Despite the nation’s leading role in the digital currency markets, South Korea has struggled to implement meaningful regulatory and taxation measures for trading these currencies. In less than a year, South Korean authorities have changed their regulatory postures on numerous occasions, and the Korean judiciary and financial regulatory agencies remain misaligned in terms of establishing a cohesive regulatory stance.
Despite the lack of clarity, an overarching regulatory trend is becoming apparent: hostility toward initial coin offerings (ICOs) and exchanges, followed by increased co-operation between the government and digital currency organizations. The evolution of South Korean digital currency regulation will be one to watch, and promises to have a significant impact on the global digital currency markets.
A turbulent history
The digital currency buzz hit South Korea with gusto. In early 2017, Bitcoin was being traded at nearly the same price globally, but by the end of that year, it was traded at a dramatically higher price in South Korea than in the rest of the world. In a phenomenon dubbed the “kimchi premium”, South Korean digital currency traders were paying nearly US$8,000 more per Bitcoin and simultaneously had access to an arbitrage opportunity with potential gains of between 30% and 50%.
In part because of these significant premiums, the South Korean digital currency market saw rampant misconduct, including mining Ponzi schemes, market manipulation and outright theft. On 20 December 2017, South Korean authorities indicted nearly two dozen people in connection with a digital currency mining Ponzi scheme operating under the name Mining Max, which swindled more than US$250 million from over 18,000 investors. Market manipulation, including spoofing (faking demand by placing large orders not intended to be filled) and wash trading (buying and selling one’s own order), became commonplace in the South Korean digital currency market. In April 2018, Korean police arrested the chief of Coinnest, a major South Korean exchange, alleging he embezzled tens of millions of dollars from customers’ accounts.
Hacking has also caused direct and significant financial damage on Korea’s exchanges. For instance, Youbit, a South Korean exchange, was hacked in both April and December, 2017. Youbit lost 4,000 Bitcoins in the first attack and had to file for bankruptcy after losing 17% of its assets in the second attack. Other exchanges such as Coinis and Bithumb have also faced hacking attacks. A cyber-attack on Bithumb, South Korea’s then-largest exchange, was blamed on North Korea by the South Korean government.
Furthermore, two large-scale hacking attacks have rocked major South Korean exchanges in June 2018 alone. On 11 June, a major South Korean exchange, Coinrail, was subject to a hacking attack, which wiped out 30% of its tokens. Investigations in the aftermath of the Coinrail hack revealed that the majority of digital currency exchanges in South Korea outside of the big three – Upbit, Bithumb, and Korbit – were operating without proper security measures and IT infrastructure. Yet on 20 June, just nine days after the Coinrail attack, Bithumb also announced that it suffered a hacking attack that cost it approximately US$35 million.
These events have continued to spur the South Korean government toward digital currency regulation. In July 2017, lawmakers began preparing a set of bills to give digital currencies “legal grounds”. This positive sentiment was quickly overrun by the Financial Services Commission’s (FSC) proposal to ban ICOs, arguing that digital currency is not a means of exchange, nor a financial product. The FSC’s proposal never actually made it to legislation and the administration of the National Assembly did not implement the ICO ban, nor did it force companies to return ICO funds. It also continued to allow local investors to put money into foreign ICOs through 2018.
In the absence of legislative direction, South Korea’s courts have stepped in. In September 2017, the Suwon District Court invalidated the seizure of 216 Bitcoins because it was “not appropriate to confiscate Bitcoins as they cannot assume an objective standard value.” Following the prosecutor’s appeal in December 2017, the previous court’s ruling was reversed based on the idea that digital currencies have economic value because “Bitcoin can be changed into money through an exchange” and it can be used “as a means of payment through merchants”. On 30 May 2018, South Korea’s top court affirmed the appellate court’s decision, recognizing digital currency as an “asset with measurable value”.
A series of administrative actions this year has steered the digital currency market toward greater regulation while acknowledging its global prominence. On 30 January 2018, in South Korea’s first concrete administrative measure aimed at digital currency exchanges, FSC vice chairman Kim Yongbeom announced measures to ban anonymous trading on domestic exchanges, in addition to a complete ban on foreigners and minors trading through digital currency accounts.
Under these regulations, digital currency exchanges are required to share users’ transaction data with banks. Also, South Korean exchange users are now required to use bank accounts in their legal name that matches the name on their digital currency exchange account. In light of this announcement, many suspected that the FSC would go so far as to put a total ban on digital currencies. However, finance minister Kim Dong-yeon has maintained that there will be no ban.
On 17 April 2018, representatives of 14 Korean digital currency exchanges, including Bithumb, Upbit and OKCoin, released a set of self-regulatory guidelines for digital currency exchanges in South Korea. The exchange representatives are members of the Korea Blockchain Association. The self-regulatory guidelines involve an inspection of all member exchanges and require the satisfaction of five conditions: (1) manage clients’ digital coins and their own separately; (2) cope with abnormal transactions quickly; (3) float new digital currency with enhanced client protection systems; (4) hold a minimum equity of KRW2 billion (US$1.8 million); and (5) publish regular audit and finance reports. The guidelines also recommend an inspection of exchange systems in order to identify “if there are loopholes that could be used for insider trading, price rigging and money laundering”. While none of these regulations is legally binding, they signal a clear movement toward transparency and government regulation.
Despite the flurry of regulatory activity from different South Korean agencies and the judiciary, market participants are still awaiting clear guidance from the National Assembly in the form of a statute that will provide a comprehensive regulatory framework. It seems that such a statute is forthcoming: On 19 June 2018, the FSC announced it would seek to place digital currency exchanges under a comprehensive regulatory scheme.
For the first time, there will be a legal definition of virtual currency in Korea – an “electronically transferable token or information regarding such token, which a trade counterparty may recognize as a means of exchange or a storage of value”. This definition is designed to exclude other plausible definitions of digital currency, including “measure of value” or “means of payment”.
Under the proposed regulatory scheme, digital currency exchanges would be required to register with South Korea’s Financial Intelligence Unit, a sub-organization of the FSC that monitors transactional flows to prevent money laundering or other attempts to evade capital control measures. The exchanges would also need to comply with “Know Your Customer” and anti-money laundering regulations at levels similar to banks. The proposed legislation is currently pending before the National Assembly.
In addition to the FSC’s proposed regulatory scheme, there are several other pending bills regarding digital currency trades and taxation measures. These bills have remained pending due to local elections in South Korea, but given a general lack of resistance toward digital currency regulation, they are expected to pass in the National Assembly soon.
One of the key pending legislations is a digital currency tax bill. Since early this year, there have been active discussions on whether digital currency trades are subject to South Korea’s standard corporate and local income tax. To address the issue, the Ministry of Strategy and Finance (MOSF) is expected to propose a revised digital currency tax bill in August this year. If it passes, South Korea could begin imposing tax on digital currency trades as early as 2019.
Along with various domestic legislative activities, the MOSF is also working on synchronizing South Korea’s regulatory measures with its G20 counterparts, signalling an increase in cross-border co-operation and enforcement activities among G20 member nations. The MOSF expects to see more detailed international regulatory guidelines in July 2018. The next six months will be a critical period for South Korea’s regulatory landscape of digital currency, one that is worth keeping a close watch on.
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