As US Treasury Secretary Janet Yellen, the Central Bank of Nigeria and the Indian Parliament have shown, governments and regulators around the world are concerned about the rise in cryptocurrency. South Korean authorities are no exception. Bank of Korea governor Lee Ju-yeol told a parliamentary committee last month that Bitcoin “has no intrinsic value” and that he “does not understand why its value is so high”.
While the Korean government doesn’t seem keen to ban crypto, it is certainly keen to regulate it. The effect can be monopoly by the largest exchanges in South Korea at the expense of smaller competitors.
One critical piece of legislation is the “Law on the Reporting and Use of Specified Financial Transaction Information”, also known as the Financial Transaction Reporting Act (FTRA), which requires providers of virtual asset services to register with tax authorities and comply with anti-money laundering (AML) regulations. The FTRA was changed to restrict crypto trading last March. However, it did not come into force until March 25, 2021. It is vital as it creates all sorts of bureaucratic and administrative complications for crypto exchanges entering the market or simply looking to survive.
From March 25, all cryptocurrency exchanges must register with the Financial Intelligence Unit (FIU) of the Financial Services Commission (FSC). The FIU will then submit the registration to the FSC, which must approve the registration before it becomes official. While the government wraps it up as a “registration process,” the FSC is actually becoming the unofficial state licensor of the Korean crypto industry.
Until the National Assembly changed the FTRA, South Korea had no specific legal language to define or describe crypto trading. Cryptocurrency was not (and is) not officially recognized as a financial asset, so there was no way to regulate it as such. Pretty much anyone who wanted to could set up an exchange and not have to register with any government agency.
The FTRA is South Korea’s allusion to the Paris-based Financial Action Task Force (FATF). It’s basically Seoul’s way of telling the world, “We adhere to the FATF’s AML guidelines.” The legislators now define crypto currencies as “virtual assets” and crypto exchanges as “service providers for virtual assets”. A VASP is defined as any business that facilitates sales, purchases, exchanges, and transfers of crypto that is fiat. This includes stock exchanges, custodians and brokers. Interestingly, peer-to-peer (P2P) platforms and crypto advisors (people who only provide information) do not qualify as VASPs mainly because they do not deal directly with fiat.
That is the key word: Fiat. As long as a Korean’s bitcoin or ether or dogecoin is never converted into Korean won, the government doesn’t seem to care. Until we see the day when people actually start using crypto as an everyday payment method until it competes with cash or replaces it, the government is unlikely to try to tax crypto in its original form.
Officially, government concerns about crypto are rooted in money laundering, or “protecting” consumers.
But perhaps the authorities’ attention has really drawn to the explosive growth in crypto trading volume in recent years. The nation’s crypto trading is dominated by four major exchanges: Bithumb, Upbit, Korbit, and Coinone. (I’ll refer to this as the Big 4 now.) Only in January and February of that year did the Big 4 trade 445 trillion won ($ 391.7 billion). In some cases, their cumulative trading volume for the whole of 2019 was 488 trillion won ($ 394.3 billion). The Big 4’s daily trading volume averaged 8 trillion won ($ 7 billion) over those two months, an almost four-fold increase over the same period in 2017.
More complicated than it seems
Some of you may be thinking: OK, the exchange needs to register with the authorities. So what? Just register and if you are real you will be approved. As long as you’re not doing something shady, you shouldn’t have to worry, right?
Theoretically yes. In practice, most likely not.
There are certain conditions an exchange must meet in order for its registration to be “approved” by the FSC. By far the most important of these conditions is the need to partner with local commercial banks.
Prior to the FTRA change, users on crypto platforms could register under different usernames and deposit cash into a company’s bank account to purchase in-platform credits that could be used to purchase crypto. These corporate accounts are known as “Hive Accounts” because a single account houses multiple users. While a thorough investigation would ultimately reveal who deposited how much of what account, a beehive account makes it much more difficult to keep track of who is who.
For the FTRA update, however, users have to register under their real names and link their personal bank accounts. In other words, goodbye beehive accounts. This requires partnerships with commercial banks, which means that the new legislation gives banks ultimate power to determine which exchanges survive. Some crypto purists won’t be happy about this because it essentially negates one of the core tenets behind crypto: freedom from traditional financial institutions.
However, in South Korea, banks have the power to determine whether or not a VASP complies with AML standards. Each bank has its own criteria that are not published, but there are two universal conditions: VASPs must distinguish between domestic assets and customer deposits, and their Information Security Management Systems (ISMS) must be certified by the Korea Internet and Security Agency (KISA). ISMS certification has proven to be time consuming and costly. It usually comes with a high consulting bill and expensive hardware. While this isn’t a problem for the Big 4, it could be an obstacle for small and medium-sized exchanges and startups.
But here’s the kicker: The Big 4 already have partnerships with commercial banks that are reluctant to work with smaller exchanges. Banks are inherently conservative and risk averse, so they tend to favor large players rather than small ones.
So if an exchange is to become legitimate, it needs a banking partnership. Because banks have the ultimate say in winning these partnerships, they have the ultimate say in the survival of the exchanges.
“Non-large-scale crypto startups will struggle to obtain their ISMS certificate, acquire banking partnerships, and meet other requirements for VASP registration,” said Ku Tae-eon, an attorney at the strategic advisory firm Tek & Law at a conference jointly hosted by CoinDesk Korea in November. Ku argued that the revised FTRA will shrink the country’s crypto industry. He has called for separate laws for crypto.
But the Big 4 also seem nervous. Bithumb, the largest of the four, recently started delisting dark coins in what appears to be a campaign that seems “more legitimate”. Trading in three dark coins (cryptocurrencies that offer greater anonymity) on Bithumb ceased on March 24th, one day before VASP registration began. Coincidence? Probably not.
Registration closes on September 24th. Any VASP that does not log in or is denied login will be closed. Sure, it could continue to run as a P2P platform, but the majority of Korean merchants will likely flock to the Big 4 for the same reason most people search Google for searches, even if there are other options: It is simply more convenient. Also, the average Korean investor (especially newbies) will most likely want to use fiat for their crypto purchases.
Industry insiders, of course, predict that the Big 4 (out of an estimated 200) will ultimately be the only crypto exchange with Fiat ramps. CoinDesk Korea’s Park Geun-mo and Kim Dong-hwan are cautiously predicting that maybe at most one or two could be added to the list. “Until September is over, there’s no way of telling what’s actually going to happen, but it’s not looking good for the smaller exchanges,” said Park.
Once their beehive accounts are removed, smaller exchanges will struggle to survive as it is virtually impossible for them to secure partnerships with banks. Banks are likely to find their AML systems unsuitable. Since banks are ultimately responsible when funds are used for money laundering or terrorist financing, there is no need for them to partner with a smaller exchange.
Survival of the coziest
The bottom line is that after September 24th it will be much more difficult for an outsider to build the specs to compete against the Big 4 or even qualify as a registered VASP. In addition, any emerging cryptocurrency that is said to have a significant impact on the Korean market must be listed on the Big 4. Busan Bank has been reported to have discussions with five other exchanges about possible partnerships, but things are still up in the air. A source at Busan Bank made it clear to CoinDesk Korea that “considering partnerships and actually implementing them are completely separate things.”
While Busan Bank is a regional bank and not as big as national names like Shinhan or Woori, it is still a commercial bank that would help legitimize an aspiring exchange.
On March 16, the FSC issued a “warning” to crypto traders to “review the registration status of exchanges” and “determine if an exchange is sustainable over the long term” before creating an account and using the platform. This is read as a de facto statement that a significant number of exchanges will be closed. It could just as easily read, “Don’t bother trading crypto unless it’s on the Big 4.”
As a signal for the future, OKEx Korea recently announced that it would cease operations next month, citing unsatisfactory profits and the difficulty of forming a banking partnership.
Strangely, Korea’s crypto ecosystem could mirror the overall economy of South Korea, where a small number of conglomerates make up a large part of economic productivity. According to the Korea CXO Institute, 64 chaebols (family-owned conglomerates) accounted for 84% of the country’s GDP, but only 10% of jobs in 2019.
Of course there is a silver lining. The average investor will certainly benefit from the fact that crypto is institutionalized and mainstream. The services on the Big 4 are likely to become much more convenient and accessible over time. But just as I can basically choose between LG and Samsung when buying a refrigerator, average Korean private investors will most likely trade their crypto on the Big 4.