Crypto currencies: Experience in Japan: Digital financial assets - OECD workshop 15-16 May 2018

1. Crypto Currencies
Experience in Japan
Yuko Kawai
Bank of Japan
General Manager Europe and Chief
Representative London
OECD, 15 May 2018 Paris, France.

2. March 2018
Bank of Japan
Payment and Settlement Systems Department
FinTech Center
Crypto Currencies
Experience in Japan

4. Where does Japan stand?
• Crypto Exchanges are ALLOWED to operate by
registration, however, we do NOT deem
Cryptos the legal tender
― Exchange should comply with AML standards
• Practical use of Crypto is so far limited
1. Medium of exchange : some retailers accept but
not much in use
2. Measurement of value : not used
3. Store of value : focus on speculation of price-rise

5. Do they have the “credibility”?
• Credibility of FIAT currencies are from;
―Credible issuer (or the secured collateral)
―Stable value
―Legal enforcement in payment (LEGAL TENDER)
• Crypto currencies, in most cases;
―No issuer
―Value is not stable
―Not enforced by laws
While bookkeeping is made immutable and provable
by technologies (Blockchain/DLT)
5

6. Value Fluctuations
• Market value of Cryptos surged in 2017
through on-exchange and OTC activities
6

7. What happened in 2017 (1) ICO
• Many new Cryptos were issued against
existing Cryptos (boom of Initial Coin Offering)
7
(source) CoinMarketCap.com

8. Non-bitcoin prices surged
• Especially Ethereum (popularly used to pay in
ICOs) gained momentum
0
10000
20000
30000
40000
50000
60000
17/1 17/4 17/7 17/10 18/1 18/4
bitcoin
ethereum
nem
ripple
（source）coimarketcap
Prices（Jan/2017＝100）

9. What happened in 2017 (2) Bitcoin fork
• Bitcoin “forked” due to the diverging opinions
in the community. Price rose after the initial
fork, which reinforced the confidence
9
(source) CoinMarketCap.com

10. What happened in 2017 (3) Retreat of China
• Breakdown of trading currencies vs. Bitcoin
has changed significantly as of Jan 2017
10

11. 2018 started with the price correction
• (Omen of) introducing/tightening regulations
• Large theft of Crypto from a Japanese
exchange in January
11

13. Are they usable?
• Use cases
―Less expensive remittance (esp. for X-border)
―More reliable storage of value (e.g., inflation)
• Issues?
1. Theoretical value is not measurable
2. Security of infrastructure has a room to improve
3. Regulations and technical measures to prevent
frauds/crimes required
4. Limitations of technologies

14. 1) Theoretical value of Cryptos
Asset
Price
Intrinsic
Value (-) Supply
discount
(+) Demand
premium
= +
• For equities, issuing
company’s future
profits/value of assets
• For bonds, issuing company’s
credit risk
• For currencies, issuing
country’s credibility, inflation
• Premium when future price
rise is expected
• Premium when supply is
limited against strong
demands
14
Do people see the economic value in Crypto to be
used to store value or to make payments? If not,
Intrinsic value must be zero

15. 2) Causes of theft (including hypothesis)
• Crypto Currencies were transferred out of the
wallet held by the Exchange
―Exchange is registered as the holder on blockchain
while economic value belong to Exchange’s clients
• It is presumed that the encryption key to access
the wallet had been stolen
―Key was kept on-line ( “hot wallet”)
―Large sum of crypto was kept in one wallet
―Multi-signature system, which requires multiple keys
to access the wallet, was not used
⇒ Not enough security for the sake of usability?
15

16. Exchange CEx
ＣEx
Wallet
CEx clients
Causes of theft (including hypothesis)
[1] Confirmation of outstanding
[2] Informing the remittance
[3] Verification of transaction data,
update of ledger, agreement within
the network
[4] Confirm the
remittance
Value transfer
transaction data
Update
Blockchain mining network
Distributed Ledger
16
Thief
Mallory
Mallory
Wallet
Using the encryption key to access
crypto coins in CEx’s wallet, Mallory
informed the blockchain network to
verify the value
Blockchain network
verified the value
transfer as if the
message were sent
by true CEx

17. FAQ
• Will thefts/hackings of cryptos be repeated?
⇒ Yes. Users must be given the information
regarding the security level of wallets
• Should users be protected?
⇒ Balance of “freedom of contacts” and
“protection”
17

18. 3) Regulatory framework for VC exchanges
• Requirement of registration with JFSA
• Duties of virtual currency exchanges
― provide information to users
― establish proper cyber security
― segregate the clients’ cash/virtual currencies
― set the capital exceeding the minimum
requirement
― receive the inspection of governance, compliance,
risk management, financial soundness et al.
18
The exchange of January 2018 incident was of a “deemed
registration” status (grandfathering status till the completion of
registration review). Seven exchanges were given administrative
punishment through the inspection conducted in February by FSA

19. International coordination required?
• Measures to prevent Anti-money-
laundering are required (FATF framework)
• Framework to recover the hacked cryptos
― international treaty?
― Need to define the legal nature universally?
Measures (legal or practical) must be discussed in accordance with
the expansion of participating community/value

20. 4) Technological issues (all chains)
• Scalability, Processing speed
―Real-time/large-volume applications may not be
processed timely
• Cyber security
• Data privacy
―Encryption is not immune forever
• Interoperability
―How to connect different chains at what timing
20

21. Technological issues (public chains)
• Lack of Finality
• Cost of proof
―Electricity
• Governance
―Who determines what in the troubled water
• Power balance and incentives
―Exchanges, large miners vs. technology
developers’ community
21

22. Technological issues (private chains)
• Single point of failure
―If a leading node or a node with the special role
were broken
• Byzantine Generals Problem
―If a leading, or a major node were malice
―⇐ Practical Byzantine Fault Tolerance solution
(not practically scalable)
• Participation is not freely admitted
22

23. Questions
• Does it really need to be “block” and/or
“chained”?
―Many use-cases simply require shared ledger or
common database
―Some types of “blockchains” are neither blocked
or chained
• Does it need to be “distributed”?
―One-company operations or a small-consortium
transactions may better be centralized
23

25. Possible Benefits
• Utilizing up-to-date information technologies
towards the more efficient ecosystem
(reducing the cost of cash handling)
• Providing risk-free tools once digital payment
becomes dominant
• Big question mark on “flexible monetary
policy” argument
25

26. Issues
• may affect private initiatives of digital
innovation
• may impact financial intermediation through
banks by squeezing bank deposits
• might cause drastic shift from commercial
bank deposits and accelerate liquidity
shortage at stressed circumstances
• require strong cyber security
• usage of collected data
26

27. Bank of Japan studies Blockchain
• Co-study of DLT with European Central Bank,
for the usability of DLTs as financial market
infrastructure
―Promising results, however, given the relative
immaturity of the technology, DLT is not a solution
for large-scale applications at this stage
• Conducting researches or forums on various
subjects, such as AI and encryption
• FinTech center facilitates information
exchanges both internally and externally
27