Hyun Koo Kang and Yongsoo Yoon of Lee & Ko provide an overview of the Korean government’s interventionist stance
A legal definition of virtual currencies has not yet been established. While talks are ongoing on how to define a virtual currency (or a cryptocurrency, as it is sometimes referred to), the Korean government's position seems to be that it is a digital representation of value which, at this stage, cannot be deemed as a form of currency or a commodity.
There have been various recent efforts to regulate virtual currencies. These include, in particular, the Proposals for Amendment to the Electronic Financial Transactions Act of July 31 2017, the Special Act for Virtual Currency Businesses on February 2 2018, and the Proposal for Cryptocurrency Transactions dated February , 2018), which have been put forward for the purpose of preventing risks that arise from virtual currency transactions. The proponents of the proposals aim to define virtual currencies and promote various means to facilitate transactions within the limits of the law.
Content of existing rules
The need to regulate virtual currencies and response
After the opening in Korea of KORBIT, the first virtual currency exchange, in July 2013, other exchanges such as Coinone followed suit. Virtual currencies continued to gain a lot of attention with the advent of bitcoin and ethereum.
Virtual currencies are extremely volatile, due to large fluctuations in value resulting from factors such as speculative demand, and changes in the domestic or international regulatory regimes. In addition, the anonymous nature of a virtual currency means it could be used as a method of payment for illegal transactions such as drug trafficking, pyramid marketing schemes, reward for ransomware/hacking, and money for terroristic activities/organisations. Hacking is another problem that has recently caused breaches of customer information and theft of customer assets through the hacking of computer systems or of the password key of virtual currency business operators.
The Korean government has maintained a non-interventionist stance for the past few years regarding virtual currencies. However, to prevent the issues discussed above, in addition to excessive speculation by the public, it was necessary for the government to step in and regulate the market.
Korean government policies and problems
The increasing volume of virtual currency transactions, the rise in price and the necessity for to protect customers, led the Korean government to form a task force consisting of various government agencies in September 2017. Authorities also provided relevant guidelines including the requirement for customer identification by the virtual account's issuing bank.
The government proposed strong regulations to prohibit all types of initial coin offerings (ICO) and credit extension activities such as coin margin transactions. As ICOs are aimed at raising capital in a manner similar to initial public offerings, the government's intention was to prevent fraudulent activities that may be involved in the issuing of coins in exchange for investment.
At the meeting of the relevant government agencies in December 2017, participants discussed the implementation of more active preventive measures regarding virtual currencies proposed the Korean Department of Justice (DoJ). At another meeting, participants prepared guidelines for customer identification for bank customers and the prohibition on transactions by underage customers. These were followed by discussions on the introduction of real name financial systems and means to close virtual currency exchanges.
The Blue House reversed the DoJ's January 11 2018 announcement that it was planning to close exchanges, a move which caused some confusion in the market. The Office for Government Policy Coordination made the announcement on January 15 2018 that the closure of the exchanges would be confirmed after sufficient discussion and coordination of opinions among the relevant parties.
The Financial Supervisory Commission (FSC) released the Money Laundering Prevention Guidelines to prevent virtual currency speculation on January 23 2018. These came into force on January 30 2018.
Problems and countermeasures
The Korean government's regulation on virtual currencies lacks foreseeability as it is unclear whether the regulation develops or prohibits virtual currency transactions.
It is not readily conceivable that the Korean government would on the one hand pursue stringent regulations on virtual currencies while on the other try to promote blockchain technology, especially considering that virtual currencies are essentially blockchain technology applied to a money currency form. In addition, virtual currencies are indispensable as a means to incentivise the creation of blocks in the case of public blockchain and meta-assets in the new digitised economy.
It is necessary to define virtual currencies and implement legal measures to protect users to prevent hacking accidents and fraudulent activities such as pyramid scheme sales.
The ICO process
For an ICO, the company issuing the coin announces their business model by publishing a white paper on their website and issuing/selling a virtual currency in exchange for investment. Investors review the white paper, determine profitability and send major virtual currencies such as bitcoin and ethereum to the issuing company's account. The issuing company issues their own virtual coins to the investors. Investors keep the coins and, if the coins are listed on the exchange and the value of the coins increases, they sell these for cash.
The Korean government announced in September 2017 that all types of ICOs were prohibited, but without legal grounds for such a prohibition. Accordingly, Korean companies pursuing an ICO are looking to other jurisdictions such as Switzerland, Singapore, Hong Kong or Estonia to avoid sanctions. With regard to such ICOs, the following issues may be raised.
Issues under the Capital Markets Act
Under the Financial Investment Services and Capital Markets Act (CMA), a security means a financial investment instrument with an investment risk (of losing the principal investment amount) with regard to which investors have a right to request reimbursement in cash or other means of payment at present or some more money than they paid at the time they acquired such the instrument. Soliciting capital through the issuance of a virtual currency such as a share security/debt security will be subject to the CMA.
Accordingly, the primary issue is whether the token qualifies as a security under the CMA. There has not yet been a case where a Korean company sought to issue a security token.
Issues under the Foreign Exchange Transactions Act
According to article 3(1) subparagraph 13 of the Foreign Exchange Transactions Act (Feta), the term foreign exchange is the means of international payment, securities, derivatives and claims in a foreign currency. If the virtual currency qualifies as a foreign exchange, and the virtual currency is used to make or receive payments to or from overseas, then the domestic investor or the issuer of coins in an ICO will be required to report to the Korean foreign exchange authorities.
However, as the legal nature of a virtual currency is yet to be determined, foreign exchange authorities have not been accepting such reports or even the reporting of foreign currency payment/receipts relating to the virtual currency. As such, foreign exchange authorities have been heavily criticised for their excessively restrictive and non-accommodating policy.
As it is possible that the payment/receipt of virtual currencies relating to the ICO may be regarded as falling under foreign currency rules depending on the relevant legislative direction, it may be subject to Feta in the future.
Issues under Act on the Regulation of Conducting Fundraising Business Without Permission
It is necessary to check if the ICO constitutes a fundraising activity without permission under the Act on the Regulation of Conducting Fundraising Business Without Permission (FBA). A fundraising activity without permission means a business activity that aims to procure funds from the public without the required permission/approval or registration/reporting, including by promising to repay an amount which is equal to the entire investment or more in exchange for receiving investment (article 2 of the FBA).
In order for the ICO to constitute a fundraising activity, the issuing company has to be engaged in the business of soliciting investment. However, considering that the issuing company directly engaged in an ICO lacks the continuity/repeatability as a money-soliciting business and that most of the investment agreements for an ICO do not provide that the investors will be reimbursed their entire investment amount or more (despite investors' expectations), it is unlikely that the ICO would qualify as a fundraising activity under the FBA.
The Korean government has not yet confirmed the legal status of virtual currencies or ICOs and seems to maintain a negative view. It has announced however a plan to tax virtual currencies as of June this year.
Accordingly, it is possible that the Korean government may provide a more concrete direction regarding virtual currencies after June 2018.
About the author
Hyun Koo Kang
Partner, Lee & Ko
Hyung Koo Kang worked as financial compliance legal counsel for the Financial Supervisory Service from 2002 to 2007 before joining Lee & Ko as a partner in the financial services & compliance team. As an expert in financial compliance, he handles complex banking, securities, insurance and non-banking licences, financial legal compliance issues in connection with credit cards, financial organisation and capital market sanctions, foreign exchange regulations and the resolution of disputes in financial and capital markets. He also has solid experience in M&A of financial institutions and relevant licensing as well as in-depth knowledge of the Electronic Financial Transactions Act and other financial related laws and regulations. He recently joined and advised the Financial Service Commission Task Force for the draft of Financial Innovation Support Special Act as a fintech expert.
About the author
Partner, Lee & Ko
Jongsoo (Jay) Yoon is a partner at Lee & Ko. His main practice areas include intellectual property rights, protection of personal information, internet, media content, broadcasting, information and communications. Mr. Yoon leads the blockchain team and has provided specialised legal services for the major domestic virtual currency exchange and various companies regarding initial coin offerings. Before he went into private practice in 2014, he served as a judge at the various courts for 21 years. During his career, Mr. Yoon has served as an assistance administrator for the Research Group for Justice Informationisation. In addition, he led the task force team for the introduction of electronic procedure in the Supreme Court.
He now serves as the chairman of Open Data Forum, a member of the Self-regulation Committee of Korea Blockchain Society and as the Advisor of National Cyber Security.