• Japan’s top financial regulator intends to introduce a new registration regulation of crypto custody and trading service providers.
• This proposal comes after the DMM Bitcoin hack, which revealed security vulnerabilities in the third-party custody business processes.
• The new structure will increase Japan’s supervision of crypto-related operations and help introduce stablecoins to leading banks. 

Japan’s Financial Services Agency (FSA) is preparing a new rule for crypto custody and trading management service providers. The rule would require them to register with authorities before offering their services.

FSA Tightens Rules on Crypto Custody

The measure aims to strengthen oversight across Japan’s growing digital asset industry. It will also close regulatory gaps that allowed third-party firms to operate without strict supervision.

According to a Nikkei report, the proposal was first discussed last week by a working group. The group operates under the Financial System Council, an advisory body to the Prime Minister.

The group supports mandating registration for custodians and trading managers handling digital assets on behalf of crypto exchanges. The FSA also wants exchanges to work only with providers that are officially registered.

Existing crypto exchanges are already mandated to ensure the security of customer funds in Japan, such as cold wallets for user deposits. However, this is not the same when dealing with third-party service providers who are in the crypto custody or running a trading business. According to regulators, the loophole would cause system risks, thefts, as well as security failures, which would adversely affect investors and the market at large.

Also Read | Stablecoin Initiative Backed by Japan’s FSA and Major Banks Gains Traction

DMM Hack Caused Stricter Crypto Custody Oversight

The 2024 DMM Bitcoin hack, which caused a loss of approximately 48.2 billion yen or  $312 million in Bitcoin, is causing the agency to refocus. It was discovered that the attack originated with Ginco, a Japanese software company that operates the trading platform of DMM Bitcoin. The scandal revealed the vulnerabilities in the crypto regulation framework of Japan, which many had believed to be a strong one.

In the months to come, the FSA will come up with a comprehensive report regarding the proposal. The amendments to the Financial Instruments and Exchange Act will be presented by the government at the Ordinary Diet session next year. The majority of the working group members regard the changes as critical since they will help make digital-asset operations clear and secure.

Japan Progresses Stablecoin and Custody Rules

Besides regulating security, the Japanese authorities are promoting the use of stablecoins to modernize their domestic finance system. The FSA gave the full go-ahead on the first yen-linked stablecoin in the country (JPYC), which went live a short time later last month.

Additionally, the agency supported a pilot program on stablecoins where the three largest banks in Japan (Mizuho, MUFG, and SMBC) initiated the adoption of blockchain payments. Japan has been identified to have some of the most stringent crypto regulations in the world.

This crypto custody registration is yet another step that will lead to an open, accountable supervisory framework for digital currency. Japan would become one of the first leading economies to oversee companies handling back-end crypto trading and custody.
When it becomes effective, the rule will strengthen regulation and investor protection in the country’s digital asset market.

Also Read | Japan’s JPYC Inc Launches First Yen-Backed Stablecoin