A Spotlight on Digital Asset Regulation in South Korea

South Korea made headlines on February 6, 2023 when the country published guidelines on which blockchain-based tokenized assets will be treated and regulated as securities under its capital markets rules. 

Also on February 6, South Korea’s largest securities firm Shinhan Securities Co., Ltd. launched its “STO Alliance”, a consultative body for tokenized securities that aims to expand the security token ecosystem. 

Shinhan Securities belongs to the umbrella group of Shinhan Financial Group, which owns and operates Shinhan Bank, South Korea’s oldest bank and equity investor of Polymesh’s newest node operator KDAC. 

As a security token blockchain, we’re excited for Polymesh to expand into South Korea given the positive and friendly attitude of regulators and institutions toward security tokens. 

This blog post is for anyone who’d like to learn more about digital asset regulation in South Korea as well as the recent developments around security token offerings (STOs) that have taken place there!

South Korea’s early involvement with crypto 

South Korea has been a hotbed for digital asset trading since 2017, when the country’s largest conglomerate, Samsung, announced intentions to find a corporate use for Ethereum. 

Since then, the crypto industry in South Korea has been growing exponentially, with the country’s exchanges responsible for a significant portion of the world’s digital asset trading volume. The size of South Korea’s digital asset market was estimated to be KRW 55 trillion (~$46 billion USD) at the end of 2021, with an average of KRW 11.3 trillion in daily transactions by around 15.25 million registered users. 

One of the main reasons for the surge in South Korea is that there is no tax on digital assets. Tax on cryptocurrencies has been put off until 2023, and is predicted to be pushed back further by the nation’s new President-elect Yoon Seok-yeol, who campaigned on a platform of deregulating the crypto sector.

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Number one in the world for enthusiasm towards emerging tech

The popularity of blockchain technology is perhaps not unsurprising for South Korea, which has long been heralded as number one in the world for enthusiasm to apply technology to everyday life. 

The country is ‘tech crazy’ and considered one of the world’s most tech-savvy, digitally-connected populations (no doubt helped by having the world’s fastest internet). 

Over one million South Koreans have already traded their physical driver’s licenses for a blockchain-based digital license in a government pilot program implemented in August 2020. Now, the country is developing a system enabling full blockchain-based digital identification, with traditional physical registration cards expected to be replaced as soon as 2024. 

The country even has its own “blockchain hub”, the city of Busan. 

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Busan: South Korea’s blockchain hub 

Busan officially became a regulatory-free zone for blockchain technology in July 2019. Since then, the city has been actively pursuing plans to develop blockchain-based applications in various industries, from tourism to finance to public safety. 

Busan is making STOs an integral part of its blockchain development and is expected to roll out a city-backed decentralized digital commodities exchange later in 2023, with all products tokenized and traded on the blockchain. This will complement its impressive array of activity in the crypto space that includes a local digital currency, a decentralized identity platform for public services, and a smart logistics system.

Busan’s digital asset exchange platform will provide automated compliance for tokenized commodities to ensure the process is end-to-end compliant with regulatory guidelines. The initiative will also take advantage of the city’s particular strengths – such as the Busan International Film Festival and G-Star – to include the tokenization not just of traditional assets such as real estate or gold but also intellectual property rights in film and game fields. 

Initially, the city was working to develop the platform in collaboration with multiple top international crypto exchanges including Binance and Huobi. However, in December 2022 it announced it had dropped them from its committee of blockchain experts, citing concerns with the inclusion of private exchanges in their plans and emphasizing they were only needed to offer initial liquidity. 

Interestingly, one of the main motivations behind Busan becoming a global hub for blockchain technology and digital assets is to attract youth– the city is faced by an aging population problem, with the aging and elderly (those 65 years old+) comprising more than one-fifth of its population. 

Government officials in Busan believe that becoming a crypto hub will help to change its demographic makeup as well as provide a means of wealth creation for South Korean youth, who face high unemployment and inflation. 

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The Financial Services Commission and other regulators 

The surge of crypto assets in South Korea hasn’t gone unnoticed by the government, which has been one of the most active regulators of crypto assets. That said, it’s been a transitory process from wanting to ban cryptocurrencies to regulating the industry.

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Ban on Initial Coin Offerings (ICOs)

In 2017, South Korea’s Financial Services Commission (FSC) announced a ban on initial coin offerings (ICOs) in the country, citing concerns over fraud and consumer protection. Later that year, it considered removing the ban for professional investors, although no serious work to lift the ban has taken place until now.

In September 2022, the Bank of Korea voiced plans to lift the ban on issuing new digital assets via ICOs as part of the country’s upcoming digital assets regulations. South Korean firms have already been circumventing the ban by carrying out ICOs in other countries, and then returning to sell the tokens in the local market. The Bank of Korea’s review recommends upcoming digital asset regulations to institutionalize ICOs as obtainable. 

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Proposed Ban on Cryptocurrency Exchanges

2018 was a similarly rocky year for regulation, with South Korea’s Justice Minister announcing a sweeping ban on all cryptocurrency exchanges. However, this was not officially endorsed by the government. The FSC did, however, confirm its intention to ban minors from using domestic crypto exchanges as well as banning foreigners from trading through South Korean based accounts. 

While regulators were considering various actions, the Korea Blockchain Association actually pledged its own self-regulations to clamp down on money laundering and fraud. 

Since then, the FSC has focused on creating a comprehensive legislative framework for crypto assets that fosters innovation while offering consumer protection. 

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Bringing digital assets within the perimeter of existing financial regulations 

Major moves on the regulatory front were made in March 2020, when the South Korean National Assembly passed a bill bringing digital assets within the perimeter of existing financial regulations. 

As should be a familiar story with Polymesh readers by now, the country was quick to demand that digital asset service providers at minimum comply with relevant anti-money laundering (AML) and know-your-customer (KYC) regulations as well as data protection requirements. 

Specifically, the passed bill was an amendment to the Act on Reporting and Use of Specific Financial Information (the AML Act) and meant that digital asset service providers were now subject to the same regulatory standards as traditional financial institutions. 

The amended law put two main necessities for digital asset companies to fulfill: (i) the completion of real-name verification and partnership with a local bank, as well as (ii) requiring a license from the FSC’s Financial Intelligence Unit (FIU). Additionally, crypto exchanges are required to obtain a security certificate from the Information Security Management System (ISMS) and register with the Korea Internet and Security Agency (KISA). 

For consumer protection purposes, the regulatory framework also requires digital asset service providers to have a certain level of capital reserves and conduct regular audits to prove they are operating in a safe manner. 

These new requirements ultimately led to the closings of most of the cryptocurrency exchanges in the country after they failed to secure licenses from local regulatory agencies. As of today, all but five South Korean exchanges have been eliminated from the market. 

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DABA: the Digital Asset Basic Act 

Today, the only legislation that explicitly defines and regulates digital assets in South Korea is the AML Act. Moves to introduce new regulations came in October 2022, when the FSC and the National Assembly (the nation’s legislative body) announced they were working together on legislation balancing blockchain development, investor protection, and financial stability. 

A high priority issue for the country’s regulators is safeguarding investors in digital assets, including cryptocurrencies, non-fungible tokens, and security tokens. 

In January 2023, the Ministry of Justice announced it would launch a “virtual currency tracking system” to tackle money-laundering and facilitate the recovery of crypto-related proceeds from crime. Evidently, the South Korean government is not in favor of fostering an industry which is highly prone to negative issues such as fraud, illegal fundraising, and hacking. 

Nevertheless, the current administration is optimistic about the emerging industry if investor protection measures are in place. 

Currently, South Korea’s National Assembly are considering 17 separate crypto-related legislative proposals, ranging from implementing reserve requirements at exchanges to establishing a separate market for digital securities.

Out of these legislations, an all-encompassing regulatory framework is expected to emerge: the Digital Asset Basic Act (DABA). Notably, DABA will protect investors while exempting tax on the profits from cryptocurrency of up to KRW 50 million. Regulators are hoping DABA  encourages the inflow of funds and human resources into the industry in South Korea. 

DABA is only at the proposal stage right now, and it might be a while before it becomes law (although it could be enacted as early as June 2023).

In the meantime, the FSC intends to regulate digital assets through existing regulations such as the Capital Markets Act, the Electronic Financial Transactions Act and the Specific Financial Information Act, as well as various guidelines. 

The Polymesh community will want to pay attention to the guidelines on security tokens, which provides criteria to classify certain digital tokens as securities as well as the relevant regulations to be applied to their issuance and related business. 

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The FSC’s Guidelines on Security Tokens 

South Korea made headlines this February 2023 when the FSC published guidelines on security tokens in preparation for the upcoming legalization of the issuance and distribution of security token offerings (STOs). 

STOs are currently not allowed under South Korea’s legal system, so the guidelines and expected legalization of security tokens (securities that have been digitized on distributed ledger technology) serve as a recognition of the digital paradigm shift. 

The FSC guidelines are designed to offer clarity around what digital assets qualify as security tokens. Specifically, the guidelines stipulate that digital assets will be regulated as securities if they have inherent characteristics that align with the country’s Capital Markets Act. 

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Legal definition of securities and other digital assets

According to the Capital Markets Act, “securities” are financial investment instruments where investors do not have an obligation to make additional payments on top of the original investment. 

Examples of digital assets the FSC is likely to classify as securities include:

• Digital assets that provide a stake in the operations of a business 
• Digital assets that provide investors with access to profits from a business
• Digital assets that offer rights to dividends or residual property ownership 

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These digital assets that correspond to securities must be issued and distributed in compliance with all securities regulations under the Capital Markets Act. 

Stablecoins and digital assets with no issuer and that “do not have to fulfill obligations commensurate with investors’ rights” will likely fall outside of the framework. Regulations around these non-security tokens are expected to appear in DABA. 

The FSC says it will determine which digital assets qualify as securities on a case-by-case basis. However, issuers and brokers such as crypto exchanges will be held responsible for the first evaluation and for keeping in line with regulations. This means that crypto participants will need to classify and assess their related tokens themselves to see if they will be regulated under the securities regime, and firms with no current securities-related license will need to obtain one.

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What’s next after the guidelines? 

Following the guidelines, the FSC is expected to present a proposal in the first half of 2023 to the National Assembly containing updates to existing financial laws such as the Electronic Securities Act and Capital Markets Act. 

The amendments will allow for corporate entities to issue digital security tokens directly without financial institutions, with the goal to establish an eventual over-the-counter market for tokenized securities. 

Ultimately, the regulations will institutionalize security tokens and help to formalize new financial products. Regulators will also contribute to this by setting up a pilot through a regulatory sandbox. 

Until then, multiple firms are eagerly preparing to handle or issue tokens in anticipation that they will receive the green-light from the FSC to offer such services. These include the Korea Exchange (the nation’s only securities exchange operator) as well as banking giants Kookmin, Kiwoom Securities, and Shinhan (an equity investor in Polymesh node operator KDAC). 

For investors, the guidelines will be a positive development as they will confer the Korea Securities Depository with authority to control the amount of issued assets and be the watchdog to token issuers. 

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Shinhan Financial Group 

No article about South Korea’s blockchain industry would be complete without mentioning at least one conglomerate!

One of the country’s leading financial conglomerates is Shinhan Financial Group, ultimate parent company of Shinhan Bank and Shinhan Securities. Shinhan Financial Group reportedly owned the equivalent of $486 billion USD in assets in 2021. 

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Shinhan Bank 

Historically the first bank in South Korea, Shinhan Bank is one of the largest banks in the country, with total assets equalling KRW 176.9 trillion (~$136 billion USD) and equity capital of KRW 9.7 trillion (~$7.5 billion USD). 

In 2020, Shinhan Bank became the first in South Korea to commercialize decentralized identity (DID) services for the financial sector when it launched a blockchain-based KYC solution in collaboration with ICONLOOP, then the only mobile app approved by the FSC.

South Korean law requires crypto exchanges offering fiat KRW trading pairs to partner with banks to provide fiat on/off ramps. Shinhan Bank is one of the three major South Korean banks that profited from crypto transaction fees in 2021 (the other two are neobank K-Bank and NH Bank). 

In partnership with Korbit exchange, Shinhan Bank made $660,000 USD in 2021 from related fiat deposit and withdrawal fees charged with customer transactions. K-Bank and NH Bank both made in the millions. Together, their profits show cautious traditional institutions that partnering with virtual asset trading platforms can pay off. 

In addition to joint collaborations, the bank has invested in the digital asset sector. In 2021, Shinhan Bank became an early investor in Korea Digital Asset Custody Co. (KDAC), a consortium of startups providing digital asset custody solutions and as of this month a Polymesh node operator! 

KDAC was formed in March 2020 by the cryptocurrency exchange Korbit, enterprise blockchain firm Blocko, and research firm Fair Square Lab. In 2021, Shinhan Bank also invested in Korbit, which it has been in partnership with since January 2018 to provide a link between customers’ bank accounts and the exchange’s digital wallets. The bank also has a prior investment in Blocko. 

The company has also experimented with stablecoins. In December 2021 it ran a real-time international remittance via stablecoin with Standard Bank of South Africa using Hedera Hashgraph’s Hedera blockchain network. 

Shinhan Bank plans to issue stablecoins to build a business ecosystem on its metaverse platform, however it is likely that the stablecoins it issues will be used by Shinhan Bank customers only, at least until further regulations around virtual assets are established in Korea. 

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Shinhan Securities 

Shinhan Securities, one of South Korea’s largest securities firms, also plans to take the lead in pioneering the security token ecosystem. 

In response to the FSC guidelines on February 6 2023, Shinhan Securities invited other companies to join its “STO Alliance” for the growth and development of the tokenized securities industry, particularly the tokenization of real-world assets. 

Through the STO Alliance, Shinhan Securities aims to inform investors of the benefits of tokenized securities, as well as set uniform standards for issuing and trading security tokens to provide them with more stable digital asset investment. 

The STO Alliance was born from the belief that tokenized securities must be carried out jointly between blockchain companies and financial institutions, however Shinhan Securities encourages any company regardless of industry to join. 

Member companies will be able to reduce costs related to issuing token securities, raise funds through process improvement, and receive support for security token distribution solutions. Additional benefits of joining include blockchain technology consulting and linkage support, as well as networking between domestic and foreign member companies. 

More recently on February 16, 2023, Shinhan Securities signed a memorandum of understanding (MOU) with Weisell Standard, operator of in-kind piece investment platform ‘Piece’, for the joint promotion of STOs. 

As a platform enabling ownership and investment of real-world assets in pieces, Weissell Standard is already preparing for the full-fledged token security industry. Together with Shinhan Securities, it plans to seek out detailed tasks, problems, and solutions for the FSC’s guidelines on security tokens. 

The two companies will also collaborate on the planning, development, operation, issuance, and distribution of STOs using blockchain. This follows an earlier agreement to jointly establish measures to protect investors and take preemptive measures such as through the formation of a blockchain network. 

Additionally, Shinhan Securities is preparing an STO platform that encompasses various types of assets such as bonds, luxury goods, and artwork. 

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Looking into the future: NFTs, the Metaverse, and more

As digital assets become an increasingly popular means of investment and transactions, regulators around the world are paying attention. South Korea is no exception, although it’s decisively much more positive in outlook.

The South Korean government recently earmarked $177 million for investment in the nascent metaverse industry– the first to be made by a national government in the typically private, Big Tech-driven sector. 

It’s not clear yet how metaverse technologies will gel with existing regulations; these are questions that the government will have to tackle in coming years. 

One potential issue is non-fungible tokens (NFTs). NFTs are growing exponentially in South Korea, with the NFT industry valued at $938 million USD in 2022 and expected to reach $4902 million USD by 2028.

NFTs are a crucial component of the metaverse, but they aren’t subject to the same rules as cryptocurrencies or security tokens in South Korea. While the FSC is working to implement new rules, none have been in place for the NFT market. 

This means that digital asset service providers that deal in NFTs might not need to comply with the regulatory requirements faced by crypto exchanges or companies involved with security tokens. 

There are also questions around whether the upcoming legislation will actually help to stabilize and safen the sector, or whether it will simply motivate regulatory arbitrage, where companies dealing in digital assets have operations offshore to avoid complying with regulations. 

For South Korea – whose political and economic society is dominated by conglomerates – the government’s explicit investment in the metaverse also raises questions around political motivations. Some in the crypto industry view the open embrace of NFTs and the metaverse as serving a populist agenda to stay in the good books of companies who sell them, such as Samsung. They claim that South Korean politicians don’t truly care about blockchain, or else they would embrace other digital assets. 

These aren’t questions we have answers to yet, but one thing that is certain is that South Korea does embrace STOs. The country’s expected legalization of security tokens should be exciting news for members of the Polymesh community, especially as Polymesh recently gained its first South Korean node operator!