South Korea faces strict crypto regulation and fears of centralization

From real-name account trading to investigating individuals using cryptocurrencies to evade taxes, government officials in South Korea are enacting stricter regulations to oversee the cryptocurrency industry in the country. These measures often require digital currency businesses to provide detailed customer data and transaction information to the relevant authorities.

With these stringent measures often comes an increase in the cost of compliance for exchanges and other crypto service providers. Privacy concerns are another issue amid the swath of information being provided to government agencies.

However, this strict regulatory climate has done little to dampen the enthusiasm for cryptocurrencies in South Korea. Crypto trading in the country continues to gain more traction, with exchange investors in line for significant price gains in shares amid the current upsurge in digital currency activity in the country.

Data from South Korea’s National Tax Service, or NTS, shows an increase in the number of crypto investors in the country over the past year. This surge in market participants has also triggered an eightfold increase in trading volume such that the crypto arena recently overtook the stock market, albeit temporarily, in daily trading volume.

South Korea’s tightened crypto regulations are also coming amid updates to the Financial Action Task Force’s, of FATF’s, guidelines on cryptocurrency regulations. The intergovernmental body continues to call for heightened restrictions on the crypto space, predicated on exerting strict oversight of centralized entities like exchanges and custodial services.

Specific Financial Transactions Act

On March 25, updated cryptocurrency regulations under the Act on Reporting and Using Specified Financial Transaction Information, commonly referred to as the Specific Financial Transactions Act, will come into effect in South Korea. These new laws herald significant policy changes for virtual asset service providers, or VASPs, in the country.

For one, all VASPs — exchanges, custodians, asset managers and wallet service providers — must be licensed to operate in the country. Exchanges must also maintain relationships with local banks to ensure mandatory real-name account trading.

For South Korean officials, the insistence on real-name crypto trading accounts is part of efforts to combat money laundering via cryptocurrencies. This rule requires exchanges to obtain and renew certain license approvals from lenders in the country.

By partnering with local banks and requiring real-name trading accounts, South Korean regulatory and law enforcement agencies can have access to crypto transaction data for their various investigative purposes. Crypto businesses in the country must abide by strict financial reporting standards following the new laws coming into effect later in March.

The Korea Financial Intelligence Unit, or FIU — an arm of South Korea’s Financial Services Commission responsible for Anti-Money Laundering oversight across the country’s financial sector — will police the activities of cryptocurrency businesses. These VASPs now have until Sept. 24 to come into full compliance with the new reporting standards.

Exchanges, wallet providers, asset managers and other crypto firms under the VASP classification must flag suspicious transactions and report them to the FIU for subsequent money laundering investigations. Also, new VASPs looking to operate in the country must register with the FIU before servicing customers in South Korea.

Meanwhile, South Korea’s NTS is also focusing its attention on the crypto space in efforts to combat tax evasion. However, with crypto taxation laws yet to come into effect, the NTS is looking at individuals attempting to evade state taxes by hiding their wealth in digital assets.

The NTS recently identified more than 2,400 individuals who hid over $32 million in assets from the government. As part of the investigation, the tax agency requisitioned customer data from major crypto exchanges in the country and is even reportedly planning to conduct a deeper probe into some of the participants in the tax evasion scheme.

The cost of compliance

Binance Korea shut down its operations back in December 2020, less than a year after its initial launch. At the time, the platform identified low liquidity and declining transaction volumes as the reason for its decision to shut up shop.

However, there was some speculation that incoming regulations prohibiting order book sharing among cryptocurrency exchanges was the reason for Binance’s decision to shutter the platform. Now, with the new regulatory standard only days away, OKEx has also shut down its platform in the country.

Of the over 100 cryptocurrency exchanges in the country, only the “big four” — Bithumb, Upbit, Korbit and Coinone — hold partnerships with local lenders to enable real-name account trading. These platforms that account for the bulk of the crypto trading volume in South Korea are likely the only ones capable of bearing the cost of compliance associated with acquiring the necessary licensing approvals from commercial banks.

For one, to obtain banking partnerships in the nation, exchanges must develop robust information security management protocols. Also, their principal executives must have clean criminal records.

Additionally, exchanges must provide proof of adequate deposit insurance to cover losses from any hacks. Indeed, South Korean exchanges have been victims of numerous cyberattacks purportedly from North Korean hackers sponsored by authorities in Pyongyang.

Earlier in March, Bithumb announced plans to upscale its AML protocols. As part of these efforts, the South Korean crypto exchange giant has begun utilizing AML tools and solutions developed by blockchain intelligence firm Chainalysis.

For smaller exchanges in South Korea, the cost of compliance brought on by these measures might prove significantly burdensome, leading to a raft of exits from the country. Such a situation could lead to a monopolized cryptocurrency trading market in the country, with only a few participants left in the arena.

Privacy concerns

When in-house solutions are inadequate to ensure compliance with these regulations, exchanges often turn to third-party services. According to Alice Nawfal, co-founder of Travel Rule-compliance platform Notabene, her company is working with several crypto businesses in South Korea. In a conversation with Cointelegraph, Nawfal revealed:

“South Korean exchanges have a 6-month grace period starting March 2021 to implement the Travel Rule. None of them to our knowledge are live yet but are actively exploring how to comply with this. Notabene is currently in talks with several Korean VASPs on how we can help them comply with the new rules.”

Counterparty information-sharing often comes with privacy concerns, and the crypto regulations soon to be in effect in South Korea are likely no different. Indeed, similar issues have been raised with the FATF’s Travel Rule, which requires VASPs to share customer data across multiple jurisdictions.

For the FATF, the guidelines are all about bringing the crypto space to a similar regulatory standard as players in the legacy finance arena. In a statement to Cointelegraph, a spokesperson for the FATF argued:

“The FATF puts the same obligations on virtual assets and their service providers as any other financial business. The FATF is not singling out any form of crypto or cryptocurrency, the FATF is bringing them up to the same standard as banks, money service businesses, securities dealers, and others in the financial sector.”

Despite several reports showing that illicit transactions constitute a minute portion of global cryptocurrency commerce, the FATF still maintained that digital currencies can be misused for illegal activities, adding:

“Money laundering fuels serious crime and terrorism. The threat of criminal and terrorist misuse of virtual assets is serious and urgent. The FATF expects all countries to take prompt action to implement the FATF Recommendations in the context of virtual asset activities and service providers.”

Back in April 2020, the FATF assessed South Korea’s efforts in combating money laundering and terrorist financing. At the time, the intergovernmental body praised the country’s “sound legal framework” while calling for more work to be done in the anti-graft arena, especially concerning corruption among government officials.