South Korea’s thoughtful approach to regulating digital assets will foster growth and innovation and result in a more vibrant and inclusive digital economy, say Rahul Advani and Angela Ang.
South Korea’s undeniable technological edge has firmly placed the country at the forefront of embracing new technology and innovations – from semiconductors and smartphones, to blockchain and digital assets. In fact, the Korea Financial Intelligence Unit (KoFIU) found that South Korea’s total market size for digital assets grew to USD 45.9 billion at the end of 2021, while the number of active users grew approximately 23% from 5.58 million in end-2021 to 6.9 million in the first half of 2022.
The growth of the sector has made it more imperative than ever for South Korean regulators and policymakers to establish regulatory clarity for digital assets, in order to ensure consumer protection and risk management requirements are addressed.
Some initial steps have been taken – in March 2020, the South Korean Parliament passed an amendment to the Act on the Reporting and Use of Specific Financial Transaction Information which came into effect a year later, extending licensing requirements to virtual asset service providers (VASPs). While the intent of the policy is sound, its broad scope for implementation has meant that almost all entities offering solutions using digital assets are brought under regulatory scrutiny – even if they are not VASPs. To date, only five entities in South Korea have met the requirements for full licensing, and over 60 entities have had to cease operations altogether. The result seems to be that firms onshore have become more cautious about dealing with digital assets, which has implications on innovation in the sector.
Developing a clear taxonomy for digital assets
In a recent white paper, Ripple highlighted the need for regulatory changes and provided policy proposals to support innovation in South Korea’s digital assets sector. The paper detailed an approach for understanding the evolving blockchain and digital assets ecosystem, while recommending a policy framework for blockchain and digital assets in South Korea. An essential part of this policy framework is the need to adopt a clear taxonomy for digital assets aligned with global best practices, thereby providing a clear distinction between payment tokens, utility tokens, and security tokens.
In a firm step towards providing such regulatory clarity, South Korea’s Financial Services Commission (FSC) recently published guidelines for defining what digital assets would be considered security tokens (STOs), and hence fall under regulations applicable to financial securities. Digital assets will be treated and regulated as securities if they have the corresponding characteristics laid out in the Financial Investment Services and Capital Markets Act.
The FSC has said that examples of digital assets which are likely to be classified as STOs include those that:
- Provide a stake in the operation of a business;
- Bear the rights to dividends or residual property; or
- Have the issuer attribute profits generated from the business to investors.
This determination will be made on a case-by-case basis, and issuers and brokers, including VASPs, will be held responsible for making such evaluations in line with these guidelines. The relevant amendments to the Capital Markets Act to recognise STOs are expected to be finalized in the first half of 2023, and could be implemented in 2024 once passed by the South Korean Parliament.
Digital assets outside the definition of STOs, such as payment tokens, will be governed by the upcoming Digital Asset Basic Act that is currently being reviewed by the South Korean National Assembly.
Regulating emerging areas of interest
Besides a token taxonomy, there are also emerging areas of interest in NFTs and stablecoins that may warrant regulatory attention in South Korea.
Following the collapse of Terraform Labs’ algorithmic stablecoin UST in May 2022, stablecoins have gained importance in the global regulatory debate on digital assets. Like many of their global counterparts, South Korean regulators continue to keep a close eye on stablecoin developments. In a report published December 2022, the Bank of Korea (BoK) highlighted that stablecoins – especially if they begin to be widely used for payments – have the potential to undermine monetary sovereignty, and will require a regulatory approach distinct from other crypto assets. In particular, the report discussed the need for minimum capital and reserve assets, as well as fit-for-purpose value stabilization mechanisms and investor protection measures. This echoes the sentiments of other global regulators such as the Monetary Authority of Singapore (MAS), the Hong Kong Monetary Authority (HKMA), and the New York Department of Financial Services (NYDFS).
On the NFT front, worldwide interest in these unique cryptographic tokens has continued to grow. Based on TRM Labs’ analysis, the number of NFTs minted across three major NFT blockchains has more than doubled over the past year, with the number of NFT transfers also doubling.
With its thriving esports industry and the global popularity of Korean pop culture, it’s no surprise that South Korea is leading the charge in NFT adoption – with current South Korean President Yoon Suk-yeol even having issued NFTs as part of his presidential campaign. Over the next five years, NFT revenue in South Korea is expected to grow 19% annually to reach USD 181 million by 2027. The South Korean Ministry of Science and ICT has also committed to investing KRW 223.7 billion (USD 173 million) to foster a metaverse ecosystem in the country.
Currently, NFTs are not regulated in South Korea as they do not fall under the definition of ‘virtual assets’, a view that was reaffirmed by a FSC representative, in line with Financial Action Task Force (FATF) guidelines. However, in making this determination, the FSC appears to have focused on how the FATF considered NFTs to be “unique, rather than interchangeable”, and hence utilized as collector items – instead of as a means of payment. Yet, NFTs can in fact be used for money laundering, as NFT issuers are not required to comply with anti-money laundering (AML) obligations since NFTs are not considered to be virtual assets.
A deeper look at on-chain risks
Aside from regulatory levers, South Korean policymakers and law enforcement agencies are also looking to enhance capabilities to detect and combat illicit digital asset-based activities. In January, the Ministry of Justice and the Financial Supervisory Service (FSS) announced plans to implement tools for virtual asset market monitoring, AML, and recovery of criminal proceeds.
This is particularly pertinent given the significant amount of illicit activity perpetrated by North Korean-linked groups. In a landmark move in February 2023, South Korea issued its first independent sanctions against four individuals and seven groups for North Korea-related crypto theft; several of which were already the subject of United States sanctions. Alongside sanctions, the South Korean government highlighted how money siphoned through crypto heists by North Korea-linked groups were likely used to fund nuclear and missile development efforts. Analysis by TRM Labs found that North Korea was likely responsible for over USD 1 billion of the record-setting USD 3.7 billion in crypto hacks perpetrated in 2022.
The move to enhance virtual asset monitoring and tracing capabilities is a positive indication that South Korea understands this fundamental truth – the same blockchain technology being exploited by North Korea and other bad actors also holds the power to identify and combat their illicit activity through blockchain intelligence. Enhanced blockchain intelligence capabilities, combined with stronger regulatory oversight, will strengthen South Korea’s position to stimulate innovation of digital assets and disrupt crypto-based crime.
The road ahead
To say the least, we can expect South Korean policymakers to continue devoting significant resources to regulating, understanding, and monitoring the digital asset space. Initial policy initiatives have shown thought towards balancing regulatory and consumer protection objectives, while fostering growth and innovation. As South Korea gears up to provide more regulatory clarity to its digital asset ecosystem, the country will only stand to reap the rewards of a more vibrant and inclusive digital economy — and further bolster its already world-renowned technological edge.
By Rahul Advani, Policy Director for APAC at Ripple; and Angela Ang, Senior Policy Advisor for APAC at TRM Labs.