Inspection of Japan Crypto Exchanges Reveals Loose Business Practices

Onsite inspections of 16 licensed cryptocurrency exchanges and 7 with licenses pending in Japan has revealed generally loose business practices and controls, according to a report released last Friday by the Japanese Financial Services Agency (FSA).

The inspections were conducted by the FSA in cooperation with Japan’s Consumer Protection Agency and the National Police Agency.

Japan was the locus of two of the most notorious cryptocurrency exchange hacks in history, and the report refers to these.

The first was the $450 million Mt Gox exchange hack in 2014 and the second was the $500 million Coincheck hack that occurred in January.

Crypto trading is big business in Japan. According to the Japan Times, in January of this year,  56.2 percent of bitcoin trades involved the Japanese yen.

Japan’s FSA has had a team dedicated to monitoring crypto exchanges in place since August 2017.

The FSA’s latest report on the state of crypto exchanges in Japan has found:

  • “arbitrary price manipulation”
  • “improperly-registered traders”
  •  “75% of the exchanges have less less than 20 employees”
  • “few executives and employees manage large amounts of user assets.”
  • “on average, one person handles assets under custody of 3.3 billion yen (approx. $29 million USD)”

The report also found that, generally-speaking, exchange operations had failed to scale appropriately in response to last year’s boom in user demand. “Corporate Auditors lacked personnel to carry out their duties,” says the report, and boards were understaffed.

Operations were otherwise amateur: “Many (exchange operators and staff) lack knowledge of the financial industry… in detail…” and the agency found few staff with,  “knowledge of risk management as a financial industry.”

They also found, “Low consciousness of user protection and spirit of legal compliance such as not performing minimum internal controls.”

As well, “Management information and financial information are not publicly announced to users,” and management and ownership tended to overlap.

“Management meetings were held, but minutes not recorded…(and) contents of the proceedings, conference materials, minutes etc,” were not saved.

On the other hand, the report found, “large expenditures for advertising rather than internal management,” and even though, “the number of users has increased sharply and the maintenance of the internal control systems can not catch up, (companies) continued aggressive advertisement,” including televison ads and celebrity endorsements.

A number of the exchanges have been ordered, “to establish an effective internal control system such as system safety management.”

Others have been issued warning letters where an “improperly-registered trader” has been identified.

The FSA crypto exchange inspection division also gave, “business improvement orders and business suspension orders to dealers whose problems are known.”

The regulator has also, “refused registration for one deemed trader,” and, “Also during this time, from 12 deemed dealers, (we received) 4 intention to withdraw registration applications…”

The FSA will conduct follow up inspections and, “Based on the results of the compilation of the report…(regarding) business improvement order(s)… will verify individually and judge whether to register (an applicant exchange.”

American crypto exchange Kraken company shut down its Japan operations this May, stating it had, “failed to gain significant market share (there after perhaps)…focus (ing) too much on regulation and not enough on marketing.”

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