A panoramic review of South Korea’s latest crypto regulatory landscape

Seung Jae Yoo, Gye-Jeong Kim and Sung Yun Kang from Kim & Chang Law Firm sorted out the evolving regulatory system for crypto assets in South Korea.

On May 3, 2022, the South Korean government announced that it plans to regulate "security-type tokens" in accordance with the Financial Investment Services and Capital Markets Act. At the same time, the South Korean government will also promulgate the Digital Asset Framework Act to comprehensively regulate all matters related to virtual/digital assets, including non-security tokens.

As part of the plan, the Financial Services Commission of South Korea has issued the Token Security Guideline for the issuance and distribution of certain security tokens. Under the Guideline, certain existing laws and regulations will be amended to allow projects to issue and distribute tokenized securities based on distributed ledger technology in a compliant manner. At the same time, regulators will also establish new legal systems to manage project accounts and over-the-counter brokerage services. To achieve the above goals, relevant agencies have also proposed amendments to the Financial Investment Services and Capital Markets Act and the Electronic Registration of Stocks and Bonds Act. These amendments are currently awaiting approval from the National Assembly.

In addition, in order to regulate the virtual asset market from the perspective of consumer/investor protection, the Virtual Asset User Protection Act was passed on July 18, 2023 and is scheduled to take effect on July 19, 2024. This law was enacted during the process of formulating the Digital Asset Framework Act and is also the first law in South Korea specifically for regulating virtual asset businesses. In addition, both the Virtual Asset User Protection Act and the Specific Financial Transaction Information Reporting and Use Act (i.e., South Korea's Anti-Money Laundering Act) stipulate the obligation of virtual asset service providers to report to the Financial Services Commission of South Korea, while also clarifying the cross-border applicability of regulations. Therefore, these two laws apply not only to virtual asset industry participants in South Korea, but also to those who reside outside of South Korea but whose activities affect the South Korean market.

Classification of Crypto Assets

The applicability of specific regulations will depend on how crypto assets are classified and treated. For example, if a crypto asset is considered a "security" as defined in the Financial Investment Services and Capital Markets Act, it will be subject to that act. If the crypto asset is considered a "virtual asset" as defined in the Specific Financial Transaction Information Reporting and Use Act, it will be subject to both that act and the Virtual Asset User Protection Act. At the same time, after the Virtual Asset User Protection Act comes into effect, the relevant content of the Specific Financial Transaction Information Reporting and Use Act will be amended to make its definitions of "virtual assets" and "virtual asset service providers" consistent with the Virtual Asset User Protection Act.

The Electronic Financial Transactions Act aims to regulate electronic payment and settlement businesses, and crypto assets that meet the definition of electronic money or pre-paid electronic payment means (PEPM) will be subject to the Act. In particular, if a crypto asset is used to pay for goods and services, or is used to settle payments, the issuer and payment service provider of the crypto asset need to obtain relevant licenses or register in accordance with the provisions of the Electronic Financial Transactions Act before conducting business.

Securities-type crypto asset trading supervision

The Specified Financial Transaction Information Reporting and Use Act defines "virtual assets" as certificates or information that can be transferred electronically, and the counterparty also recognizes it as a medium of exchange or has added value. However, the Act also clearly stipulates that several assets in electronic form are not virtual assets, such as "electronically registered securities" defined under the Stock and Bond Electronic Registration Act, which are not considered "virtual assets." Whether a crypto asset is considered an electronic security or a virtual asset will depend on its characteristics, transaction terms, and the specific provisions of the revised Stock and Bond Electronic Registration Act. It can be understood that if a crypto asset is an electronic security rather than a virtual asset, it will not be subject to the provisions on virtual assets and virtual asset service providers under the Specified Financial Transaction Information Reporting and Use Act.

If a certain type of crypto-asset is considered a security, the trading of such crypto-asset will be subject to the unfair trading provisions of the Financial Investment Services and Capital Markets Act. There is also a similar provision in the Virtual Asset User Protection Act. However, given the difficulty in practice in directly relying on court rulings based on the Financial Investment Services and Capital Markets Act to determine the extent of regulation (partly due to the differences in the provisions of the Virtual Asset User Protection Act and the Financial Investment Services and Capital Markets Act, as well as the differences between crypto-assets and traditional securities), we expect that there may be some gray areas in the actual application of the Virtual Asset User Protection Act.

Regulatory framework for tokenized securities

In February 2023, the Financial Services Commission of South Korea released its "Plan for Improving the Regulation of the Issuance and Distribution of Token Securities", which applies to the issuance and distribution of token securities in South Korea (the Financial Services Commission of South Korea has not yet officially stated whether the plan applies to cross-border projects). It is worth noting that the Financial Services Commission of South Korea deliberately used the term "token securities" (rather than security tokens) in the plan to emphasize the classification of tokens as securities.

The launch of this plan has its specific background, namely, the Financial Services Commission of South Korea allows security-type crypto assets (hereinafter referred to as "token securities") that meet specific requirements to be issued under supervision in compliance with the Financial Investment Services and Capital Markets Act, the Stock and Bond Electronic Registration Act and other relevant regulations. As a new term introduced by the Commission, the term "token securities" was proposed by the plan, specifically referring to a form of securities issued through distributed ledger technology. The Financial Services Commission of South Korea stated that the Commission itself did not introduce new types of securities, nor did it adjust the existing definition of "securities" in the Financial Investment Services and Capital Markets Act.

The plan also states:

• The Token Securities Guidelines further clarify certain specific principles for determining whether a token is a security and the concept of token securities; and

• How regulators are preparing to amend the Financial Investment Services and Capital Markets Act and the Electronic Registration of Stocks and Bonds Act to regulate the issuance and distribution of tokenized securities (including issuance systems, issuer account management institutions and over-the-counter brokerage institutions).

Under the plan, individuals who provide brokerage services for tokenized securities transactions need to obtain an OTC brokerage license required by the Financial Investment Services and Capital Markets Act, and such licenses can only be obtained by financial institutions or newly established entities that meet certain strict requirements. Before the Financial Services Commission announced the plan, Korean financial institutions were actually restricted from participating in virtual asset service businesses (except for banks providing real-name verification services to local crypto asset exchanges). In this sense, allowing financial institutions to seek and obtain OTC brokerage licenses for trading tokenized securities under the plan seems to be a major development made by Korean financial regulators.

In addition, the plan provides for:

• More than 51% of the nodes should be operated by multiple parties, including electronic registries, financial institutions, and account management institutions that are not affiliated with the project issuer.

• Separate virtual assets may not be used to record any rights holders and transaction information (i.e., crypto assets cannot be used to settle transaction fees). Given the practical limitations, we expect that the issuance of international or cross-border token securities on public chains under this plan may face some difficulties.

Virtual Asset User Protection Law

Under the newly enacted Virtual Asset User Protection Law, virtual asset service providers must provide consumer protection measures, including:

• The assets deposited by users are stored or entrusted to a custodian institution such as a bank to keep them separate from their own assets.

• Separate its own virtual assets from the virtual assets of users and actually hold the same type and amount of virtual assets entrusted by users (Translator's note: avoid asset misappropriation); and

• Take necessary steps to fulfill security responsibilities in the event of a hacker attack or computer failure.

The Virtual Asset User Protection Law broadly covers unfair trading practices involving virtual assets, and violations of the law may result in criminal penalties or administrative fines. In particular, the law prohibits:

• Virtual asset service providers, virtual asset issuers, and their respective executives, employees, agents, and major shareholders, as well as any acts of obtaining and using non-public information from the above persons (Translator's note: this can be understood as insider trading);

• Specific unfair trading practices (such as sham trading, changing or fixing prices); and

• Fraudulent trading practices

In addition, the law also prohibits virtual asset service providers from participating in virtual asset trading activities issued by themselves or their affiliates.

Congress and the government are discussing broader legislative improvements under the supplementary opinion on the Virtual Asset User Protection Act. The supplementary opinion requires financial regulators to take specific measures or assist market participants to address the following matters before the Virtual Asset User Protection Act takes effect:

• Potential conflicts of interest in the issuance and distribution of virtual assets

• Regulating Stablecoins

• Regulating the business activities of virtual asset service providers

• Supervision of the banking industry's real-name verified deposit and withdrawal account system (referring to accounts whose holders' identities have been verified by local banks)

• Listing information disclosure system; and

• Regulate virtual asset trading activities issued by virtual asset service providers or their affiliates

Since the Virtual Asset User Protection Act only covers some of the businesses and unfair trading activities of virtual asset service providers and is similar to the provisions of the Specific Financial Transaction Information Reporting and Use Act, other innovative crypto businesses, such as decentralized finance ( DeFi ), still face regulatory uncertainty.

Crypto assets for payments and cross-border remittances

CBDC (Central Bank Digital Currency)

Given that the Virtual Asset User Protection Act explicitly excludes central bank digital currencies (CBDCs) from the definition of virtual assets, if South Korea also launches CBDC services, we expect that their issuance and distribution will be regulated by other separate laws and regulations. Given that the Bank for International Settlements appears to be considering building a CBDC ecosystem involving tokenized deposits, a unified ledger, and a single currency, the Bank of Korea and domestic commercial banks in South Korea are also discussing the issuance of CBDCs. In summary, it can be expected that the Bank of Korea will announce its CBDC plan soon.

Stablecoins

The Token Securities Guidelines provide that if a cryptoasset is issued for the consumption of goods or services, or to maintain its stable value as a means of payment or exchange, and cannot be redeemed, then the cryptoasset is unlikely to be considered a security. From this point of view, stablecoins do not seem to be subject to the Token Securities Guidelines. It is worth noting that the legal classification of stablecoins should be determined on a case-by-case basis. That is, unless it clearly meets the definition of "exclusion clauses" for virtual assets in the regulations, the stablecoin may still be considered a virtual asset. On September 18, 2023, the Financial Services Commission of South Korea issued a regulatory interpretation stating that stablecoins may be considered virtual assets in certain circumstances and emphasized that specific issues should be analyzed specifically. In addition, even if a stablecoin does not meet the provisions of the Token Securities Guidelines, it may be recognized as a security under the Financial Investment Services and Capital Markets Act. At the same time, according to the provisions of South Korea's foreign exchange law, stablecoins may also be recognized as some form of foreign exchange.

While South Korea’s foreign exchange regulator has yet to comment on whether foreign-currency-backed crypto assets are subject to South Korea’s foreign exchange regulations, in theory, such crypto assets could be regulated by the country’s foreign exchange system.

Payments and cross-border remittances

If any cross-border remittance, payment or settlement services provided to Korean users involve crypto assets, such services may be subject to Korean regulations related to payment, settlement and foreign exchange. In this case, depending on the role of the project participants and the transaction structure, the regulator may require specific licenses (this matter has not yet been determined).

in conclusion

Although South Korea has made some significant progress in virtual asset regulation, there are still many issues that need to be addressed by the government and private entities. For example, when preparing the Token Securities Guidelines, the Financial Services Commission of South Korea did not seem to take into account the decentralized nature of the blockchain ecosystem. In addition, the Virtual Asset User Protection Act seems to focus only on asset segregation and prohibition of unfair trading practices by virtual asset service providers, and does not consider regulating smart contract services, such as those based on DeFi, decentralized autonomous organizations (DAOs), and Web3.0, which have not received regulatory attention. To address these issues, the South Korean government and industry participants must actively participate in and promote the development of the virtual asset industry and ensure that the interests of users are protected.