency allows users to be anonymous and is used worldwide. Transactions occur extremely quickly. Also, regulations regarding virtual currencies differ by country. Given that it is difficult to identify the origin and beneficiary of transactions, there is a high risk that money laundering can occur.

Organized crime is a threat to international society. As criminal proceeds can be used by organized crime, all of international society is setting forth regulations to prevent and eradicate money laundering.

As of June 2018, of the 20 matters that were prosecuted of virtual currency exchanges, 16 of them were money laundering. Accordingly, it is critical to keep anti-money laundering strategies in mind.

A. Virtual currency and Criminal Proceeds Transfer Prevention Act

1. What is the Criminal Proceeds Transfer Prevention Act

The Criminal Proceeds Act governs acts where criminal profits are used for business activities in a manner that negatively affects the economy and strives to prevent any transfers of such criminal profits (“Money Laundering”) and capital support of terrorism that could deprive or damage the economy or its recovery. This act governs enumerated business actors within the financial sector to accomplish this purpose.

2. Relationship between Virtual Currency and the Criminal Proceeds Act

Virtual currency exchange services have been included as enumerated business actors to be regulated under the Criminal Proceeds Act (Criminal Proceeds Act article 2(2)(31)). At the G7 Elmau Summit on June 8, 2015, there was a declaration that the Financial Action Task Force (“FATF”) standards need to be effectively implemented. The FATF was created by 35 countries and 2 international organizations for international harmonization of anti-money laundering regulations. The FATF revisits money laundering and anti-terrorism policies, auditing the compliance of participating countries and regions. The FATF created a “Guidance for a Risk-Based Approach to Virtual Currencies” on June 26. It covers the registration and licensing policies of virtual currency and standard currency exchanges, procedures and record-keeping obligations for customer identification and other anti-money laundering, anti-terrorism policies. This led to the amendment of the Payment Service Act in Japan and the Criminal Proceeds Act’s regulation of virtual currency exchanges was introduced.

B. Other Japanese Laws relating to Anti-Money Laundering

1. International Foreign Exchange and International Trade Law

Under international foreign exchange law, notice to the Ministry of Finance is necessary when Japan remits payment to another country or if a resident remits payment to a non-resident unless an exception applies (International Exchange Act article 55). “Payment” does not only mean the transfer of a currency that has mandatory recognition but also a transaction that addresses a claim or debt, or some other transfer of an asset values. Accordingly, if virtual currency transactions occur between Japan and a foreign country or a Japanese resident and a non-Japanese resident, address some form of claim or debt or transfers some form of asset value, or if the value exceeds 30,000,000 yen, the Ministry of Finance must be notified. Virtual currency has a high degree of volatility and the manner in which to calculate it becomes an issue. The Financial Services Agency states that the date the payment is made should be the market for virtual currency. Also, if the virtual currency exchange is deemed a capital transfer, the transferrer must verify the transferee’s identity and record and preserve it pursuant to the International Exchange Act. (International Exchange Act article 18, 18(5)).

2. Act on Submission of Statement of Overseas Wire Transfers for Purpose of Securing Proper Domestic Taxation

Under this act, customers of financial institutions that conduct overseas wire transfers and acceptances of funds from overseas are required to do the following: (1) submit a notice to the financial institution; (2) submit a confirmation materials and electronic signature confirmations to the financial authority; and (3) receive confirmation from the financial institution. The notice must contain an individual or entity’s registration number. Accordingly, registration to secure a My Number under the My Number Act is required.

3. Freezing Terrorist Financing Act

The National Public Safety Commission regulates any property transactions with international terrorists. It is a crime to violate these regulations.

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About ZeLo’s Blockchain Law Series

ZeLo’s Blockchain Law Series translated excerpts from the following book: Masataka Ogasawara, Blockchain Business: A Feasibility Study of ICOs, Shoji Houmu (2018).The series strives to provide a comprehensive outlook of Japanese legal regulations related to blockchain. With blockchain technology stemming from Satoshi Nakamoto, who has Japanese origin; Just as all other jurisdictions in the world, the Japanese government, n the financial government Agency, is still trying to figure out how to regulate this gray area of ​​the law that combines securities law, financial law, data privacy law, and many other legal areas.

This series was last updated as of November 2018 and will continue to be updated as developments arise.

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