FinTech

Japan's Digital Currency Frontier: Understanding New Stablecoin Regulations and the Future Digital Yen

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read
Slide summary: Japan’s stablecoin licensing & Digital Yen pilot—issuer types, AML duties, two-tier CBDC timeline
TL;DR: Japan couples strict fiat-backed stablecoin rules under the Payment Services Act with a cautious two-tier CBDC pilot. Banks, fund-transfer firms and trust banks can issue 1-to-1 yen stablecoins, while the Digital Yen remains in testing. Global firms must navigate licensing, AML travel-rule duties and data-privacy limits before full rollout.

Table of Contents

  1. Regulating the Stablecoin Landscape: The Payment Services Act Amendments
  2. The Digital Yen: Japan's CBDC Exploration
  3. Cross-Cutting Issues and International Context
  4. Conclusion: A Regulated Path Forward

The global financial landscape is undergoing a profound transformation driven by the rise of digital currencies. From privately issued stablecoins aiming to bridge traditional finance and the crypto world, to central bank digital currencies (CBDCs) representing the next evolution of sovereign money, innovation is rapidly outpacing regulation in many jurisdictions. Japan, however, has taken a notably proactive stance, establishing a comprehensive legal framework for certain types of stablecoins while simultaneously exploring the potential issuance of its own CBDC, the Digital Yen. For international businesses and legal professionals interacting with the Japanese market, understanding these developments is becoming increasingly crucial.

This article explores Japan's regulatory approach to digital money, focusing on the landmark 2022 amendments to the Payment Services Act concerning stablecoins and the ongoing exploration of a Digital Yen.

Regulating the Stablecoin Landscape: The Payment Services Act Amendments

In June 2023, amendments to Japan's Payment Services Act (PSA) came into effect, creating a specific regulatory category for certain stablecoins, distinguishing them clearly from crypto-assets (known as angō shisan in Japan). This move positions Japan as one of the first major economies to implement a dedicated framework for stablecoins backed by legal tender.

Defining "Electronic Payment Instruments"

The amended PSA introduces the concept of "Electronic Payment Instruments" (denshi kessai shudan) to cover stablecoins that meet specific criteria. Broadly, these are digital assets that:

  1. Can be used for payment for goods or services with unspecified persons.
  2. Can be purchased from and sold to unspecified persons.
  3. Are electronically recorded and transferable.
  4. Are denominated in a fiat currency (like Japanese Yen, US Dollar, etc.).
  5. Are not traditional securities, electronic recordable claims, or prepaid payment instruments (like typical e-money cards, with some nuanced exceptions).

Crucially, this definition primarily targets stablecoins pegged to fiat currency, often referred to as "Digital Money-like Stablecoins." The key regulatory requirement is that these instruments must promise redemption at face value (e.g., 1 stablecoin unit = 1 Yen). This structure ensures value stability, differentiating them from volatile crypto-assets.

Distinguishing from Crypto-Assets

Stablecoins that do not meet the criteria for Electronic Payment Instruments – such as algorithmic stablecoins or those backed by assets other than fiat currency – generally fall under Japan's existing (and relatively strict) regulations for crypto-assets. These are governed by different provisions of the PSA and the Financial Instruments and Exchange Act (FIEA), primarily treating them as investment assets rather than payment instruments. This clear demarcation is a cornerstone of Japan's approach, aiming to regulate digital assets based on their function and risk profile.

Issuer Regulations: A Restricted Field

A significant aspect of the new framework is the restriction on who can issue Electronic Payment Instruments. Unlike the broader crypto-asset space, the issuance and redemption of these fiat-backed stablecoins are considered "exchange transactions" (kawase torihiki), akin to traditional money remittance. Consequently, only licensed entities are permitted to issue them:

  1. Banks: Licensed banks can issue stablecoins, likely structured as transferable electronic deposit claims.
  2. Fund Transfer Service Providers (FTSPs): Registered shikin idō gyōsha can also issue stablecoins. Japan categorizes FTSPs into three types based on the permitted transaction value (Type I: unlimited, Type II: up to 1 million JPY, Type III: up to 50,000 JPY). While all types can technically issue stablecoins, the stringent collateral/guarantee requirements for Type I and the low transaction limits for Type III make Type II FTSPs the most likely candidates in practice. These providers typically structure their stablecoins as electronic claims on funds held by the provider ("undelivered obligations"). They must fully secure user funds through methods like deposits with the authorities, bank guarantees, or trust agreements.
  3. Trust Companies/Trust Banks: Stablecoins can also be structured as electronic beneficial interests in a trust (tokutei shintaku juekiken), specifically a money trust where 100% of the entrusted funds are managed solely through bank deposits (excluding negotiable certificates of deposit). Only licensed trust companies or trust banks can act as trustees and issue these trust-type stablecoins. This structure benefits from an exemption from certain collateral requirements applicable to FTSPs, potentially making it an attractive model.

Notably absent from this list are entities solely registered as crypto-asset exchanges or other fintech companies without these specific licenses. Furthermore, while banks are permitted issuers, regulatory guidance suggests caution, particularly regarding stablecoins operating on permissionless blockchains, due to potential conflicts with banking stability and operational integrity (e.g., managing depositor data in a decentralized environment). The trust model, therefore, appears to be a likely favored structure for new stablecoin entrants in the near term.

Intermediary Regulations: Gatekeepers of the Ecosystem

The amended PSA also establishes a regulatory regime for intermediaries handling Electronic Payment Instruments, creating the category of "Electronic Payment Instruments Transaction Service Providers" (denshi kessai shudan tō torihiki gyōsha). These providers must register with the authorities and comply with regulations similar to those for crypto-asset exchanges. Their regulated activities include:

  • Buying, selling, or exchanging Electronic Payment Instruments.
  • Acting as an intermediary, agent, or proxy for such transactions.
  • Managing users' Electronic Payment Instruments (custody/wallet services).

These intermediaries play a vital role, particularly for facilitating user access and managing wallets. They are subject to strict user protection rules, including segregation of user assets (stablecoins and fiat funds) from the provider's own assets, provision of clear information to users, cybersecurity measures, and robust internal controls. The regulation requiring intermediaries to hold user funds primarily in trust (except under specific conditions) adds another layer of protection but also operational complexity.

Interestingly, the 2022 amendments also extended intermediary regulations to cover existing forms of digital money, such as the electronic balances issued by FTSPs (like PayPay Money or LINE Pay Money) or transferable bank deposits (like J-Coin Pay). This allows for a separation between the issuer and the user-facing service provider, potentially fostering more specialized roles within the digital payments ecosystem.

AML/CFT Compliance: A Core Requirement

Given the potential for digital currencies to be misused for illicit purposes, Anti-Money Laundering and Countering the Financing of Terrorism (AML/CFT) compliance is paramount. Intermediaries (Electronic Payment Instruments Transaction Service Providers) are designated as "Specified Business Operators" under Japan's Act on Prevention of Transfer of Criminal Proceeds (hanzai shūeki iten bōshi hō).

This designation imposes several obligations:

  • Know Your Customer (KYC): Rigorous identity verification is required when onboarding customers and establishing wallets/accounts.
  • Transaction Monitoring: Systems must be in place to monitor transactions for suspicious activity.
  • Record Keeping: Detailed records of transactions and customer identification must be maintained.
  • Suspicious Activity Reporting (SAR): Suspicious transactions must be reported to the authorities.
  • Travel Rule: For transfers of Electronic Payment Instruments between providers (both domestic and international), originator and beneficiary information must be transmitted alongside the transaction. This rule is applied broadly to domestic transfers as well, unlike traditional wire transfers where it mainly applies internationally. Notably, the travel rule obligations are placed on the intermediaries, acknowledging the peer-to-peer potential of some stablecoins.
  • Unhosted Wallet Considerations: While the travel rule primarily applies to transfers between regulated entities, the regulations acknowledge the existence of unhosted (self-custodied) wallets. Intermediaries are required, as part of their overall AML/CFT system, to make efforts to assess the risks associated with transactions involving unhosted wallets and collect available information about the counterparty where possible.

These measures align Japan's digital currency regulations with international standards set by bodies like the Financial Action Task Force (FATF).

The Digital Yen: Japan's CBDC Exploration

Alongside regulating private stablecoins, the Bank of Japan (BOJ) and the Japanese government are actively exploring the feasibility of issuing a CBDC, commonly referred to as the "Digital Yen."

Motivations for a Digital Yen

The primary drivers behind Japan's CBDC exploration mirror those in many other countries:

  • Complementing Private Payments: Ensuring the provision of a safe and reliable digital payment instrument backed by the central bank, especially as cash usage potentially declines and private digital payment options proliferate.
  • Monetary Sovereignty: Maintaining the central bank's role in the monetary system in an increasingly digitalized economy.
  • Payment System Efficiency: Potentially improving the efficiency and resilience of the overall payment infrastructure.
  • Financial Inclusion: Exploring possibilities for providing access to digital payments for underserved populations (though Japan has relatively high financial inclusion already).
  • Future Innovation: Providing a foundation for new financial services leveraging programmability.

The "Indirect / Two-Tier" Model

Japan is strongly leaning towards an "indirect" or "two-tier" model for a potential Digital Yen. In this structure, the BOJ would issue the CBDC, but private sector intermediaries (banks, FTSPs, etc.) would handle the end-user interface, including account/wallet provision, onboarding (KYC), and transaction processing.

This approach leverages the existing financial infrastructure and customer relationships of private institutions, avoiding the immense operational burden of the central bank dealing directly with millions of individuals and businesses. It also allows intermediaries to potentially offer value-added services built upon the CBDC platform, fostering innovation while ensuring the central bank maintains control over the core ledger and monetary policy. Government discussions indicate a clear preference for this model to balance efficiency, innovation, and the central bank's focus on its core mandate.

Key Design Considerations and Challenges

While still in the exploratory phase (including pilot programs involving private sector participation since April 2023), several key design considerations are being debated:

  • Legal Tender Status: Should the Digital Yen have the same legal tender status as physical cash (Bank of Japan notes and coins)? Making it legal tender would promote acceptance but raises questions about forcing merchants, especially small ones, to accept a new form of payment requiring specific infrastructure. EU proposals for a Digital Euro include exceptions for micro-enterprises.
  • Coexistence with Cash: Japanese authorities have emphasized that a CBDC would complement, not replace, physical cash, which remains widely trusted and used. Ensuring continued access to cash is a stated policy goal.
  • Anonymity vs. Transparency: Balancing user privacy expectations with the need for AML/CFT compliance is a critical challenge. While cash offers high anonymity, a fully anonymous CBDC is considered incompatible with AML/CFT requirements. The design will likely involve tiered access to data – intermediaries handling KYC and transaction details, with the central bank having limited, possibly anonymized or aggregated, data access except under specific legal circumstances (e.g., law enforcement requests). Achieving "privacy-by-design" is a key objective.
  • Offline Functionality: The ability to make payments without an internet connection (similar to cash) is desirable for resilience (e.g., during natural disasters or network outages). However, offline capabilities increase risks like double-spending and counterfeiting. Initial rollouts might prioritize online functionality, given the continued availability of cash.
  • Holding Limits and Remuneration: To prevent a sudden, large-scale shift from commercial bank deposits to CBDC (which could destabilize the banking system), regulators are considering implementing holding limits on the amount of Digital Yen individuals or businesses can possess. Furthermore, paying interest (remuneration) on CBDC holdings is generally seen as unlikely, as it could excessively compete with bank deposits and complicate monetary policy implementation. The goal is typically to maintain equivalence with cash (which bears no interest).

Cross-Cutting Issues and International Context

Data Privacy and Utilization

The shift towards digital payments, including stablecoins and CBDCs, inevitably generates vast amounts of transaction data. While this data holds potential for developing new services (e.g., improved credit scoring, personalized marketing), it also raises significant privacy concerns.

In Japan, the handling of personal data is governed by the Act on the Protection of Personal Information (APPI). Financial institutions, including digital currency issuers and intermediaries, are also subject to specific guidelines issued by the Financial Services Agency (FSA) and potentially confidentiality obligations similar to traditional banking secrecy.

Striking a balance between enabling data-driven innovation and safeguarding user privacy and confidentiality is crucial. The "two-tier" CBDC model, where intermediaries manage most user data, is partly designed to limit the central bank's direct access to sensitive information. However, clear rules and robust oversight regarding data access, usage, consent mechanisms, and security are essential across all forms of digital cash.

Interoperability

As various digital payment methods emerge – bank-issued stablecoins, FTSP-issued stablecoins, trust-type stablecoins, existing e-money, and potentially a CBDC – ensuring interoperability becomes vital for a seamless user experience and an efficient payment system. A fragmented ecosystem where users cannot easily transact across different platforms would hinder adoption and utility. A CBDC is sometimes envisioned as a potential "common infrastructure" or bridge that could facilitate transfers between different private digital payment systems.

Impact on International Business

For US companies, Japan's evolving digital currency landscape presents both opportunities and challenges:

  • Payment Rails: New stablecoins and potentially a Digital Yen could offer more efficient and lower-cost options for cross-border payments and remittances compared to traditional methods.
  • Compliance: Businesses operating in Japan or providing services to Japanese customers must navigate the specific regulatory requirements for handling Electronic Payment Instruments, including potential registration, AML/CFT obligations, and data protection rules. Foreign-issued stablecoins face particularly high hurdles for distribution in Japan.
  • Market Access: Companies involved in fintech, payments, or blockchain technology may find new market opportunities but must contend with Japan's specific licensing and regulatory framework for issuers and intermediaries.
  • Supply Chain: As digital currencies become more integrated, they could impact supply chain finance and transaction processes.

Conclusion: A Regulated Path Forward

Japan is charting a deliberate course in the digital currency era. By establishing a clear regulatory framework for fiat-backed stablecoins under the Payment Services Act and carefully exploring a two-tier CBDC model, the country aims to foster innovation while mitigating risks related to financial stability, user protection, and illicit activities.

The distinction between regulated "Electronic Payment Instruments" and crypto-assets, the restricted licensing for issuance, and the robust AML/CFT requirements underscore a cautious yet forward-looking approach. While challenges remain, particularly concerning data privacy, interoperability, and the practical economics of operating under the new regulations, Japan's early moves provide a valuable case study in how a major economy is adapting to the future of money. For international businesses, staying informed about these regulatory nuances and technological developments will be key to navigating the evolving Japanese financial system.