Legal Framework and Current Status of Digital Money in Japan

There is no general legal definition of digital money in Japan, and the already existing digital money is generally classified as follows.

One of the activities that a bank may engage in as banking business under the Banking Act is exchange transactions. There is no statutory definition of “exchange transaction”, and it is generally understood to mean the transfer of funds at the request of a customer using a mechanism for transferring funds between persons at a distance without directly exchanging cash between them. The term, “digital money using deposits” refers to digitised transfers of funds between deposit accounts. The issuance and redemption of such digital money by banks is regulated by the Banking Act as exchange transactions. A specific example is debit cards issued by a bank.

A funds transfer service provider is a person other than a bank, and the like, registered under the Act on Settlement of Funds to engage in exchange transactions as a business. A funds transfer service provider cannot keep money received from a user as a deposit, but it may keep money for the purpose of exchange transactions by managing the money in an account, and obligations related to such kept money are referred to as the “outstanding obligations” and are distinguished from deposits. “Digital money using outstanding obligations” is the digitisation of transfers between accounts by a funds transfer service provider. The issuance and redemption of such digital money by a funds transfer service provider is regulated by the Act on Settlement of Funds as an exchange transaction. A funds transfer service provider delivers a service where it issues digital money by keeping money from a user, and upon the user presenting such digital money, the digital money balance in the user’s account is transferred to another user’s account, thereby enabling transfers to/from the other user or the payment of consideration.

A “prepaid payment instrument” is defined in law as a voucher, and such, issued in exchange for payment of consideration corresponding to the amount shown on the voucher, for example, which can be used for payment of consideration in the purchase of goods from the issuer or a person designated by the issuer (merchant). Persons registered under the Act on Settlement of Funds may issue so-called “prepaid payment instruments for third-party business” that can also be used by the merchant.

The issuance of prepaid payment instruments for third-party business is a service that could be considered as an exchange transaction since it intermediates the transfer of funds between a user and a merchant, but it is distinguished from an exchange transaction in that the issuer does not keep funds received from the user and refunds are prohibited in principle. “Digital money using prepaid payment instruments” is a digital version of such fund transfer between such user and merchant. The issuance of such digital money is regulated by the Act on Settlement of Funds as the issuance of prepaid payment instruments for third-party business.

The issuer of a prepaid payment instrument for third-party business provides a service of issuing a prepaid payment instrument displaying a balance to a user in exchange for consideration (in some cases, a physical medium that displays the amount such as an IC card (Integrated Circuit card – a rechargeable card used to pay fares on public transportation, for example) is issued to the user, while in others, the balance is only recorded on a server and displayed online), and allowing a user to pay consideration for product purchases, for instance, at a merchant up to the displayed balance by presenting such prepaid payment instrument. Hybrid digital money that uses both the above-mentioned outstanding obligations and prepaid payment instruments is also widely available.

In June 2022, the Banking Act and the Act on Settlement of Funds were amended and the following institutional arrangements were made for digital money using distributed ledger technology in response to the recent rapid expansion in the United States and other countries of transactions involving stable coins and other instruments that incorporate distributed ledger technology in the fields of remittance and settlement.

Among stable coins, those that are issued at a price linked to the value of the legal tender and are intended to be linked to the legal tender by offering redemption at the same amount as the issue price are newly defined as “electronic payment instruments” under the Act on Settlement of Funds, and the act of issuing and redeeming them constitutes an exchange transaction and requires a banking licence or registration as a funds transfer service for conducting such transactions. This means that, in addition to already existing digital money, electronic payment instruments are now positioned as a new type of digital money in the system.

The use of distributed ledger technology has made it possible to provide services in a form in which the “issuer” and the “person who transfers and manages” (“intermediary”) are separated. Therefore, regulations on intermediaries were established for electronic payment instruments, and new regulations on intermediaries were also established for digital money that uses deposits or outstanding obligations, where previously only issuance and redemption were regulated as exchange transactions.

Currently, a type of electronic payment method that uses trust beneficiary interests is being considered for practical application as digital money using distributed ledger technology.

As a matter of definition, electronic payment instruments can be broadly divided into (i) tokens which are promised to be redeemed with legal tender and (ii) trust beneficiary interests that meet certain requirements and are represented by tokens.

The former is a token that falls under the definition of a crypto asset except for there being a promise of redemption, and the issuer is a bank or a funds transfer service provider. However, because there are no clear substantive legal requirements for transfer, and there are difficulties in actual issuance in relation to various other regulations imposed on issuers under the Banking Act or the Act on Settlement of Funds, the examination of practical application of this category has not progressed much. In addition, most of the stable coins issued and circulated overseas are of the former type, and although it is not impossible to handle them in Japan, they would need to meet a number of strict requirements under the Act on Settlement of Funds for such handling to be allowed.

In contrast, the electronic payment instrument using trust beneficiary interests has a trust bank or trust company as the trustee of such trust beneficiary interests as the issuer, and thus the bar based on other regulations to be considered is lower when issuing the instrument. In addition, by using specific trust mechanisms under Japanese law, it is possible to overcome the substantive law issues related to the transfer of rights, as long as the rights are distributed on a permission-type blockchain. Because of these circumstances, the practical application of electronic payment instruments using trust beneficiary interests is being examined, ahead of other types of electronic payment instruments. This type of electronic payment instrument is expected to be put to practical use, for example, as a means of settlement that enables simultaneous settlement of security tokens.