The Importance of "User Protection" for Crypto Assets Exchange Service Providers

With the spread of crypto Assets, there has been increasing number of crypto asset exchanges

It is extremely important for providers of crypto currency exchange services to adhere to laws and regulations and implement suitable measures to safeguard users. In the event that user protection measures are deemed inadequate, the business operator may face administrative sanctions, such as a suspension order.

In this article, we will discuss the significance of user protection in the crypto currency exchange business, with a focus on the case of administrative action against FTX Japan Co., Ltd.

Examples of administrative actions against crypto assets exchange service providers

On November 10, 2022, the Financial Services Agency issued a statement regarding the imposition of administrative measures against FTX Japan Co., Ltd., a provider of cryptocurrency exchange services.

Reference: Financial Services Agency | Administrative action against FTX Japan Co., Ltd.

What kind of behavior of FTX Japan was regarded as a problem?

FTX Japan Co., Ltd. is a subsidiary of FTX Trading Limited, which is based in the United States.

This company has suspended the withdrawal of deposit assets without providing a clear explanation to users, citing the policy of its US parent company, FTX Trading Limited. However, despite the suspension of asset withdrawals, the company has continued to accept assets from users and engage in cryptocurrency transactions with them.

Meanwhile, it was reported that FTX Trading Limited, the parent company of FTX Japan Co, Ltd. in U.S, was faced to credit concerns.

This company is required to temporarily halt new transactions with users. In addition, they should give top priority to protecting users so that assets of FTX Japan Co., Ltd. will not be able to withdraw assets that have been suspended due to outflow of assets overseas.

However, FTX Japan Co., Ltd. failed to implement any measures to safeguard users.

Administrative Action Against FTX Japan

FTX Japan Co., Ltd. has received administrative sanctions under the Payment Services Act (referred to as the “Payments Act”) and the Financial Instruments and Exchange Act.

Related article: Regulations governing crypto assets – Explanation on the interplay between the Payment Services Act and the Financial Instruments and Exchange Act

Administrative Actions under the Payment Services Act

FTX Japan Co., Ltd. has received an administrative sanction under the Payment Services Act, consisting of a business suspension order (Article 63-17, Paragraph 1 of the Payment Services Act) and a business improvement order (Article 63-16 of the Payment Services Act).

During the period of November 10, 2022 to December 9, 2022, they temporarily ceased all operations pertaining to the crypto asset exchange business and the acceptance of new assets from users in accordance with the business suspension order.

FTX Japan Co., Ltd. may be able to resume operations before December 9, 2022 if it is prepared to promptly return legal currency and crypto assets entrusted to it by users.

FTX Japan Co., Ltd. has been issued a business improvement order, which includes the following requirements:

• Accurately grasp the user and the assets entrusted by the user
• Preserve assets entrusted to us by users and do not unfairly consume assets owned by FTX Japan Co., Ltd.
• Take all possible measures to protect users
• Thoroughly inform users about the protection of their assets and take appropriate measures

Administrative Disposition under the Financial Instruments and Exchange Act

It has been issued that the Supervisory Measures for Financial Instruments Business Operators (Article 52, Paragraph 1 of the Financial Instruments and Exchange Act) and issuing a Business Improvement Order to a Registered Financial Institution (Article 51, Financial Instruments and Exchange Act) as same as Payment Services Act about the administrative disposition under the Financial Instruments and Exchange Act.

Also, it has been issued that the Retention of Assets Within Japan.

During the period from November 10, 2022 to December 9, 2022, they were obliged to suspend business operations related to over-the-counter derivatives trading and the initiation of new deposit accounts, as per the business suspension order.

Under the Payment Services Act’s business suspension order, the operations associated with the exchange of crypto-assets and the acceptance of new user assets are subject to the business proposal order. The difference from a business suspension order based on the Financial Instruments and Exchange Act lies in the nature of the suspended business.

The suspension of operations does not apply to operations that have been approved individually by the Kanto Local Finance Bureau.

FTX Japan Co., Ltd. may be able to resume operations prior to December 9, 2022, if they are prepared to promptly return user margin deposits and other funds.

FTX Japan Co., Ltd. has been issued a business improvement order which requires them to:

• Accurate understanding of investors and assets entrusted by investors
• Preservation of assets entrusted to us by investors and not unfairly expending assets owned by FTX Japan Co., Ltd.
• Take all possible measures to protect investors
• Thoroughly inform investors about the protection of investor assets and take appropriate measures

In addition, FTX Japan KK has been instructed to maintain assets in Japan from November 10, 2022 to December 9, 2022, equal to the amount of liabilities recorded in the liabilities section of FTX Japan KK’s balance sheet, minus liabilities to non-residents during the same period.

User Protection in Crypto Assets Exchange Business

The case of FTX Japan Co., Ltd. highlights the importance of cryptocurrency exchange service providers taking measures to protect their users, as emphasized by the Financial Services Agency.

It is crucial to have a clear understanding of the user’s information and entrusted assets, and maintain strict management. Furthermore, it is imperative to manage the assets entrusted to us by users appropriately, and prevent any unauthorized or unjustified use of these assets.

In order to ensure the utmost protection of our users, we recognize the importance of promptly notifying them and taking appropriate actions in the unlikely event of any issues that may arise.

When the parent company is situated abroad, such as in the case of FTX Japan Co., Ltd., there is a likelihood that safeguarding users may not be completely fulfilled due to differing regulations in different countries. As a provider of crypto asset exchange services, it is crucial to adhere to relevant laws and regulations while taking necessary steps to ensure user protection is not compromised.

Future of FTX Japan

The Kanto Local Finance Bureau has requested FTX Japan Co., Ltd. to submit a written business improvement plan by November 16, 2022, for both the business improvement order based on the Payment Services Act and the business improvement order based on the Financial Instruments and Exchange Act. FTX Japan Co., Ltd. has reportedly submitted their business improvement plan to the Financial Services Agency on November 16, 2022.

FTX Japan has not disclosed the specifics of its business improvement plan. On December 1, FTX Japan Co., Ltd. issued a statement detailing its efforts to restore service. According to the statement, the plan for resuming withdrawal services has been approved at the headquarters, and the engineering team has begun development along this plan. The company also stated its intention to implement robust and secure processes, incorporating controls, security audits, reconciliations, and reviews.

FTX Japan Co., Ltd. has been directed to submit monthly written reports to the Kanto Local Finance Bureau by the 10th of each month, detailing the progress and implementation status until the completion of business improvement based on the submitted business improvement plan. Furthermore, the company has stated that during the continuation of the business improvement order from the Kanto Local Finance Bureau, they will report to the authorities every Monday on the status of asset management and other relevant matters.

As of December 5th, FTX Japan Co., Ltd. has yet to resume its operations.

It is anticipated that business enhancement will be conducted in the future, relying on the submitted plan for business improvement.

Regulations on Crypto Asset Exchange Business Consultation with a Lawyer 

In the preceding text, we emphasized the significance of safeguarding users for enterprises that run crypto-asset exchanges, citing administrative penalties as a case in point. If a user protection issue arises and you become the target of administrative measures, it could impede your operations.

It is advisable for companies in the crypto asset exchange sector to seek the counsel of a lawyer with expertise in business operations and user safeguarding.

Guidance on Countermeasures by Our Office

Monolith Law Office is a highly specialized law firm with extensive expertise in both IT, particularly the Internet, and law. The burgeoning crypto asset industry has garnered significant attention in recent years and requires rigorous legal scrutiny. Our firm conducts legal risk assessments based on various regulatory frameworks for businesses that have already commenced operations or are planning to do so. We endeavor to legalize these businesses to the fullest extent possible without hindering their operations.