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I. Introduction

Japan has enacted and improved crypto regulations since 2017. Japan was once one of the most crypto-friendly nations in the world, but after 2018, it adopted a stricter regulatory stance. It is, however, now becoming more friendly to the Web3 industry again, with an intention to attract foreign investment.

This article provides an overview of cryptoasset regulations in Japan in 2024.

History of Cryptoasset Regulations in Japan

Early Friendly Era
February 2014 MtGox, located in Shibuya, Tokyo, and the largest exchange in the world, went bankrupt.
March 2014 Japanese LDP (Liberal Democratic Party, a governing party in Japan) discussed with the government and decided not to regulate virtual currency at that stage but asked the industry to form a self-regulatory organization.
May 2016 Japan enacted the first virtual currency act in the world. The act was made as an amendment to the Payment Service Act (“PSA”). The act was friendly to startups and intended to foster the industry.
April 2017 The amended PSA stated above was enforced.
2017  There were ICO booms all over the world, and the price of crypto went up. The trading volume of Japanese exchanges became number 1 in the world. Many foreign players came to Japan to start their business.
Era of Stricter Regulation
February 2018 A massive hacking incident, under which approximately JPY 58 billion equivalent NEM was hacked, happened in Japan (Coincheck incident).
2018-2021 After the Coincheck incident, the Japanese government tightened the operation of the regulation. Many exchanges received business improvement orders and suspension orders, and the market became shrunk.
May 2020 The amended PSA and the amended FIEA were enforced.
Era that Web3 became a national strategy
2021- The Japanese government’s national growth strategy in 2021 includes the statement that Web3 became one of the national strategies. Under this strategy, the LDP’s Web3 project team has issued policy recommendations titled the Web3 White Paper1in order to foster Web3 every year since 2022.
June 2022 Japan enacted one of the world’s earliest stablecoin regulations. The act was made as an amendment of the PSA and the Banking Act.
2022 In 2002, there were collapses of Tera Luna, Three Arrows Capital, and the FTX Group. As a result, the global regulatory environment became stricter. However, Japan had already implemented stringent regulations, which proved effective. (*1) Therefore, Japan did not need to change its regulations even after these collapses.

(*1) Even in the FTX Group’s bankruptcy, the assets of FTX Japan’s customers were all preserved because the regulations required 100% of users’ assets to be segregated.

June 2023 Stablecoin regulation was enforced.
May 2024 DMM Bitcoin was hacked, resulting in a loss of approximately JPY 48.2 billion worth of Bitcoin. However, we have not seen any regulatory tightening in response to this incident at this stage.

II. Cryptoasset, NFT, and Stablecoin Regulation 

 1. Definition of Cryptoassets

The PSA defines cryptoassets as property value with the following elements:

(i) which is recorded by electronic means and can be transferred by using an electronic data processing system,
(ii) which can be used in relation to unspecified persons for the purpose of paying consideration for the purchase or leasing of goods, etc. or the receipt of provision of services and can also be purchased from and sold to unspecified persons acting as counterparties, and
(iii) excluding the Japanese currency, foreign currencies, currency-denominated assets, and Electronic Payment Instruments.
Electronic property value, which can be mutually exchanged with the above assets, also falls under the category of cryptoassets.

 2. Cryptoasset Exchange Services

(1) Definition

Under the PSA, the Cryptoasset Exchange Service means any of the following acts carried out in the course of trade:

(i) sale and purchase of cryptoassets (i.e., exchange between cryptoassets and fiat currency) or exchange of cryptoassets into other cryptoassets;
(ii) intermediary, brokerage, or agency service for the acts described above (i);
(iii) management (custody) of fiat currency on behalf of the users/recipients in relation to the acts described above in (i) and (ii) and
(iv) management (custody) of cryptoassets on behalf of the users/recipients.
We hereafter call a cryptoasset exchange service provider as “CESP”.

(2) Meaning of “in the course of trade”

Sales and purchases of cryptoassets to Japanese residents are not subject to the regulation unless they are conducted “in the course of trade (gyo to shite)”. An act in the course of trade is generally understood to be a repetitive and continuous act vis-à-vis the public. For example, trading in cryptoassets for one’s own investment purposes or taking custody of cryptoassets of a wholly owned subsidiary are not considered acts in the course of trade.

It should be noted that just because your clients are only institutional investors is not considered as it is not in the course of trade.

(3) Solicitation to Japanese Residents

Whether or not a CESP solicits Japanese residents is also considered an important factor in determining the regulation’s application. The determination of whether solicitation towards residents of Japan is being conducted is made on a case-by-case basis. For instance, actions such as not blocking access to a website from Japan, providing information in Japanese, or introducing products at events in Japan could be considered factors that indicate solicitation towards residents of Japan.

(4) Management of Cryptoassets

The custodian of cryptoassets shall take the CESP license. According to the FSA guidelines, whether each service constitutes the management of cryptoassets should be determined based on its actual circumstances. Generally, if a service provider can technically transfer its users’ cryptoassets, it falls under the category of the management of cryptoassets. If a service provider does not possess any of the private keys necessary to transfer its users’ cryptoassets, the service provider is basically not considered to manage cryptoassets.

Accordingly, wallet services, such as non-custodial wallets, where the users manage the private key on their own, are not considered to constitute the management of cryptoassets.

(5) Intermediary, Brokerage, or Agency Service

An intermediary generally means a factual act that involves efforts to conclude a legal act between two others. Brokerage or agency service means to perform a legal act in one’s own name and for the account or on behalf of another person.
With respect to a purchase and sale agreement of cryptoassets between third parties, the acts of (i) soliciting the signing of the agreement, (ii)explaining the product for the purpose of solicitation, and (iii) negotiating the terms and conditions fall, in principle, under the category of an intermediary.
The mere distribution of product information papers, etc., may not fall under the category of an intermediary and should be considered on a case-by-case basis.

(6) Requirements for the License and Cost

The PSA requires minimum capital, financial requirements, a physical office, a sufficient number of personnel on staff, segregation of assets, an annual audit, a customer identity verification system, accountability to users, protection of person/s’ information, including sensitive information, and, if outsourced, must retain authority. The service provider must be equipped with the systems for adequate operation and legal compliance deemed necessary to operate a Cryptoasset Exchange Service appropriately and securely. Although the applicant must have a minimum capital base of at least JPY 10 million, and it must not be in negative assets, from our experience, the cost of obtaining the license and starting the internet exchange business can be more than JPY 1 billion.

(7) Exchange M&A

We are often asked by companies interested in entering the Japanese crypto market whether they can start their business by acquiring an already licensed CESP rather than obtaining a new license. The answer is Yes. Regulatory speaking, change of major shareholders is done just ex-post notification and you can start your business after purchasing the already licensed CESP.

The major issue here is that the purchased CESP shall satisfy the governance and compliance levels, which are similar to those a new licensed exchange shall achieve. If one purchases a cheap CESP, which is just having a license but has not done a business actively, to reach these levels might be difficult and time-consuming. Furthermore, if you wish to change the business model or system of the purchased CESP, you must provide an explanation to and obtain approval from the FSA. The cost of purchasing the licensed CESP, combined  with this additional expense, can sometimes be comparable to the cost of obtaining a new license. Therefore, careful consideration is necessary.

 3. Crypto Exchange’s Obligations

(1) Management of Users’ Property

The PSA requires the users’ cryptoassets to be segregated from the CESP. Further, the CESP shall keep (i) at least 95% of the users’ cryptoassets in cold wallets and (ii) equivalent to 100% minus those kept in the left column of its own cryptoassets in cold wallets. Thus, as a consequence, the CESP shall hold the equivalent of 100% of users’ cryptoassets in cold wallets.

With respect to fiat currency, the CESP shall deposit its users’ fiat currency in a bank account under a different name from where the CESP deposits its own funds.

A CESP must undergo an annual audit of its financial statements and segregation of assets.

(2) Anti Money laundering

Anti Money Laundering law requires CESPs to conduct a know-your-customer of users. Stricter regulations for anti-money laundering came into effect on June 1, 2023. According to the new Travel Rules, when assets over a certain amount are sent by a user, the receiving and sending CESPs must share information about the users. The lack of interoperability in such information-sharing systems has prevented users from sending and receiving cryptoassets between some CESPs.

 4. DEX

The regulations applicable to decentralized exchanges (DEX) are not clear. There is an argument that the regulations do not apply to exchanges that are completely decentralized and have no administrator at all, as there is no entity subject to crypto regulations. However, it is necessary to carefully consider whether there is truly no administrator. Further, entities that provide access software to a DEX may be subject to the regulations for being intermediaries.

As stated later in section III. 1, the sale of cryptoassets issued by oneself is subject to crypto regulations. Providing liquidity to a DEX for cryptoassets issued by oneself may also be considered as engaging in the sales of the cryptoassets.

 5. NFT

Pure NFTs, such as trading cards and in-game items recorded on blockchains that do not function as payment instruments, are not considered cryptoassets. The FSA states that the distinction between cryptoassets and pure NFTs is as follows:

(i) the issuer of the NFTs prohibits its use as a payment instrument by technical feature or by agreement
(ii) the quantity and price of the NFTs are not suitable as a payment instrument (specifically, one NFT costs more than ¥1,000 or the total number of the NFTs issued is less than 1 million).

Generally speaking, pure NFTs are not regulated in Japan. Please, however, note that whether NFTs are considered as “pure” NFTs needs careful discussion. For example, if an NFT gives some dividend or economic benefit, it might be considered as a security. Further, an NFT, which is linked to real-world assets, might require a discussion of whether regulation of real assets may apply.

 6. Stablecoins

Japan was one of the first countries in the world to establish stablecoin regulations. Stablecoins pegged to fiat currency are defined as electronic payment instruments and require a license different from CESP to offer the related service.

Other stablecoins that adjust their value through algorithms could be regulated as cryptoassets or securities. Stablecoins classified as cryptoassets are subject to crypto regulations, while stablecoins classified as securities are subject to securities regulations (FIEA).

III. Crypto Financing

 1. ICO, IE

ICO (Initial Coin Offering) is an act of issuing and selling tokens to raise fiat currency or crypto assets from the public. ICO is regulated in Japan. The applicable regulations depend on the legal nature of the issued tokens. If the tokens are considered securities, the token issuance will be regulated by the FIEA. If the tokens are considered cryptoassets, the token issuance will be regulated by the PSA.

The issuance of new cryptoasset-type tokens in Japan is generally done by IEO (Initial Exchange Offering). IEO is an act of raising fiat currency or cryptoassets by an entity entrusting the sales of tokens to a licensed CESP. In the case of IEO, if the issuer itself does not conduct sales activity, the issuer does not need to take the crypto exchange license. If, however, the issuer itself wants to conduct sales activity for its new tokens, it needs to have a crypto exchange license, which requires significant cost and time compared to IEO. Several IEO projects have already been launched in Japan.

The IEO process requires examinations by the exchange, JVCEA, a Japanese self-regulatory organization, and the FSA. The examination checks the feasibility of the project for which the funds will be used, the financial soundness of the issuer, and other factors.

 2. SAFT, SAFE

SAFT (Simple Agreement for Future Tokens) is a way to raise funds in exchange for the right to purchase tokens to be issued in the future. SFAT targeting Japanese residents is considered to be subject to fund regulation or crypto regulation, depending on the legal nature of the agreement. However, both regulations do not apply unless the act is done in the course of trade, so we may argue that entering into a SAFT with limited numbers of specific persons, such as business partners who will contribute to developing projects, should not be regulated.

SAFE (Simple Agreement for Future Equity) with token warrant is subject to general equity investment regulations, depending on the attributes of involved entities and investors.

Japanese entities sometimes use J-KISS, a Japanese convertible equity, with a side letter that provides tokens.

IV. Crypto Staking

Generally speaking, we believe staking service for POS tokens is not regulated in Japan. For example, staking one’s own cryptoassets or becoming a validator for ETH is not regulated in Japan.

Not all staking services, however, are exempted from the regulation. If service providers manage the private keys of users’ cryptoassets (we understand some exchanges provide those services), custody regulation may apply. In addition to managing private keys, if the service providers distribute rewards as well as slashing penalties to the users, fund regulations might apply.

We understand that there are some NFT projects that say that they sell NFTs for crypto, and purchasers can stake NFTs, and can get rewards. We understand fund regulation might apply to such cases, especially in cases where staking does not have any actual usage for providing security.

V. Crypto Lending

In crypto lending services, a service provider borrows cryptoassets from users for a certain period of time and pays a lending fee in exchange. No regulation applies to that lending because the Money Lending Business Act regulates money lending, but it does not deem cryptoassets as money.2

It should be noted that crypto custody regulations may apply in cases where the service is considered as custody, not lending, even if a service is titled as crypto lending. One factor that distinguishes lending and custody is whether users can withdraw their assets at any time (deposit) or whether there is a specific required time of non-withdrawal (lending).

VI. Crypto Mining

Mining cryptoassets requires large amounts of electricity. Thus, mining appears to be regulated in some countries, such as Kazakhstan3Regulation of mining in certain areas in Russia is also being discussed4. In Japan, mining itself is not regulated.

A business that collects money from the public to conduct mining operations and then distributes the proceeds from mining to the customers may be regulated under the FIEA as a fund.

Schemes that one sell mining machines, accept deposits of the machines, and promise to pay fees for the mining results may also be regulated under the Act on Deposit Transactions. If the Act on Deposit Transactions is applied, the business must obtain confirmation from the Prime Minister, but it is said that to get such confirmation is nearly impossible. Creating a scheme to avoid such regulation is important.

VII. Crypto Taxation

 1. Tax on Individuals

principle, classified as miscellaneous income. Miscellaneous income is income that is neither interest income, dividend income, real estate income, business income, employment income, retirement income, forestry income, transfer income, or temporary income. The tax rate for miscellaneous income ranges from 5% to 45%, depending on the amount of total income. The maximum tax rate is about 55% when we calculate income tax as well as residential tax and special reconstruction income tax.

 2. Tax on Corporations

Profit generated by cryptoassets transactions is subject to corporate tax which is about 30% depending on the amount of income and how big a company is.
Cryptoassets for which there is an active market must be valued using the mark-to-market method at the end of the fiscal year and are taxable even if companies do not sell them.
This unrealized gain tax treatment became a huge issue in Japan, and many Web3 companies left Japan.

In 2022, the Japanese government decided to reform this unrealized gain tax, and now the tax is not levied if an issuing company of tokens continues to hold its tokens with certain technical transfer restrictions.

In 2023, another tax reform was proposed and approved by the government. Under the reform, an unrealized gain tax is not applied if a company holds tokens with a certain transfer restriction, even in the case that tokens are issued by other entities (including Bitcoin and Ether etc.)

Disclaimer

The content of this article has not been verified by the relevant authorities or organizations mentioned herein and represents only a reasonable interpretation of their statements. Our interpretation of laws and regulations reflects our current understanding and may change in the future. This article is not intended to be legal advice and provides a summary for discussion purposes only. If you need legal advice on a specific topic, please feel free to contact us.

EOD

This article discusses the structure of EigenLayer, which has recently gained rapid attention in the DeFi space, and the applicable regulation on it under Japanese law.
Our firm is a law firm well-versed in the Web3 domain, and we have published numerous articles in both Japanese and English on legal issues related to the Web3 field1. In May 2024, we published a Japanese article titled “Structure of Restaking Services such as EigenLayer and Japanese Law2.”
While the Japanese version of the article provides a more detailed analysis, this article summarizes the conclusions of the Japanese version to facilitate easy understanding for overseas entities considering offering restaking services in Japan.

I Overview of EigenLayer

The Structure of Restaking in EigenLayer

EigenLayer is a service designed to ensure secure execution for programs running outside of the Ethereum Virtual Machine (EVM) by using ETH.
For instance, when a DeFi application that uses the Ethereum blockchain consists of parts that operate within the EVM and parts that do not, the security for the EVM parts is guaranteed by the Ethereum blockchain. However, the parts that run outside the EVM are not covered by the security of the Ethereum blockchain, making them vulnerable. The traditional approach to this issue has been to issue native tokens for that application, but this comes with several problems:

  1. If the native tokens have low value, the threat of “slashing” is less effective.
  2. If the native tokens are not widely distributed (e.g., if the initial developers hold many tokens), the system may not function effectively.
  3. There is little incentive for users to purchase native tokens.

EigenLayer aims to provide a solution to these problems.
In simple terms, EigenLayer “reuses” ETH that is already staked on Ethereum to provide security to services built on EigenLayer (Actively Validated Services, or AVS). For example, consider an AVS that periodically surveys numerous crypto exchanges and DeFi protocols to collect token price information and calculate their average values. In this case:

  1. Only those who have staked a certain amount of ETH can act as “operators” and provide price information.
  2. If false information is provided, the ETH, etc.3restaked by the operator on EigenLayer will be slashed.
  3. Operators are rewarded by the AVS for providing accurate information.

A key feature is that ETH staked for the regular Proof of Stake mechanism on Ethereum can also be used as collateral for multiple AVS, allowing operators to earn additional rewards. Furthermore, users who are not operators can deposit their ETH, etc. into EigenLayer, restake it through selected operators, and receive a share of the rewards that operators earn from the AVS. The advantage for users is that they can earn multiple layers of rewards through EigenLayer restaking compared to simple ETH staking.

Liquid Restaking

In addition, external entities offer a service related to EigenLayer known as Liquid Restaking. This service involves users depositing their ETH with a liquid restaking provider, who then stakes the ETH on Ethereum and restakes it through EigenLayer once the minimum staking unit of 32 ETH is accumulated. In this case, users only interact with the liquid restaking provider, while the provider handles transactions with EigenLayer. This arrangement frees users from the responsibility of selecting operators. Liquid restaking services thus play an important role in providing users with the opportunity to generate revenue through EigenLayer.

II Laws to Consider and Conclusions

Restaking and Japanese Law

(1) Legal Considerations for Restaking services such as EigenLayer

When considering restaking services such as EigenLayer under Japanese law, it is primarily necessary to evaluate the applicability of:

  1. Custody regulations under the Crypto Act (a subset of the Payment Services Act);
  2. Fund regulations under the Financial Instruments and Exchange Act (FIEA);
  3. Regulations under the Act against Unjustifiable Premiums and Misleading Representations (UPMR).

(2) Custody Regulations under the Crypto Act

If the act of depositing ETH, etc. into EigenLayer is viewed as the entrustment of crypto, the custody regulations under the Crypto Act may apply. However, if the deposit is made to a smart contract and the smart contract technically prevents EigenLayer, the AVS, the operators and other people except for users to transfer the ETH, etc., we believe the custody regulations would not apply.

(3) Fund Regulations under the Financial Instruments and Exchange Act

FIEA regulates funds that collect money, use such money for some kinds of investment or some business activities, and distribute the profits to investors. There is a concern about whether the fund regulations under the FIEA apply to the mechanism where EigenLayer receives deposits of ETH, etc., operators provide security to the AVS in return for rewards, and a portion of these rewards is distributed to users, who also bear the risk of penalties such as slashing. However, if the deposited ETH, etc. is not used for investment or business activities but merely locked in a smart contract as a form of collateral to address penalties like slashing, we believe that the fund regulations under the FIEA would not apply.

(4) Regulations under the Act against Unjustifiable Premiums and Misleading Representations

In restaking services such as EigenLayer, users may receive points4.as rewards. These points might lead to future airdrops. The potential applicability of the UPMR, which prohibits excessive premiums provided in connection with transactions of goods and services, needs to be considered. Under UPMR, premiums refer to (1) economic benefits such as goods or money that are provided (2) as a means to attract customers, and (3) in connection with transactions. In this respect, users of restaking services likely view these points as part of the rewards associated with restaking, and the high yields might incentivize them to restake. Therefore, these points can be seen as part of the primary transaction, not as “premiums” provided in connection with the transaction, implying that the UPMR might not apply.

Liquid Restaking and Japanese Law

(5) Legal Considerations for Liquid Restaking Providers

Liquid restaking providers, being external entities, likely operate under various structure. It is necessary to evaluate the applicability of:

  1. Custody regulations under the Crypto Act;
  2. Trading regulations under the Crypto Act;
  3. Fund regulations under the FIEA;

(6) Custody Regulations under the Crypto Act

If the act of depositing ETH for liquid restaking is deemed as custody, the custody regulation under the Crypto Act may apply. Whether liquid restaking providers manage private keys is a critical issue. We believe, however, it seems that most liquid restaking providers do not own private keys and thus the custody regulation do not apply.

(7) Exchange Regulations under the Crypto Act

There is a concern about whether issuing Liquid Restaking Tokens upon depositing ETH constitutes crypto exchange. Legally, if tokens are issued as proof of deposit, it would not be considered trading or exchange under the Crypto Act, and thus, the trading and exchange regulations would not apply.

(8) Fund Regulations under the Financial Instruments and Exchange Act

Fund regulations must also be considered for liquid restaking providers. Key considerations include how private keys are managed. If the smart contract ensures that the deposited ETH is used solely as collateral and cannot be otherwise utilized, we believe the operation may not be classified as a fund. Conversely, if the smart contract is not properly set up and allows the provider to use the private keys and crypto assets, the operation may be subject to fund regulations.

Disclaimer
The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may, therefore, change in the future. This article does not recommend the use of staking, liquid staking, liquid restaking, EigenLayer or LIDO, etc.. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.

I  DePIN

DePIN (pronounced ‘dee-pin’) stands for Decentralized Physical Infrastructure Network. While there is no definitive conclusion on what DePIN exactly is, according to ChatGPT, it can be described as follows:

DePIN, which stands for Decentralized Physical Infrastructure Networks, refers to networks that leverage blockchain technology to develop, maintain, and operate physical infrastructure in a decentralized manner. These networks use crypto tokens to incentivize individuals and organizations to contribute resources such as data storage, wireless connectivity, computing power, and energy.

In recent years, DePIN has become a major topic in the Web3 industry, with globally renowned projects such as Hivemapper, Helium, and Filecoin. In Japan, the number of Hivemapper users is increasing, and the country’s largest power company, Tokyo Electric Power Company, has launched a DePIN game called PicTrée, further highlighting the growing interest in DePIN. A summary of this game is provided for reference in section III below.

Our firm is a law office well-versed in Web3 and has addressed various legal issues related to Web3 under Japanese law in numerous articles written in Japanese. Although DePIN has recently garnered attention in Japan, it seems that adequate legal scrutiny has not yet been conducted. Therefore, to support the business development of DePIN in Japan, we have compiled the Japanese article1.  While the Japanese article contains a more detailed analysis than this English article, this English article is designed for overseas businesses considering offering DePIN in Japan. It summarizes the conclusions of the Japanese article to facilitate easy understanding of the discussion

II  Laws to Consider and Conclusions

There are various types of DePIN projects. Therefore, the laws potentially applicable when introducing DePIN to residents of Japan may vary depending on the project. Here, we considered the introduction of the current major DePIN projects listed in section I for residents of Japan.

In conclusion, for these projects, it is necessary to consider the following regulations:

1. The crypto regulation part of the “Payment Services Act,” which establishes regulations related to crypto exchange registration, (hereinafter referred to as the “Crypto Act”).

2. The Act against Unjustifiable Premiums and Misleading Representations (hereinafter referred to as the “Premiums and Representations Act”), which regulates the provision of premiums attached to the purchase of goods or services.

3. The Act on Specified Commercial Transactions, which regulates transactions that induce consumers to purchase equipment by offering benefits such as business opportunities.

4. The Radio Act.

5. The Telecommunications Business Act.

6. Other laws related to the import and sale of equipment.

The summary of our current analysis is as follows:

(1) Crypto Act
In Japan, when engaging in the “selling and buying,” “exchanging,” or “managing” of crypto as a business, regulations under the Crypto Act apply, and registration as a crypto exchange business is required. These regulations apply not only to crypto exchanges but also to ICOs and IEOs.

Regarding the relationship between DePIN and the “selling and buying” or “exchanging” of crypto, many projects have a mechanism where users receive tokens as a reward for contributing to DePIN. Even if these tokens are considered crypto, the provision of tokens as a reward for contributions to the project does not constitute “selling and buying” or “exchanging,” and therefore, the Crypto Act does not apply.

Concerning the relationship between DePIN and the “managing” of crypto, if tokens are granted to a user-owned address on the blockchain (where the user manages the private key), it is not considered that the DePIN operator is “managing” the crypto, and thus, the Crypto Act regulations do not apply. On the other hand, if the operator holds tokens granted to the user (the operator manages the private key), registration as a crypto exchange may be required. Therefore, to ensure that it is not considered as “managing” the crypto, it is necessary to send rewards to the user each time they occur. It is desirable to use a blockchain where even small rewards can be sent with low gas fees.

If usage fees are paid by credit card, resulting in tokens being burned and mined, this does not constitute the “selling and buying” of crypto.

In DePIN, it is common to list tokens granted as rewards to users to provide trading opportunities. In this case, for the exchange listing these tokens to sell crypto to Japanese residents, registration as a crypto exchange is required. On the other hand, there are no regulations that apply merely to users of the crypto exchange.
 
(2) Premiums and Representations Act
In Japan, attaching high-value premiums to the purchase of goods or services is regulated by the Premiums and Representations Act. For example, if premiums are uniformly provided to all purchasers, they are limited to 20% of the purchase price. If provided through a lottery, they are limited to the lesser of 20 times the purchase price or 100,000 yen, and also must not exceed 2% of total sales.

When users receive tokens as a reward for contributing to DePIN, these tokens are considered compensation for contributions and are not subject to the premium regulations under the Premiums and Representations Act.

(3) Act on Specified Commercial Transactions
Some DePIN projects require users to purchase specific equipment to participate in the project.

For businesses that involve (i) the sale of goods or the provision of services (including brokerage thereof), (ii) the inducement of users by presenting a business opportunity that provides rewards, and (iii) the imposition of the burden of purchasing necessary equipment for users to carry out the business, regulations such as the obligation to provide written documentation are imposed.

(4) Radio Act
Many of the devices used in DePIN are likely to emit radio waves for wireless communication.

To use these devices, a license under the Radio Act is required unless they bear a Technical Conformity Mark (GITEKI mark). It is effectively necessary to use general-purpose equipment that already has a GITEKI mark or to obtain the GITEKI mark for specific equipment.

(5) Telecommunications Business Act
For projects like Helium that involve setting up hotspots to connect to the internet and earn rewards, users may need to submit a notification under the Telecommunications Business Act. This requirement makes it difficult to carry out such DePIN in Japan.

(6) Other Laws Related to the Import and Sale of Equipment
When importing or selling specific equipment, laws such as the Electrical Appliances and Materials Safety Act, the Consumer Product Safety Act, the Household Goods Quality Labeling Act, and the Product Liability Act must be considered.

III  PicTrée (Demonstration Experiment by DEA and TEPCO Group)

In April 2024, “PicTrée,” a GameFi demonstration experiment by the Singapore-based GameFi company Digital Entertainment Asset (DEA) and Tokyo Electric Power Company Power Grid Inc., was launched.

“PicTrée” is a GameFi project where game users receive rewards for taking photos of utility poles and manholes. Utility poles and manholes require continuous maintenance and inspections, which incur significant costs. In this experiment, game players take photos of the current state of utility poles and manholes. Based on these images, the power company determines whether inspections or repairs are necessary, aiming to reduce costs while maintaining safety.

Similar to Hivemapper, this DePIN project allows participants to contribute to society by taking photos and receiving rewards. It is a more accessible DePIN project, as it can be participated in using one’s smartphone and a free app.

Overview of the PicTrée Mechanism
1. Team Division: Users are divided into three teams: “Ampere,” “Volt,” and “Watt.”
2. Points: Users take photos of utility poles and manholes. Each time a user take photo of utility poles or manholes, the ownership of that utility poles or manholes can change to a different team. Additionally, by using game items to connect the utility pole or manhole to other utility poles or manholes of the same team, the team earns points.
3. Rewards: Users receive rewards based on their performance within the team, which can be in the form of Amazon gift cards or tokens. The winning team also receives team rewards.
4. TEPCO’s Benefit: Through these photos, Tokyo Electric Power Company can determine if maintenance or inspections are needed for the utility poles, thereby reducing maintenance costs.

Game Description and Source of Diagram: Digital Entertainment Asset Pte. Ltd. Press Release, March 4, 20242 (Translated by So & Sato Law Offices)

Disclaimer
The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may, therefore, change in the future. This article does not recommend the use of DePIN or the purchase of DePIN equipment. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.

This article describes the structure of and applicable Japanese law to liquid staking, which has been expanding rapidly in recent years, and its most significant protocol, LIDO.

I. A Summary of Legal Analysis

(1)  To analyze liquid staking, it is generally necessary to consider (1) the sales, purchase, and exchange regulations of the Payment Services Act (We call crypto regulation in the Payment Services Act the “Crypto Assets Act” after this), (2) the custody regulations of the Crypto Assets Act, and (3) the fund regulations of the Financial Instruments and Exchange Act, which is a kind of Japanese Security Act (the “FIEA”).
(2)  For staking, LIDO accepts staking of ETH and issues stETH in exchange for staked ETH. We believe that this conduct is not considered as “sales, purchase, or exchange of crypto asset” in the terms of the Crypto Assets Act. We believe stETH is just issued as proof of staking and not “exchange” under the Japanese Civil Code.
(3)  If the staking of ETH is considered a custody of crypto assets, the custody regulation of the Crypto Assets Act may apply. However, if the deposit is made against a smart contract and the protocol or node operator is technically incapable of transferring the ETH, etc., the custody regulation does not apply.
(4) The most controversial question should be whether the fund regulations of the FIEA would apply to liquid staking. LIDO’s mechanism might be considered as a fund because (i) ETH, etc., is contributed to the protocol by a user of LIDO, (ii) the node operator manages it, (iii) a portion of the staking fee is distributed to the user, (iv) the user seems to bear the penalty risk and thrashing risk of the staking, and (v) this mechanism seems to like a fund. However, we believe that we can argue that the fund regulation will not apply to LIDO because (i) staked ETH itself is not converted to anything, (ii) it is used for just a kind of collateral to compensation to penalty/slashing, and (iii)we can argue this mechanism is entirely different from usual funds.
(5) In addition to the above, we can argue that the Japanese financial regulation might not apply to DeFi if there is no “operator” because Japanese law just regulates persons and legal persons. However, this argument needs an actual fact analysis of the relevant liquid staking. Further, this argument cannot apply to a person or legal entity, if any, who intermediate Japanese residents to DeFi. Thus, the arguments from (1) to (4) above are important.

II Basic Overview of Liquid Staking, ETH Staking, and LIDO

1 Liquid Staking

Liquid staking is a DeFi (decentralized finance) mechanism whereby a person receives a staking fee for a crypto asset while receiving an additional alternative asset (a staking-proof token) and can invest said alternative asset in another DeFi.

2 Proof of Stake and Staking

Proof of Stake (POS) is the authentication mechanism of the blockchain by a person who has a certain level of involvement (stake) in the crypto asset.

Unlike the Proof of Work (POW) mechanism used in Bitcoin and other cryptocurrencies, authentication can be performed without requiring a large amount of calculations, thus reducing electricity consumption and making it more environmentally friendly.

3 ETH Staking

Ethereum has been structured using POS instead of POW from ETH 2.0. In Ethereum staking, (1) you can become a validator by depositing 32 ETH, (2) the validator authenticates each transaction on Ethereum and thereby receives a certain amount of ETH as a reward, and (3) if the validator intentionally provides false information, he/she will be penalized by forfeiting a part of the deposited ETH (thrashing), (4) a validator is always required to be online, and if they are down, they will also be penalized to a certain extent.

4 How LIDO Works

LIDO is the world’s largest protocol for Liquid Staking. At present, it is estimated that more than 30% of the staking volume of Ethereum is done via LIDO. LIDO is supposed to work as follows:1

Prepared by So&Sato Law Offices from published materials

①LIDO allows users to stake ETH without maintaining their staking infrastructure and without economically locking up their assets.

②When a user wants to stake ETH to LIDO, the user should send ETH to LIDO’s smart contract. In response, the user receives a 1:1 token called stETH.

③stETH is a token that represents the deposit of ETH to LIDO for staking, and when a user sends stETH to LIDO to burn stETH, the user will receive ETH. stETH can be freely bought and sold, and if there is another DeFi that accepts stETH, the user can earn double rewards by using stETH on another DeFi (however, DeFi protocols that accept stETH still seem to be limited).

④LIDO will use ETH received through the smart contract to perform staking. LIDO will receive 10% of the reward obtained from staking, which will be distributed to the person in charge of the staking (node operator) and the LIDO DAO. The remaining 90% will be distributed to the users. The distribution to the users is made by adding the number of stETH in the address of stETH, and the number of ETH managed by LIDO is always the same as the number of stETH.

⑤LIDO uses multiple node operators. Node operator candidates apply to LIDO, stating that they wish to become node operators, their experience and technical capabilities, etc., and are then voted on by the DAO, which is composed of LIDO token holders, the LIDO’s governance tokens, to determine whether they are eligible to become node operators.

⑥Note that ETH has thrashing risks and penalties. LIDO hedges against such risks by using a large number of node operators. LIDO also manages some ETH separately and uses it as insurance against thrashing risk.

⑦LIDO is an open-source, peer-to-peer protocol and is not operated by a single operator, etc., as the LIDO DAO makes the decision on its operation.

III Liquid Staking and Japanese Law

When offering liquid staking like LIDO, it is necessary to consider whether the trading and custody regulations of the Crypto Assets Act apply and whether the fund regulations of the FIEA apply.

1 Regulation of the Issuance of Crypto Assets

When a user contributes ETH to LIDO, the user will receive stETH, and conversely, when a user sends stETH to LIDO, the user will receive ETH.

The question arises as to whether this action constitutes an exchange of ETH for stETH. If it is considered an exchange of crypto assets, the regulations of the crypto asset exchange services might apply.

StETH, however, is issued to prove the deposit of ETH, and we believe the issuance of such stETH does not constitute a sale or exchange under civil law and thus does not constitute an exchange of crypto assets (and vice versa).

2 Custody Regulation of Crypto Assets

The contribution of ETH to LIDO might be considered a deposit of crypto assets to LIDO and raises the issue of whether the custody regulations of the Crypto Assets Act apply to LIDO.

However, it appears that the contribution to LIDO is a contribution to a smart contract, and LIDO cannot use said ETH except for staking (i.e., it does not control the private key) due to the structure of the smart contract.

Under the Japanese custody regulations, “If a business operator does not possess any of the private keys necessary to transfer the crypto assets of a user, the business operator is not considered to be in a position to proactively transfer the crypto assets of the user. In such case, the business operator is basically not considered to fall under the category of “managing crypto assets for others” as defined in Article 2.7.4 of the Payment Services Act. (Result of Public Comment No. 9 on the Draft Cabinet Order and Cabinet Office Ordinance Concerning Amendment to the Payment Services Act, etc. of 2019). If the smart contracts can technically prevent the free transfer of ETH by people related to LIDO, we believe LIDO is not considered to be subject to the custody regulations under the Crypto Assets Act.

3 FIEA Regulations

The question arises whether LIDO or liquid staking is considered a fund (collective investment scheme), given the mechanism of receiving ETH contributions, the node operator managing it, distributing a portion of staking fees to users, and users bearing the risk of thrashing and other penalty risks.

The definition of a fund under Japanese law is generally as follows (Article 2, Paragraph 2, Items 5 and 6 of the FIEA). If a fund investor’s right is tokenized, the tokens are considered electronically recorded transferable rights (Article 2, Paragraph 3, Pillar 1 of the same law).

If the issuer itself is offering or private offering the tokens, registration as a Type 2 Financial Instruments Business is required (Article 2, Paragraph 8, Item 7, (g), Article 28, Paragraph 2, Item 1, and Article 29 of the same law, Article 1-9-2, Item 2 of the Order for Enforcement of the FIEA), and if the third party is offering or private offering the tokens, registration as a Type 1 Financial Instruments Business is required (Article 28, Paragraph 1, Item 1 and Article 29 of the FIEA).

Definition of the Funds under Japanese law
(A) (i) partnership contracts, (ii) silent partnership agreements, (iii) limited partnership agreements for investment, (iv) limited liability partnership agreements, (v) membership rights in incorporated associations, and (vi) other rights (excluding those under foreign laws and regulations).
(B) The Investor(s) receives the right to receive dividends of income or distribution of properties that arise from a business conducted by using money (including crypto assets) invested or contributed by the investor(s).
(C) None of the following
 (a) the case where all of the investors are involved in the business subject to the investment (in the way specified by a Cabinet Order)
 (b) the case where the investor(s) shall not receive dividends or principal redemption more than their investment
 
Funds under Foreign Law
(D) Rights under foreign laws that are similar to the above rights.

The concept of “other rights” in (A) above is very broad, and it is said that (i) through (v) are merely an enumeration of examples, regardless of the legal form. It can be argued that tokens issued in fully decentralized finance are not “rights” because they are not considered “rights” in the usual legal interpretation, but there is currently a prevailing view that some rights are recognized for Bitcoin, etc.2, and in relation to this article, we assume that some kind of right is recognized even for smart contracts.

Nor does it fall under any of the exceptions in (C) above.

The main issue is the interpretation of (B) above, which states “dividends of income or distribution of properties that arise from a business conducted by using money” and “invested or contributed.” If we simply take the point that ETH is sent to the smart contract, it is used in the business of the POS, and the award from staking ETH is distributed to users, it would seem to satisfy both the “dividends of income or distribution of properties that arise from a business conducted by using money,” and “invested or contributed” requirement.

However, liquid staking is very different from ordinary funds in the following respects, and, arguably, liquid staking is not a fund to which the FIEA applies.

(1)In the case of a regular fund, the money and other assets contributed are fully owned by the fund operator, and the fund operator can technically use them in various ways, although they are contractually bound. In the case of liquid staking, the ETH contribution is made to the smart contract, and LIDO or node operators are not free to use it; ownership (ownership-like rights) over ETH is always considered to be held by the user,

(2)In the case of a regular fund, the money received is used to purchase shares, fund a business, etc., and changes from money to shares, etc. In LIDO staking, the ETH sent to the smart contract is not specifically changed into anything else but is maintained as it is.

(3)The only reason ETH is locked is to ensure that there is no thrashing in the event of fraudulent reporting in the validation process or penalties if a node goes offline.

(4)Based on (1) through (3) above, if we compare the legal nature of staking to a traditional economic act, it can be thought that the user is merely locking ETH into a smart contract as a kind of collateral to secure default liability and is merely receiving compensation for providing third party collateral. The provision of such collateral and the receipt of compensation do not satisfy the requirements of “dividends of income or distribution of properties that arise from a business conducted by using money” and “invested or contributed,” as referred to in the fund.

4 Argument that the Operator Does Not Exist and Therefore Is Not Subject to Regulation

In the case of DeFi, it could be argued that the operator does not exist in the first place and is not subject to regulation. Japanese law is a legal system that regulates persons and legal entities, such as operators. A completely decentralized financing scheme would not be subject to regulation. However, we need to carefully consider whether there really is no operator for DeFi. In general, DeFi aims for the operator to be non-existent, but even so, it is unclear whether many DeFi are truly completely operatorless.

Further, if the scheme is subject to financial regulations under the law, assuming there is an operator, the intermediary for the scheme could be subject to regulations even if there is no operator for DeFi itself. It would prevent, for example, an unlicensed Japanese company from sending customers to the DeFi.

Therefore, when examining the legal issues of DeFi, it is necessary to consider two issues: (i) if there is an operator, whether it is subject to legal regulation, and (ii) whether an operator exists.

However, it is unclear from the published documents whether the LIDO DAO is truly decentralized, so this article mainly discusses (i) above.

Disclaimer
The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may, therefore, change in the future. This article does not recommend the investment in LIDO or liquid staking. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.

Ⅰ Introduction

Recently, Web3 companies often ask us whether they can issue and sell tokens linked to ownership or value of real world assets (“RWA tokens”) in Japan. The types of linked real assets include artwork, real estate, whiskey, vintage cars, government bonds, securities, gold, etc.

Applicable Japanese regulations to RWA tokens vary depending on the types of tokenized assets and the scheme. We will provide an overview of the applicable regulations to RWA tokens and then substantive legal issues of RWA tokens.

Ⅱ Crypto Regulation

Japanese law differentiates crypto assets, which are regulated, and NFTs, which are not regulated, and most RWA tokens are structured as NFTs.

If RWA tokens fall under the category of crypto assets, selling and purchasing the tokens as a business requires a crypto asset exchange license. For example, Zipang Coins, which are RWA tokens representing gold and issued by a Japanese major trading company group, are structured as crypto assets, and only licensed exchanges can sell them as a business.

On the other hand, most RWA tokens are structured as NFTs. From the legal viewpoint, the difference between crypto assets and NFTs is whether they can be used as a payment method. FSA has submitted a guideline and answers to public comments and stated that if tokens satisfy the following requirements, they are not crypto assets and are not regulated under the Payment Service Act.

Required Factors to be considered as not regulated Crypto Asset but non-regulated NFTs
(i) the use as a means of payment to unspecified persons is prohibited, and (ii-a) the number of issued tokens is less than 1 million, or (ii-b) the transaction price is more than JPY 1,000.

Ⅲ Fund Regulation

If RWA tokens are considered securities, to sell and purchase the tokens as a business requires a financial instruments business operator license. If the token holder has the right to receive a dividend or more than 100% principal redemption, they are generally considered securities. The definition of the collective investment scheme (fund) in Japan is as follows. As the definition covers “all rights” that can receive a dividend or more than 100% principal redemption, you should carefully analyze whether the tokens are considered securities when its structure includes a profit distribution element.

Definition of the Funds under Japanese law
(A) (i) partnership contracts, (ii) silent partnership agreements, (iii) limited partnership agreements for investment, (iv) limited liability partnership agreements, (v) membership rights in incorporated associations, and (vi) other rights (excluding those under foreign laws and regulations).
(B) The Investor(s) receives the right to receive dividends of income or distribution of properties that arise from a business conducted by using money (including crypto assets) invested or contributed by the investor(s).
(C) None of the following
 (a) the case where all of the investors are involved in the business subject to the investment (in the way specified by a Cabinet Order)
 (b) the case where the investor(s) shall not receive dividends or principal redemption more than their investment
 
(D) Funds under Foreign Law (rights under foreign laws that are similar to the above rights)

Ⅳ Goods Deposit Transaction Regulation

Another regulation that is related to RWA tokens is the Goods Deposit Transaction regulation. In Japan, there have been some controversial transactions in which (i) a merchant sells some goods to buyers, (ii) the merchant accepts deposits of the sold goods from the buyers for more than 3 months, and (iii) the merchant promises to pay some fee such as a rental fee to the buyers or promises to buy-back the sold products more than the sales price. These kinds of transactions were often used as financial investments without regulation. The Goods Deposit Transaction regulation now regulates these kinds of transactions. The regulation requires an explanation to buyers if the transaction involves the above (ii) and (iii) elements and requires approval from the government if the transaction involves the above (i), (ii), and (iii) elements. Please note that there has been no case the approval was obtained yet, and, thus, no one knows the difficulty of obtaining the approval.

We are often asked the way to give economic benefit to RWA token holders. Simply giving the economic in principle causes the issues of both or either of fund regulations and goods deposit transaction regulation and makes token issuance not feasible.

Ⅴ Prepaid Payment Instruments

There are RWA tokens that give a right to acquire products or use products such as hotel rooms, etc. Issuance of tokens linked to the right to acquire or use real assets is, in principle, subject to prepaid payment instrument regulation under the Payment Services Act. Some RWA tokens give those rights to holders and are subject to the regulation. For example, Not A Hotel NFT, which gives a holder to stay in a luxury residence, is subject to the regulation.

There are two types of prepaid payment instruments. The first type is the private-type prepaid payment instrument, which can be used only against the issuer or its closely related persons. The issuer of the private prepaid instrument shall file a notification to the Finance Bureau and deposit half amount of the unused amount, except for the case when the issuer only issues instruments that have less than 6 months’ expiration date or the unused balance at a certain reference date is 10 million yen or less.

The second type is the third-party type prepaid payment instrument, which can be used against other than the issuer or its closely related persons. The issuer of the third-party type prepaid payment instruments shall register with the Finance Bureau, except for the case when the issuer only issues instruments that have less than 6 months’ expiration date.

Ⅵ Secondhand Goods Business Regulation

A business that sells, purchases, or exchanges once-used goods such as used cars, used bags, used jewelry, and published artwork is, in principle, subject to the secondhand goods business regulation. A person who conducts the secondhand goods sales and purchase business shall file a notification to the police agency and shall conduct KYC of its customers. It is conceivable, however, that this regulation would not apply to the division and sale of the right of secondhand goods, and thus RWA tokens, which related to the divided right of real goods, are exempted from the regulation.

Ⅶ Other Regulation

In addition to the above, sales, etc., of assets might require consideration of asset-specific regulations. For example, to sell alcohol needs an alcohol sale license, and the seller of RWA tokens UniCask, which relates to a barrel of whiskey, takes the alcohol sale license.

Ⅷ Substantive Legal Issues

Compared to a simple sale of real world assets, RWA tokens require more careful consideration of what rights will be transferred and how to perfect the transfer. Holding RWA tokens does not necessarily mean having ownership of real assets, and transferring RWA tokens does not necessarily mean automatically transferring the ownership of the real assets.

For example, when you transfer real estate, you need to file a real estate transfer registration, and without it, you cannot insist that you are the owner of the real estate to third parties, and just transferring tokens on a blockchain may not suffice this requirement. To transfer tangible property in Japan might be possible just by transferring tokens, but careful consideration is necessary. The law regarding the transfer and perfection of real assets may vary in different jurisdictions, and generally, the laws in the country where the real asset is located apply.

Disclaimer
The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may, therefore, change in the future. This article does not recommend investment in RWA tokens. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.

1 What is DAO?

A DAO is a decentralized autonomous organization that drives a business or project forward using smart contracts without a specific owner or manager. Overseas clients sometimes ask our firm whether they can sell DAO tokens in Japan.

2 Summary of regulation on sales of DAO tokens to Japanese residents

(1) You need to consider Japanese regulations when you sell DAO tokens to Japanese residents, even if you reside outside Japan.
(2) Regulations on DAO tokens differ depending on whether they are investment DAO tokens or community DAO tokens.
(3) Investment DAO tokens are generally considered “security.”  Their sale is usually regulated by the Financial Instrument and Exchange Act (FIEA).  The seller must obtain FIEA registration or delegate the sale’s activities to a licensed FIEA company.  Some exemptions exist, but they are not easy to use.
(4) Sales of community DAO tokens are either (i) unregulated, (ii) regulated by the Crypto Asset Exchange Business Law, or (iii) regulated by the FIEA, depending on the nature of the tokens.

Below is a chart you need to consider before selling DAO tokens to Japanese residents.

<Chart to be considered>

3 Community DAOs and financial regulation

Community DAOs often issue governance tokens.

To consider the financial regulation of sales of DAO tokens in Japan, we must look at (a) whether the DAO provides some kind of dividend or more than 100% redemption of the principal (“Dividend, Etc.”), (b) whether the DAO has any legal entity nature that is similar to a joint stock company or LLC and whether the tokens represent nature similar to shareholders rights, and (c) whether DAO tokens can be used as a payment method.

3.1 DAO tokens that distribute Dividend, Etc.

Tokens in most community DAO do not have any dividend feature or profit distribution feature for token holders.  If there are such features, the regulation on investment DAO tokens will be applied.  Please see item 4 below.

3.2 DAO tokens issued by a company

If a DAO is structured in the form of a company, which happens rarely, and the DAO token awards member rights of the company to token holders, the right might be deemed as securities.  Type 1 Financial Instruments Business Registration is required for the sale of those tokens.

3.3 DAO tokens issued by non-company

In general, many DAOs are formed without clarification of the legal form.  Some DAOs just use a smart contract and do not have any form of legal entity.  Under Japanese law, such DAOs may be classified as partnerships or “associations without a juridical person.”  The rights of partnerships and associations without juridical persons do not fall under securities unless there are Dividend, Etc.

The sale of DAO tokens without Dividend, Etc. and so on issued by an organization other than a company should be classified as a crypto asset or NFT.

If the tokens fall under the definition of crypto asset, their sale shall be made by a licensed crypto asset exchange business operator.

However, if the DAO token is considered an NFT, there are no restrictions on its sale.

The distinction between a crypto asset (FT) and an NFT

In 2023, the Financial Services Agency (FSA) issued guidelines stating the distinction between a crypto asset (FT) and an NFT: (https://www.fsa.go.jp/news/r4/sonota/20221216-2/20221216-2.html).

The guideline states that if the asset does not have “means of payment” characteristics, it is not a crypto asset and that having “means of payment” characteristics can be determined by the following criteria: In general, if (a) DAO tokens cannot be used as a payment method, and (b-1) the price of the token is more than JPY 1,000 or (b-2) the issued number of tokens is less than 1M, the tokens are considered NFTs, and their sale is not regulated.

FSA’s revised guidelines
a)       The issuer must make it clear that the tokens are not intended to be used to pay for goods or services to an unspecified person.  For, example the terms and conditions provided by the issuer or business operator handling the product clearly prohibit the use of the product as a payment method, or the system is designed to prevent the use of the product as a payment method.
b)      Taking into consideration the price and quantity of the relevant property value, technical characteristics and specifications, and other factors as a whole, the tokens that can be used to reimburse an unspecified person for the price of the goods and so on must be limited.  For example, the tokens must have one of the following characteristics:
・The price per minimum transaction unit must be high enough not to be used as an ordinary means of settlement (JPY 1,000 or more).
・The issued number of tokens divided by the minimum trading unit (issued volume considered after divisibility) must be limited (1 million or less).

4 Investment DAOs and Financial Regulation

4.1 Investment DAO tokens are generally considered securities and regulated by FIEA

Under the FIEA, DAO tokens that pay Dividend, Etc. generally fall under the category of “electronically recorded transfer rights.”  Thus, in order to sell electronically recorded transfer rights, you must either register as a Type 1 Financial Instruments Exchange Business Operator (Type 1 FIEBO) and conduct the sales yourself or have a Type 1 FIEBO do it for you.  Furthermore, when soliciting 50 or more persons and issuing 100 million yen or more, the solicitation of the tokens becomes a public offering (Article 2, Paragraph 3 of the FIEA), which requires the submission of complex offering documents and continuous disclosure.

4.2 Exemption from FIEA might apply to some tokens, but it is not easy to use

As an exception, if sales are made only to qualified institutional investors (QIIs, professional investors) or wealthy individuals (with financial assets of JPY 100 million or more) who are 49 or younger, and if technical restrictions are in place to prevent other individuals from becoming DAO token holders through resale, then the sale falls under the exception category called “special business for qualified institutions, etc.,” and self-offering only requires a simple notification under Article 63 of FIEA.

We have heard that many investment DAOs in the US are issued to QIIs, and many investment DAOs limit their sales to avoid US security regulations.  The problem in Japan is that the definition of “professional investors” is much narrower than in the US.  In Japan, one criterion for becoming QII is that corporations and individuals must have at least JPY 1 billion in securities.  In the US, a person who has more than USD200,000 annual income can become a QII, and in the EU, a person who has more than EUR500,000 in financial assets (in addition to satisfying other requirements) can be a QII.  These requirements are much easier to satisfy than the requirements in Japan.

Japan also has a narrower exception to submit offering documents.  In Japan, offering documents are required for offerings exceeding JPY 100 million.  In contrast, exemptions apply for offerings less than USD6 million in the US (sales by Reg A Tier 1) and less than EUR5 million in some countries in the EU.

In light of the above, the issuance of investment DAOs is not popular in Japan but is still possible if you obey Japanese regulations.

EOD

I. What is a Blockchain Game?

A blockchain game is a game that uses the blockchain and uses crypto assets, tokens or NFTs (Non-Fungible Tokens).

In a typical game the following occurs:
(1) user purchases game assets that belongs to the game operator rather than the user,
(2) such game assets cannot be freely transferred, sold, or lent out, and
(3) even time-consuming data disappears after game distribution ends.

Whereas in blockchain games, it is said that the following occurs:
(1) the user is the holder of the token (game asset),
(2) the token can be transferred, sold, or lent out to third parties,
(3) third parties can also use the token, and
(4) as long as the blockchain exists,1the recorded digital assets will exist in perpetuity.

Ⅱ. Laws to Consider and Conclusions

When providing a blockchain game to Japanese residents, the laws listed below should be taken into account. Here is a summary of the laws that pertains to this matter:

(1) Fund Settlement Law and Security Act
To issue and sell NFT itself is not regulated in Japan. Exception to it is (i) if tokens are deemed as crypto assets, such as fungible token which might be used as a payment method, they might be regulated under the Fund Settlement Law and (ii) if tokens are deemed as security, such as tokens including dividend feature, they might be regulated by the Financial Instrument Exchange Act.
(2) Act against Unjustifiable Premiums and Misleading Representations (hereinafter refer to Premiums Law or Premium and Representation Law)
Blockchain Game players might be given tokens, digital currencies, NFTs, digital assets or other gifts which have financial value when a user register, login, play a blockchain game. These gifts might be considered “premiums” or “free gifts” under the Premiums Regulations of the Premiums Law and the value of them are limited. 
If the Play to Earn games allow players to (a) purchase NFTs and (b) earn some reward (e.g., NFTs or tokens) by playing the game, the reward portion may be subject to the prize regulation. There is an argument that depending on the game design, the reward may not be considered an extra (premium) and may not be subject to the Premiums Law.

III. Legal Considerations

The following is a discussion of each legal issue.

1. Crypto Asset Law and Security Act

(a) Where is the problem?
Under blockchain games, the game operator frequently sells game characters, items, weapons, and land etc. as NFTs to users in exchange for ETH or other crypto assets.

Japanese law does not regulate sales of pure NFT, but regulate sales of crypto assets and sales of securities. Thus, whether sold tokens are not deemed as crypto assets or securities are crucial issue.

(b) What are crypto assets?
Under the Fund Settlement Act, the seller, Crypto Asset is defined as follows:

Definition of Crypto Assets (Article 2 Section 5 of the Fund Settlement Act
Definition of Type 1 Crypto Asset
A property value that is recorded in electronic record and transferred electrically, that can be used to pay for the purchase of goods or receive services to an unspecified person, and that can be purchased and sold to an unspecified person (excluding some stable coins and securities).
Definition of Type II Crypto Assets
Crypto Asset that is recorded in electronic record and transferred electrically which can be mutually exchanged with the Type I Crypto Asset with an unspecified party (excluding some stable coins and securities).

Selling or providing custody of crypto assets are highly regulated and must generally be handled by registered crypto asset exchange operator and also it is not feasible for a blockchain game operator to obtain registration.

At this moment, whether tokens are considered as crypto assets is determined by the number of issued tokens and whether the tokens can be used as some form of payment. NFTs are generally not considered as crypto assets, but if a game operator says it is an NFT, and the NFT has payment features etc., it may be considered a crypto asset.

(c) What are Securities?
Japanese Financial Instrument and Exchange Act (FIEA or Security Act) governs the issuance or sales of securities. Securities includes stocks, bonds, mutual funds, collective investment scheme etc. We have been often asked by blockchain game operators whether it is legal in Japan to sell NFTs, such as land, which generate “income” or “dividend”. If NFTs generate income without the participation of players, they may be classified as securities. Thus, when selling profit-generating tokens, the game should consider including features of players’ effort, such as editing land to attract customers.

2. Gambling offenses

(a) General Remarks
The crime of gambling under the Penal Code is established by (1) contesting the gain or loss of property profits by (2) winning or losing by chance. In addition, not only money but also “property interest” is considered to be the object of gambling, and rice, land, and debt collection are all considered to be “property interest” subject to the crime of gambling. Crypto assets are also considered to fall under the category of property interest.

Article 185 (Gambling)
A person who engages in gambling shall be punished with a fine of not more than 500,000 yen or a fine. However, this shall not apply when the betting is limited to betting on objects provided for temporary entertainment.

(b) Gacha (Loot Box), Reveal and Gambling Law
Some blockchain games have features of Gacha (loot box) and reveal. Users pay money or crypto assets to a gaming company and get NFTs randomly. For example, users pay 1ETH to get a game character NFT. Game characters may include Julius Caesar, Guanyu, Genghis Khan, Napoleon, George Washington etc, and those characters have different strength, powers, rarity etc, and what users can get is not revealed to users.
It was believed that these sales might be considered as gambling because (i) users pay property value, (ii) users receive property value which differs by chance, and (iii) there is winning or losing (of property value) by chance. However, in 2022, blockchain industries talked with a famous criminal law professor and some regulatory authorities and issued the guideline which states certain Gacha and reveal is not considered as gambling. Although the guidelines have no effect to police or criminal courts, the industry is now considering how following the guidelines may reduce the likelihood of criminal penalties.

The requirement is that the issuer and operator of games do not sell the same NFTs at different prices (for example, if the issuer sells NFTs that include Napoleon with 1ETH via Gacha, the issuer is not allowed to sell Napoleon NFT at a different price in another method), and do not buy back NFTs in a secondary market (for example, the issuer cannot buy back Napoleon NFT in 0.5ETH or 1.5ETH). In such cases, there is either winning or losing), and the issuer and operator shall not overstate the value of some NFTs in Gacha over other NFTs in Gacha.

(c) Synthesis
The same theory that applies to Gacha may apply to synthesis, but because synthesis is not discussed in the guidelines, we take a more cautious approach to synthesis.

3.Premiums and Premiums Law

(a)Initial Start
Developers often ask us of blockchain games if it is possible to give NFTs, game currency, crypto assets, other property to users free as a login bonuses, playing bonus and ranking bonuses etc. When conducting such distribution, it is necessary to consider the relationship with the Premiums and Representation Law.

(b) About the Premiums and Representation Law
The Premiums and Representation Law prohibits the offering of excessive premiums.
Premiums are (1) offered as a means of inducing customers, (2) offered incidental to a transaction, and (3) economic benefits such as goods or money. As the definition of economic benefits is broad, crypto assets, NFTs, in-game currencies, and other benefits might be considered as economic benefits.

Excessiveness will vary depending on whether the sweepstakes is general sweepstakes, joint sweepstakes, or all-inclusive sweepstakes, Still, it will be based on the following criteria to the extent that it is considered relevant to the game.

  Description Example Limits on Premium and Prizes
Total Prizes Offering prizes to anyone who uses the products or services or visits the store, not through sweepstakes. Gifts for all purchases, gifts for all visitors, etc. Transaction value less than 1,000 yen – Premiums up to 200 yen.
Transaction value is over 1,000 yen – Premiums are capped at 2/10ths of the transaction value

General Sweepstakes

Offering prizes to users of goods or services by chance, such as lotteries, or by the superiority of specific actions. In-store raffles, quiz and game competitions. Transaction value less than 5,000 yen – 20 times the transaction value.
Transaction value of more than 5,000 yen – 100,000 yen.
(Both are capped at 2% of the total expected sales amount)

(c) Ranking Rewards and the Premiums and Representation Law
In traditional smart phone games, the top-ranking players frequently receive in-game currency. The economic value of in-game currency has been treated as zero or very low by game operating companies, and there is no issue under the Premiums and Representation Law.

In blockchain games, crypto assets and NFTs, which can be sold outside of the game might be given as prizes. In this case, the general sweepstakes restrictions apply. The transaction value determines the amount of the prize. Although it is difficult to determine how much the transaction value is, a reasonable approach would be to set the minimum charge as the transaction value and allow rewards of up to 20 times the minimum amount or 100,000 yen, whichever is lower.

(d) Play to Earn and the Premiums and Representation Law
If we consider a Play to Earn game as a game where players (a) purchase NFTs or game currency and (b) earn some reward (e.g., NFTs or game currency) by playing, the reward portion may be subject to the Premiums Regulation.

However, whether earned NFTs or game currencies will be considered “premium” is unknown. There is an argument that the Premiums Law does not apply to Play to Earn games because the rewards are not “extras (premiums),” but rather the purpose of purchasing NFTs and playing the game itself. Lottery winnings and game-play prizes, for example, are not considered “premiums,” but rather “the purpose” of the transaction itself (gambling law shall be discussed lottery winnings and game-play prizes). This issue has not been resolved in Japan, and careful deliberation is required.

Reserved Matters
The contents of this document have not been verified by the relevant authorities and are merely a description of arguments considered reasonable under the law. It is only the current thinking of our firm, and our firm’s thinking is subject to change.
This document does not recommend using blockchain games or purchasing NFTs.
This document is intended for blogging purposes only. Please consult your lawyer if you need legal advice on a specific case.

Introduction

Clients often ask us whether it is possible to structure a Decentralized Autonomous Organization (DAO) in Japan. Currently, Japan does not have regulations targeting DAOs, unlike Wyoming State or the Marshall Islands. So, we have written this article summarizing what is typically considered when forming a DAO in Japan.

1.DAO

1.1 What is DAO?

A decentralized autonomous organization (DAO) is a new legal structure with no central authority and members committed to acting in the organization’s best interests. DAOs are used to make decisions in a bottoms-up management style and have gained popularity among cryptocurrency enthusiasts and blockchain technology.

1.2 Classification of DAOs

There are several classifications of DAO described below:

1.     Investment DAO
 
Investment DAOs are for-profit DAOs aim at co-investing in a project. They are more likely to attract funds than Grant DAOs because they aim to generate profits mainly through “economic capital.”
Examples: Genesis DAO, The LAO, BitDAO, etc.
 
2.     Grant DAO
 
The community contributes monies to the grant pool and votes on funds allocation and distribution decisions in a Grant DAO. Innovative DeFi projects are funded using these DAOs, showing how decentralized communities are more flexible with funding than traditional organizations.
Examples: MolochDAO, MetaCarteDAO, Aave Protocol, Uniswap Grants, etc.
 
3.     Protocol DAO
 
When tokens serve as a voting metric for implementing any changes in the protocol, such a governance structure represents protocol DAOs. For instance, MakerDAO has revolutionized the DeFi space with its DAI stablecoin.
Examples: Maker, Compound, Uniswap, Aave, Yearn, Sushi, etc.
 
4.     Service DAO
 
A Service DAO is a decentralized working group. They can receive tokens as compensation for their projects.
Examples: RAID GUILD, DXdao, PartyDAO, etc…
 
5.     Social DAO
 
A Social DAO offers digital democracy where opinions are heard, and people can share common interests.
Example: Bored Apes (BAYC)
 
6.     Collector DAO
 
Artists who use nonfungible tokens (NFTs) to create art rely upon collector DAOs to establish ownership of their art.
Example: PleasrDAO
 
7.     Media DAO
 
Media DAOs allow product owners of content (i.e., readers) to contribute directly without involving advertisers for the native token as a reward in return for their contributions.
Example: Fore Front (FF), Bankless DAO, etc…

Source https://cointelegraph.com/daos-for-beginners/types-of-daos

1.3. Example of an Existing Overseas Law

A few places where DAOs are regulated are Wyoming State and the Marshall Islands. Below is a short description of forming a DAO in the Marshall Islands.

The Legal Form of a DAO on the Marshall Islands

Marshall Islands proposes a non-profit corporation (limited liability company) as a legal entity form for DAO, which stands out from the general practice to establish DAO as a foundation. Such a company is established in compliance with the general corporate law of the Marshall Islands with specific features that:
  • No part of the income or profit of the corporation is distributable to its members, directors, or officers; and
  • Members’ ownership of such a company may be defined in such a plain document as the register of members AND in the company’s smart contract.
  • You must clearly state the company’s purpose and connect it to the non-profit activity. The purpose will be furtherly indicated in the Certificate of Incorporation.

How does this work?

Generally speaking, such a company works as a limited liability company managed by its members. It has three essential constitutional documents: Certificate of Incorporation, Operating Agreement, and Charter of the Company.
The Operating Agreement should include the most crucial matters of your DAO management:
  • additional governing bodies;
  • voting and counting of votes of such governing bodies;
  • amendment of a smart contract;
  • creation and management of treasury.

You can amend any of these matters by the members’ decision in compliance with the procedure prescribed in the previous version of the Operating Agreement. 

Registering a Marshall Islands LLC for DAO


Here’s what the process of establishing a legal wrapper for DAO on the Marshall Islands looks like: 
  • You start by clearly defining the name and purpose of your DAO. Once again, the purpose of your DAO should indicate the non-profit element;
  • At least three founding members draft the Operating Agreement (you may amend the Operating Agreement at any time upon establishment of the company; therefore, it is a common practice to use the template at the first stage to speed up the process);
  • The founding members should pass the KYC process with the local regulator. Apart from the founders, anyone who holds 10% or more governance rights over the company must pass the KYC process
  • The founding members sign the drafted Operating Agreement, Certificate of Incorporation, and Foreign Business Investment License form and file these documents with the regulator;
  • If everything is alright with the documents, the regulator sends the Charter of the limited liability company to the founders.

The above is a reference from Taras Zharan Web 3 Virtual Legal Officer.

 https://legalnodes.com/article/marshall-islands-llc-as-a-dao-legal-wrapper

2. Financial Regulations on DAOs

2.1. Points to Consider

When structuring a DAO, one must consider the financial regulations and the legal form characteristics.

Here are several points to keep in mind:

1. Security regulation under the Financial Instrument and Exchange Act (“FIEA”) may apply when tokens have the possibility of dividends or redemption of the principal of more than 100% (dividends and redemption of the principal of more than 100% are from now on collectively referred to as “dividends, etc.”). As a general rule, token sales of such DAO must be conducted by a Type 1 Financial Instrument and Exchange Business Operator (“Type I license”) or by obtaining a Type 2 Financial Instrument Exchange Business Operator license (“Type II license”).

2. When selling Fungible Tokens without dividends, etc., it is necessary to have a Crypto Asset Exchange Operator conduct the sale or to obtain a Crypto Asset Exchange Operator license.

In contrast, these financial regulations generally do not apply when selling NFTs without dividends, etc.

3. You also need to consider the tax benefits. If you want to pursue tax advantages in an Investment DAO with dividends, etc., you can use a partnership or GK-TK scheme. If tax advantages are not particularly important, an association without rights, a general incorporated association, or a limited liability company can be considered a scheme to issue tokens. For the issuance of Fungible tokens or NFTs without dividends, etc., it may be better to have no particular legal structure.

2.2. Reference Table of Conclusions

The table below summarizes the legal scheme and financial regulations that should be considered in establishing a DAO.

The following regulations apply to token sales of Investment DAOs with dividends, etc. (assuming dividends or principal redemption of more than 100%).

Type of Member’s Rights Form under Japanese Law Free distribution of Tokens Token Sale Investment Management
DAO member’s rights as shareholders’ rights in Limited Liability Companies and Joint-stock Companies Tokenization of shareholders’ rights of limited liability companies, etc. Free distribution of the shareholders’ rights is not allowed under corporate law, etc.

Sales by a third party for an issuer need a Type I license. A Type II license is necessary for the self-offering of a limited liability company. No license is required in the case of self-offering of a joint-stock company.

In the case of solicitation of 50 or more people, there needs to be a submission of a registration statement regarding securities, etc.

No regulation
DAO member’s rights (with dividends), not including shareholders’ rights TK investment, partnership investment, tokenization of rights that are difficult to classify into prescribed legal forms, etc. Unregulated

Sales by a third party for an issuer need a Type I license.

Self-offering needs a Type II license.

In the case of solicitation of 50 or more people, there needs to be a submission of a registration statement regarding securities, etc.

No regulation

(Possibility of Investment Management Business license in the case of securities investment)

On the other hand, a DAO without dividends, etc., is also possible. Its regulations are as follows:

Tokens/NFT Free Token Distribution Sale of Tokens Investment Management(Assuming no dividend)
Utility Tokens No regulation Crypto Asset Exchange Business regulation No regulation
NFT No regulation No regulation No regulation

With respect to possible legal forms for DAOs, the following comparisons can be made:

Status Legal Form Limited Liability Is it possible to distribute? Avoid Double Taxation Others, Comprehensive Evaluation
No Legal Entity Status Association without rights +Tokens with unclear rights 〇? ×

△~〇 High degree of freedom. A good scheme if there is no problem with double taxation.

Civil Law Partnership + Partnership Equity Token ×

△~〇 High degree of freedom. A good scheme if there is no problem with limited liability.

Investment Business Limited Liability Partnership + partnership Equity Token

× Although other points are reasonable, there are restrictions on investment destinations and businesses, such as not being able to purchase NFTs. It’s usually hard to use this scheme as DAO.

Limited Liability Partnership + Partnership Equity Token

× There are valid points; however, to use as a DAO is problematic because of the need to register the name of the union member.

DAO has Legal Entity Status

Corporation (*1) + Tokenization of Anonymous Partnership (e.g., TK-GK scheme)

△ It is necessary to operate in accordance with the Companies Act and the General Incorporated Associations Act. It should be noted that TK holders do not have the right to instruction. The good point is that there is no double taxation and limited liability.

Corporation (*1) + Token with unknown rights

〇?  〇 × △ ~ 〇 It is necessary to operate under the Companies Act and the General Incorporated Associations Act. Besides that, it has a high degree of freedom and is a good scheme if you don’t mind the double taxation problem.

Corporations (*1) + Tokenization of shareholders rights (*2)

 〇  〇(× For general incorporated associations) ×

× Is there a low degree of freedom due to the need to operate per the Companies Act and the General Incorporated Associations Act? For example, it is necessary to manage members as shareholders.

*1 Legal entities include limited liability companies, stock companies, and general incorporated associations. LLCs are generally easier to establish and operate than joint-stock companies. If you want to have a more public image, use a general incorporated association.
*2 Membership rights of a limited liability company, stocks of a stock company, membership rights of a general incorporated association.

2.3 Tokenization of Rights

Tokenization of rights of funds or partnership, where there is an investment of funds (including money and crypto assets), investment management, dividends, or redemption of the principal of more than 100%, would be broadly considered a collective investment scheme (fund) under Japanese law. Below is the summary of the Definition of a Collective Investment Scheme.

Summary of Definition of Collective Investment Scheme
Rights that satisfy the following (i) to (iv)
(i) Rights under a partnership agreement as defined in Article 667(1) of the Civil Code, a silent partnership agreement as defined in Article 535 of the Commercial Code, an investment limited partnership agreement as defined in Article 3(1) of the Act on Limited Liability Partnership Agreement for Investment Business, or a limited liability partnership agreement as defined in Article 3(1) of the Act on Limited Liability Partnership Agreement for Investment
(ii) The existence of a business (the “Invested Business”) in which money (including cryptographic assets) contributed or contributed by the person who has such rights (the “Investor”) is allocated to the Invested Business;
(iii) The investors are entitled to receive dividends of profit generated from the invested business or distribution of assets related to the invested business;
(iv) There are no exceptional circumstances, such as all investors being constantly involved in the business.

The revised Financial Instruments and Exchange Act, which came into effect on May 1, 2020, created the legal concept of Electronic Record Transfer Rights. The rights of tokenized collective investment schemes usually fall under the Electronic Record Transfer Rights below.

Outline of Definition of Electronically Recorded Transfer Rights
Rights that satisfy the following (i) to (iii) but exclude (iv) (Article 2, Paragraph 3 of the FIEA):
(i) Rights listed in each item of Article 2, Paragraph 2 of the FIEA (funds, trust beneficiary rights, members’ rights of general partnerships, limited partnerships, limited liability partnerships, etc.);
(ii) When they are expressed in property values that can be transferred through an electronic data processing system;
(iii) When recorded in electronic devices or other objects by electronic means;
(iv) Cases provided in the Cabinet Office Ordinance have considered the nature of distribution and other circumstances.

The sale of this electronic record transfer right requires a Type 1 Financial Business registration. If soliciting more than 50 people, it will be a public offering (Article 2, Paragraph 3 of the Financial Instruments and Exchange Act), and a securities registration statement must be submitted based on Article 5 of the FIEA.

If the sale is limited to qualified institutional investors or wealthy people of 49 or less, and even if there is resale, there are technical restrictions so that other people cannot become DAO token holders.

When the Investment DAO is formed, it can be sold in such a limited form at first, and after it grows, it can be sold to the general public while complying with increased regulations.

2.4 Tokenization of Company Membership Rights and Financial Registration Regulations

Regarding tokenization of company membership rights, a Type I FIBO license is necessary when a third party sells the rights, and Type II is essential in the case of self-solicitation. In the case of tokenization of company membership rights (shareholders rights) of a joint stock company, a Type I license is necessary in the case of solicitation by a third party, and no license is required in the case of self-solicitation.

2.5 Regulations on Public Offerings, etc.

 If any of the following applies, it becomes a public offering. In principle, it is necessary to submit a securities registration statement.

(i) When soliciting the acquisition of securities from 50 or more persons (excluding Qualified Institutional Investors (QII) in the case there are restrictions on resale other than QII);

(ii) When it does not fall under any of the following categories: Private Placement for QII, Private Placement for Professional Investors, and Private Placement for Small Groups.

2.6 Financial Regulations for DAOs without Dividends

If DAOs have no dividends, etc., they are not considered securities, but different financial regulations may apply.

Tokens/NFTs Free token distribution Token Sales Investment Management (Assumption without dividends)
Utility Tokens Unregulated Crypto Asset Exchange Business License Unregulated
NFTs Unregulated Unregulated Unregulated

Disclaimer

The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may therefore change in the future. This article does not recommend investment in DAO. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.

Ⅰ. Introduction

We posted (1) an article titled “Crypto Fund“( in Japanese) on 1 June, 2018, and (2) an article titled “Funds Regulations in Japan” on 30 June, 2020.

In 2021 and 2022, we received many inquiries regarding setting up crypto funds. Considering (i) the amendments in 2020 to the Payment Services Act(PSA), (ii) the rise of NFT, DeFi, and stablecoins, and (iii) changes to the taxation of crypto assets,  we therefore are updating  (1) the article titled “Crypto Fund.”

In general, the term “crypto fund” can be used in a variety of ways, such as where (i) the fund’s financial source is crypto assets which include Bitcoin and Ether, (ii) the fund’s investment targets are crypto assets or crypto related businesses for instance BTC, ETH, SAFT, ICO tokens, NFT, stablecoins, security tokens, DeFi, and stocks of crypto related companies, and (iii) the investor’s rights are tokenized.

Therefore, the following is an overview of the regulations that apply to each type of structure.

Since this article focuses on crypto funds, other kinds of funds (investment in fiat currency and securities management) are not mention in this article, except in section VIII.1. For regulations on other kinds of funds, please refer to (2) the above article titled “Funds Regulations in Japan. “

Ⅱ. Regulations on Fund Raising

1. Regulations on Fund Raising in Fiat Currency

Under the Financial Instruments and Exchange Act (FIEA), soliciting investments in money (fiat currency), using it to conduct business, and distributing the proceeds from the business falls under a collective investment scheme (Article 2(2)(v) of the FIEA).

Soliciting investments in a collective investment scheme (public offering or private placement, Article 2(8)(vii)(f)) falls under the Type II Financial Instruments Business (Type II FIB) (Article 28(2)(i) of the FIEA) in principle, and public offering or private placement is not allowed without registration as a Type II Financial Instruments Business Operator (FIBO) (Article 29 of the FIEA). This is also the case for crypto funds where the means of fundraising is money, and the investment targets are crypto assets.

There are some exceptions to this fund regulation under the FIEA, such as (i) cases where the fund completely outsources the solicitation to another Type II FIBO and does not solicit any acquisitions on its own, (ii) cases where the fund uses the exemption so called Specially Permitted Businesses for Qualified Institutional Investor (QII) (Article 63 of the FIEA) (Article 63 Exemption or QII etc. Exemption), and (iii) cases where the fund is more than 50% funded by overseas investors and the domestic investors are limited to certain investors such as QII (Overseas Investors Exemption)( Article 63-8 of the FIEA).

Whether or not the issuer does not conduct any solicitation for acquisition is determined by the circumstances in each case. Solicitation for acquisition refers to the solicitation of an application to acquire newly issued securities and similar activities (Article 2, Paragraph 3 of the FIEA). Solicitation is generally understood to be an act that attracts and encourages investors to acquire a particular security, whether in writing, verbally or through advertising.

Specially Permitted Businesses for QII is an exemption that allows a fund manager to engage in fund services by making a simple notification to the Financial Services Agency (FSA) when all investors in the fund are QII or when the investors include one or more QII and 49 or fewer persons who are expected to have certain investment abilities. However, that exemption has been subject to tighter regulations under the 2015 amendment to the FIEA. Before the amendments, the scope of 49 or fewer investors included general individual investors. It should be noted that after the amendment, individual investors whose total amount of investable financial assets (referring to securities, etc., but not including crypto assets) is 100 million yen or more and who have been in a security account for one year would be able to invest.

2. Regulations on Fund Raising in Crypto Assets

Until the amendment of the FIEA in 2020, soliciting investments in funds with crypto assets was not subject to the FIEA regulation. However, due to the amendment, crypto assets are now considered as money equivalent in relation to fundraising (Article 2-2 of the FIEA). Fund raising with crypto assets is now subject to the same regulations as fund raising with money.

(Summary of Regulations on Fund Raising )

  General Registration Requirements Exceptions
When Completely Outsourced to a Third Party

Article 63 Exemption

(QII etc. Exemption)

Overseas Investor’s Exemption
Sales by Issuer Type II FIBO
Registration

N/A
(for the third party, Type II FIBO

registration)

Available Available
Sales by Third Party (on behalf of the issuers) Type II FIBO
Registration

N/A
if sales activities are sub-delegated to a registered third party

(rarely the case)

N/A
Type II FIBO
Registration

N/A
Type II FIBO
Registration

Ⅲ. Regulations on Investment Management of Funds

1. Regulations When Investments are Primarily in Securities or Derivatives

With respect to funds the term investment management business is understood as the management of money or other property invested by a person connected with investments primarily in securities or derivatives which are based on investment decisions requiring the valuation and analysis of such instruments. In this context, “primarily” means that generally more than 50% of the assets under management are invested in securities or derivatives. To conduct an investment management business, a company must register as an Investment Management Business Operator (Article 28(4) of the FIEA). Similar to Type II FIBO, persons engaging in the investment management business must meet certain criteria, including minimum capital requirements and hiring proper personnel (e.g. a compliance officer with eligible knowledge and experience) for operating the business.

The securities include stocks as well as general security tokens. In order to avoid this regulation, it is necessary to set a limit on the investment objectives to the effect that no more than 50% of the investment should be in securities or derivatives. Similar to the above II.1, there are some exemptions. For example, registration as an investment management business is not required if (i) the fund meets requirements such as full outsourcing of management to other investment management companies, (ii) the fund is conducted as Article 63 Exemptions, or (iii) the fund is set up in a foreign country and investment from Japan is limited.

2. Regulations When Investments are Primarily in Crypto Assets

If the investment target is mainly crypto assets, the FIEA does not apply to the management. Since the management of crypto assets is for investment purposes and not for business purposes, the PSA does also not apply. When investing in NFT, SAFT, DeFi, stablecoins, the FIEA and the PSA do not apply to the management, as it does when investing in crypto assets.

(Summary of Regulations on Investment Management)

  General Registration Requirements Exceptions
When Completely Outsourced to a Third Party Article 63 Exemption (QII etc. Exemption) Foreign Funds that Meet Certain Requirements

Management of Funds that Invest +50% in Securities by GP

Registration of GP as Investment Management Business Operator N/A
(For the third party, Investment Management Business Operator Registration)
Available No registration required

Management of Funds that Invest +50% in Securities by Third Party

Third party must register as Investment Management Business Operator N/A
If management activities are sub-delegated to a registered third party
(rarely the case)

N/A

Third party must register as Investment Management Business Operator Registration
N/A
Third party must register as an Investment Management Business Operator registration

Management of Other Funds (incl. crypto assets)

N/A N/A N/A N/A

 

Ⅳ. Regulations on the Content of Investors’ Rights

1. Regulations on the Distribution of Money and Crypto Assets

A fund is generally set up by using a silent partnership agreement, a limited partnership agreement, or an overseas partnership agreement (collectively, partnership agreement), and investors have rights under such partnership agreement. In a crypto fund, it is assumed that there are cases where (1) the fund’s investment is solicited in crypto assets and then dividends or principal redemption in money, (2) the fund’s investment is solicited in money and then dividends or principal redemption in crypto assets, and (3) the fund’s investment is solicited in crypto assets and then dividends or principal redemption in crypto assets.

Since the transfer of the crypto assets is not a sale or exchange thereof, we believe that the PSA does not apply except in cases of legal evasions, such as formally soliciting investment in a fund with money and immediately redeeming the principal with crypto assets.

2. Regulations on the Tokenized Interest

With the 2020 revision of the FIEA the concept of Electronically Recorded Transfer Rights (ERTR)

were introduced. Article 2(3) of the FIEA defines ERTR as follows:

“Electronic Recorded Transfer Right” are rights that fulfill all requirements from (1) to (3)
and do not fall under (4):
(1) Rights listed in Article 2(2) of the FIEA (funds, beneficial interest in a trust, membership rights of general partnership company, etc.)
(2) which are recorded electronically, and
(3) may be transferred by using an electronic data processing system.
(4) Cases specified by Cabinet Office Ordinance taking into account the liquidity constraints and other circumstances.

Some crypto funds may also consider tokenizing their rights. Interests in a fund which are tokenized are generally considered ERTR. Given their (potentially) increased liquidity they are subject to the same regulations as more liquid Type I Securities. Third parties engaging in the sale of tokenized interests must therefore register as Type I FIBO (Article 28 (1) (i), Article 2 (8) (ix) of the FIEA).

The self-solicitation of tokenized interests by a fund is subject to the same registration requirements as the self-solicitation of funds in general. A fund must therefore register as a Type II FIBO and, if ≥50% of the money is invested in securities or derivatives, as an Investment Management Business Operator, unless an exemption applies. The QII exemption 1 and the exemption in case of entrustment of all sales and investment activities to third parties also apply to tokenized funds.

For more detailed information on security token offerings (STOs), please click here.

(Business Regulations and Notifications Requirements under the FIEA for the Sale and Management of Tokenized Funds)

 

General Registration Requirements

Exceptions

When Completely Outsourced to a Third Party

Article 63 Exemption (QII etc. Exemption)

Foreign Funds that Meet Certain Requirements

Sales
Sales by Issuer Type II FIBO
registration

N/A
(for the third party, Type II FIBO

registration)
Available Available
  Type I FIBO
registration

N/A
If sales activities are sub-delegated to a registered third party

(rarely the case)
N/A
Type I FIBO
registration

N/A
Type I FIBO
registration

Investment Management

Management of Funds that Invest +50% in Securities by GP

Registration of GP as Investment Management Business Operator

N/A
(for the third party, Investment Management Business Operator registration

Available

No registration required

Management of Funds that Invest +50% in Securities by Third Party

Third party must Register as Investment Management Business Operator

N/A
If management activities are sub-delegated to a registered third party
(rarely the case)

N/A
Third party must register as Investment Management Business Operator Registration

N/A
Third party must register as Investment Management Business Operator registration

Management of Other Funds (incl. crypto assets) N/A

N/A

N/A N/A

Ⅴ. Disclosure Regulations

Since ERTR are generally subject to the same regulations as Type I Securities, disclosure requirements apply if investors’ rights are tokenized. An issuer of ERTR is therefore obliged to prepare a prospectus (Article 13 (1) of the FIEA) and to register the offering with the FSA (Article 4 (1)). In addition to the initial disclosure, ongoing disclosure requirements apply (Article 24). Something different only applies in the case of private placements. These are placements with QII, professional investors or a small number of investors (≤ 50 investors) only.
If investors’ rights are not tokenized, disclosure requirements apply to public offerings of type II securities, which fall under the category of Rights in Securities Investment Business, etc. (Article 3 (iii) (a)) that mainly invest in securities. In the case of Type II Securities, if the number of holders is less than 500 in response to a solicitation for acquisition, it does not fall under public offerings (Article 2 (3) (iii) and Article 1-7-2 of the FIEA Enforcement Order), and disclosure requirements do not apply.


(Disclosure Regulations)

Type of
Securities
Type of Solicitation Investors Obligation to Disclose
Type I
Securities

Private
placement

Private

placement with

QII only*

QII only Notification of specific matters
(Article 23-13 (4) of the FIEA,
Article 20 (1) of the Cabinet Order on Disclosure of Regulated Securities)

Private

placement to a

small number of

investors*
≤49 investors

Private

placement to

specified

investors*

Specified

investors only
N/A
Public offerings Unlimited
number of
investors

Securities registration statement **

(continuing disclosure of semiannual

reports, extraordinary reports, etc.)

Type II
Securities

Private placement

≤499 investors N/A

Public offerings

Unlimited
number of
investors

Generally not applicable

Rights in Securities Investment
Business, etc. are regulated

* Technical measures must have been taken to restrict resale.
** When the total issue price is less than JPY 100 million the obligation to file a securities registration statement does not apply (Article 4(1)(v) of the FIEA).

Ⅵ. Fund Scheme

1. Fund Scheme if Investing in Crypto Assets

Funds are generally structured using various types of partnership agreements. In Japan, investment Limited Liability Partnership (LLP) agreements are often used to set up PE funds and VC funds, etc. However, LLP is legally only allowed to engage in certain businesses (Article 3 (1) of the Act on LLP), and it does not include the acquisition and holding of crypto assets or stablecoins. Therefore, if the investment target is crypto assets or stablecoins, LLP cannot be used, and silent partnership agreements should be considered2.

2. Fund Scheme if Investors Rights are Tokenized

Suppose a fund tokenizes rights under a partnership-type agreement and transfers the token to investors. In that case, it seems necessary to consider whether simply tokenizing existing rights on the agreement will work properly.
For example, the following issues should be considered:

Ⅶ. Supplement

1. Investment in Crypto-Related or Blockchain-Related Companies

Funds that are financed in cash and invest primarily in shares of crypto-related or blockchain-related companies are sometimes called crypto-related funds.
As a fund that invests primarily in securities, such as this fund is, in principle, required to be registered as a Type II FIBO for its public offering or private placement and as an investment management business operator for its management (refer to II1. and III1.).

2. Management of Own Funds

When a company launches an “in-house fund” to invest its own funds in shares of crypto-related or blockchain-related companies, it may also be called crypto-related funds.
However, this does not fall under “investment of money or other properties invested or contributed from a person who holds the following rights or other rights specified by the Cabinet Order” (Article 2 (8) (xv) of the FIEA), so fund regulations under the FIEA do not apply.

3. Tax Issues of Crypto Funds

We are not experts in tax issues, but we describe here for your reference since tax issues are often a significant issue when setting up a crypto fund.4
If a company owns actively traded crypto assets in Japan, it is taxed at market value at the end of the term (so-called unrealized gains tax).
When a crypto fund is set up with TK-GK scheme, the silent partnership investors are not considered to own the assets, but GK is deemed to own, and therefore, in principle, unrealized gains are taxed in GK. However, if such unrealized gains are distributed to investors based on the silent partnership agreement, GK will not be taxed on that portion (effectively pass-through), while the portion equivalent to such gains will be treated as income of the investors (both individual and corporate investors).

When a crypto fund is set up with an overseas partnership, it is taxed as if investors themselves own assets of the fund (pass-through). Therefore, corporate investors of the overseas partnership are subject to unrealized gains tax.

Unrealized gains tax might be avoided by using a scheme in which a company is set up in a foreign country that does not tax unrealized gains and Japanese investors invest in the company as a silent partnership, and then unrealized gains are not allocated to the investors. However, it is necessary to consider Anti-Tax Haven Rules when using this scheme. If the overseas company’s shareholders are domestic companies or domestic individuals, the overseas company may be deemed to be a paper company or not meet the economic activity standards, and income of the overseas company might be deemed as income of the shareholders.

Therefore, you should consider the following factors and consult with legal and tax professionals to structure a crypto fund.

Scheme Unrealized Gains
Taxation on SPV
Unrealized Gains Taxation
on Corporate LP
Unrealized Gains Taxation
on Individual LP
Taxation on Shareholders of SPV
TK-GK

Taxed on GK
(if unrealized gains are distributed, GK will not be taxed)

Taxed if it is distributed Taxed if it is distributed N/A
(in principle)

Overseas
Partnership

N/A
(depending on country)

Taxed N/A N/A
(depending on country)
TK-Overseas
Company
N/A
(depending on country)
N/A
(in principle)
N/A
(in principle)
Anti-Tax Haven Rules may apply

Disclaimer

The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may therefore change in the future. This article does not recommend the investment in crypto funds. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.

In this post, we analyze non-fungible tokens (NFTs), play-to-earn scholarships, and the Yield Guild DAO under Japanese laws. With respect to the scholarships, it is worth noting that they are mainly offered overseas – presumably in compliance with the relevant laws – and that Japanese laws only apply if Japanese residents are involved. The following post is written under the assumption that this is the case.

You can find more information about the legal and regulatory environment for NFTs in our previous posts:

  1. ‘Play to Earn’ under Japanese Laws (September 2, 2021)
  2. NFTs: An overview of the current state in Japan, the legal and regulatory environment, and the latest guidelines by the JCBA and BCA (April 27, 2021)
  3. Buyer Beware – Digital Art and Non-Fungible Tokens (NFT) (March 22, 2021)

1. Overview

1.1. Play-to-Earn (P2E)

The P2E model was pioneered by Axie Infinity. Axie Infinity is an online game that allows players to receive rewards in the form of Smooth Love Potions (SLP) when playing the game. SLP are tokens that are needed for breeding new Axies and which can be traded on global crypto exchanges.

1.2. Scholarships

To play Axie Infinity, a player needs at least three Axies. In August 2021, the price for three Axies was around USD 1,000 and as such unaffordable for many players. Yet, despite the high costs, the game continued to gain popularity – especially in countries with low incomes. One of the reasons behind the continued success were scholarships. Under the scholarship program, owners of Axies give their Axies to players who in turn use them for playing the game. When earning SLP as rewards, players must share them with the owners of the NFTs. The percentage players retain is somewhere between 40 and 75 percent, depending on the provider of the scholarship and scholarship program.

Scholarship programs in a nutshell
  1. Owners of Axies search for scholars on discord and other platforms.
  2. Scholars sign scholarship agreements with an owner and start playing the game.
  3. Rewards earned in the game are shared between the players and the Axies’ owners.
Even though scholars may use Axies for playing, they are not authorized to sell them under the scholarship agreement.

1.3. Yield Guild Games

Yield Guild Games (YGG) describes itself as a “play-to-earn gaming guild, bringing players together to earn via blockchain-based economies”. YGG initially raised funds from a16z and other investors in exchange for YGG tokens and invests those funds into NFTs that are used in blockchain games. Proceeds from utilizing the NFTs – for example from lending the NFTs to players of P2E games or selling them on the market – are distributed to YGG token holders.

In some cases, YGG further brokers scholarships for NFT holders who want to put their NFTs to use and earn a passive income. Initial activities focus on Axie Infinity, The Sandbox, and League of Kingdoms. Further games will be added in the future.

While the core team of YGG currently manages all activities, YGG aims to become fully decentralized in the future. Once the transition is completed, decision-making will be transferred from the core team to the YGG DAO, i.e. the YGG token holders.

2. Analysis under the Applicable Laws and Regulations

2.1. Legal Structures of Scholarships

Scholars and managers enter into scholarship agreements on an individual basis. Usually, the agreements are initiated via Discord or other channels. Under Japanese laws, the following structures may be considered.

2.1.1. Lease Agreement

Where a scholar promises to pay a certain amount of money for the use of Axies and to return the Axies at the end of the agreement to the manager, the agreement might be considered some form of lease. Since Article 601 Civil Code only covers the lease of tangible assets, it cannot be applied directly to the lease of intangible assets such as Axies. Applying Article 601 ff Civil Code by way of analogy seems, however, possible.

Assuming Articles 601 ff Civil Code can be applied analogously, scholars would not be allowed to sublease Axies to third parties without the prior consent of the managers (Article 612(1) Civil Code). In cases where the contract period is not specified by the scholarship agreement, the agreement may be terminated by either party by giving the other party one day’s notice (Article 617(1)(iii) Civil Code). As it is not clear whether courts will allow for an analogous application of Articles 601 ff Civil Code, it is advisable to cover all matters comprehensively in the scholarship agreement.

Since the use of Axies is not subject to restrictions under the Copyright Act, it is further advisable to implement proper measures to ensure that owners are sufficiently protected (e.g. prohibition to use Axies for breeding, prohibition to create merchandise with the Axie).

2.1.2. Contract for Work or Delegation

Managers may among others specify how many hours a scholar must play per month, require daily logins, or instruct scholars to only use Axies with certain characteristics for breeding. In addition, the scholarship agreement may stipulate a minimum amount of SLP a scholar must earn during a pre-defined period. In exchange, the manager agrees to pay a remuneration to the scholar.

Depending on the exact arrangement, the scholarship agreement may either be considered a contract for work (Article 632 Civil Code) or delegation without legal authority (Article 656 Civil Code). In both cases, scholars would have to deliver earned SLP to the NFT’s owner (Articles 632 and 646 Civil Code. Where the scholarship agreement is structured as a contract for work, NFT owners may further require scholars to complete the agreed work (Articles 559 and 562 Civil Code).

It is our understanding that the rewards collected by scholars are generally passed to the manager. Based on the scholarship agreement, the manager will then return a predefined amount to the scholar for playing the game. The situation is, therefore, similar to revenues generated by tenants of farmland.

2.1.3. Fund

The scholarship arrangement may further be structured as a partnership according to Article 667 Civil Code or a silent partnership according to Article 535 Commercial Code. In these cases, both the owners of the NFT and the scholar make contributions in kind – the owner by providing his Axies and the scholar by contributing his labor. Profits generated by the partnership or silent partnership are then distributed between NFT owners and scholars according to the scholarship agreement.

In a partnership, the owner may for example invest Axies and appoint the scholar as an executive of the partnership (Article 670(2) Civil Code). Here, the NFT owner would have the right to inspect the scholar’s business but lose the right to manage the partnership on his own (Article 673 Civil Code). If the scholar does not play the game and defaults, the agreement cannot be canceled (Article 667-2(2) Civil Code). Instead, the manager may request the dissolution of the partnership (Article 683 Civil Code). A voluntary resignation from the managing position by the scholar appointed as the manager of the partnership would only be possible if the scholar has a valid reason for resignation (Article 672(1) Civil Code).

NFT Owners’ Rights and ObligationsScholars’ Rights and ObligationsOther
Lease
  • receipt of royalties
  • obligation to provide Axies to the scholar
  • obligation to replace Axies that do not conform with the characteristics outlined in the scholarship agreement
  • obligation to return Axies upon expiration or termination of the scholarship agreement
  • obligation to manage the Axies with the care of a good manager
  • prohibition to sublease the Axies
  • right to demand the reduction of royalties in cases of defect
If the term is stipulated in the scholarship agreement, the agreement is automatically terminated with its expiration. Otherwise, it can be terminated by either party by giving one day’s notice.
Delegation / Contract for Work
  • obligation to pay remuneration
  • obligation to provide Axies to the scholar
  • right to decline or reduce remuneration in case of non-performance by the scholar
  • obligation to process certain paperwork and to complete the work
  • obligation to deliver SLP rewards to the manager
  • payment for performed services
The agreement may automatically terminate upon expiration of the term (if specified) or can be canceled by the manager at any time. If the manager decides to cancel the agreement which constitutes a contract for work, he must generally compensate the scholar for losses. If the agreement constitutes a delegation agreement, it may be terminated at any time by either party.
Fund
  • obligation to invest Axies as an in-kind-investment
  • right to inspect the status of the business
  • right to participate in profits
  • right to demand dissolution of the partnership
  • obligation to invest labor as an in-kind-investment
  • obligation to perform certain services
  • right to participate in profits
  • right to demand dissolution of the partnership
If the partnership has achieved the purpose for which it was set up, it is automatically dissolved. It is also dissolved if there are other reasons for dissolution which are stipulated in the scholarship agreement.

Proceeds are distributed in proportion to each partners’ contribution in case of liquidation.

 2.2. Regulatory Considerations for the Different Scholarship Structures

The regulatory considerations vary greatly depending on the legal structure of the scholarships. For scholarships structured as leasing arrangements, money lending regulations may be considered. For agreements structured as partnerships or silent partnerships, the Financial Instruments and Exchange Act (FIEA) may be applicable. For scholarship structured as delegation agreements or contracts for work, no particular regulations apply.

2.2.1. Money Lending Business Act

Article 2(1) Money Lending Business Act defines money lending business as the business of lending money (including the provision of funds by discounted bills, the sale of mortgages, or similar methods) or acting as an intermediary for the lending of money. Businesses engaging in money lending services must register with the Financial Services Agency (FSA) (Article 3(1) Money Lending Act).

Since Axies neither constitute money nor a currency-denominated asset, the lending of Axies does not fall under the Money Lending Business Act. It is therefore not necessary to register with the FSA.

2.2.2. FIEA

The FIEA applies to a wide range of financial instruments and provides a comprehensive registration regime for businesses engaging in financial instruments services (Article 2(8) FIEA). According to Article 29 FIEA, businesses providing financial instruments services must generally register as a financial instruments business operator (FIBO) with the FSA. This also applies to those soliciting the offer to sell rights in a partnership or silent partnership. Both are generally considered collective investment schemes under the FIEA (Article 2(2)(v) FIEA).

Axies do, however, not fall under the category of money or money equivalent as specified in Article 2(2)(v) FIEA, Article 1-3 FIEA Enforcement Order, and Article 5 FIEA Definitions Ordinance. Even where the owner of NFTs contributes his NFTs to the partnership or the silent partnership, the FIEA does therefore not apply.

2.3. Regulatory Considerations concerning YGG’s Activities

2.3.1. Scholarship Brokerage

Since NFTs do not constitute money or currency-denominated assets (see item 2.2.1 above), the brokerage of scholarships does not constitute an intermediary service for money lending and is therefore not regulated.

2.3.2. YGG Tokens

On August 19, 2021, YGG announced that it had raised USD 4.6 million from a16z and other major venture capital firms. In exchange for their investment a16z and the other investors received YGG tokens. The tokens allow them to participate in the revenues generated by the YGG. Assuming the tokens were sold to investors in Japan, it is highly likely that they would qualify as rights in a collective investment scheme under Article 2(2)(v) FIEA – and given the tokenization of those rights – as electronically recorded transfer rights (Article 2(3) FIEA). In order to offer electronically recorded transfer rights to the public, it is generally necessary to file a prospectus and to register as a type II FIBO (Articles 28(2)(i), 2(8)(vii), 29 FIEA). Where the rights are only offered to qualified institutional investors a notification under Article 63 FIEA is sufficient.

If the solicitation is, however, performed by a DAO with a sufficient degree of decentralization, the solicitation falls outside the scope of the FIEA as there is no eligible intermediary that could be regulated. As YGG is still managed by the core team, this degree of decentralization has most likely not been achieved yet.

Finally, it should be noted that collective investing schemes investing in NFTs are not subject to disclosure obligations under Article 4 FIEA, as NFTs do not constitute securities.

2.3.3. Investment in NFTs

A fund investing exclusively in NFTs does not invest “in securities or in rights connected with derivatives transactions, based on investment decisions that are grounded in an analysis of values of financial instruments” as stipulated in Article 2(8)(xii) FIEA. It is therefore unlikely that the investment management regulations apply to the investment manager (Article 28(4)(i) FIEA).

As NFTs are further not considered crypto assets within the meaning of Article 2(7) Payment Services Act, the buying and selling of NFTs for investment purposes does not constitute a crypto asset exchange business. It is therefore not necessary to register as a crypto asset exchange service provider.

Disclaimer

This post is for discussion only. The content of this post has not been confirmed by the relevant authorities or organizations mentioned in the post but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may therefore change in the future.
This post does not recommend the use of or investment in NFTs, scholarships, or any other tokens or projects.
Axie Infinity and Yield Guild Games are only used for illustrative purposes. Given the format of the post, not all details of the game mechanics and token design have been considered comprehensively, so that the results of the assessment may deviate from the results by the regulator, or a legal opinion prepared by us or another law firm. By no means, the explanations should be understood as a legal opinion. If you need legal advice on a similar project, please free to contact us or consult with your lawyer.