South Korean Financial Regulator Vows to Take Innovation into Account for Crypto Regulations

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Working Towards A New Framework for Secure and Regulated Cryptocurrency Transactions

South Korea’s Financial Services Commission is introducing the Virtual Asset User Protection Act, effective July 19, 2024, focusing on regulating cryptocurrencies to safeguard investor interests.
The Act defines virtual assets, excludes certain digital forms like NFTs and CBDCs, and mandates stringent measures for VASPs, including separate storage of customer funds and investment limitations for custodian banks.
Enhanced security protocols require VASPs to store over 80% of virtual assets in cold wallets and establish insurance or reserves for crisis management, aiming to bolster market integrity and consumer protection in the crypto sector.

South Korea is reinforcing its stance on cryptocurrency regulation with the introduction of the Virtual Asset User Protection Act, scheduled to take effect on July 19, 2024. This Act, proposed by the Financial Services Commission (FSC), aims to balance innovation in the crypto sector with stringent measures for protecting virtual asset users.

It addresses the growing need for a secure and regulated digital asset market in South Korea, especially in light of recent challenges and the evolving landscape of virtual currencies.

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What is the Virtual Asset User Protection Act of South Korea?

The Act provides a clear definition of virtual assets, which are characterized as electronic tokens with economic value that can be traded or transferred electronically. It notably excludes specific categories from its scope, such as game money, electronic stocks, electronic bills, central bank digital currency (CBDC), electronic bonds, mobile gift certificates, deposit tokens linked to CBDC, and non-fungible tokens (NFTs). This demarcation is crucial for understanding the regulatory perimeter and ensuring that emerging digital asset forms, like NFTs, are aptly considered.

A significant feature of the Act is its focus on safeguarding user deposits and enhancing market integrity. Virtual asset service providers (VASPs) are mandated to manage and securely store their customers’ deposits and virtual assets. In doing so, VASPs must separate customers’ funds from their own and deposit them with credible financial institutions, primarily banks. These custodian banks are permitted to invest these deposits only in safe assets such as government bonds. Additionally, VASPs are obligated to pay fees to their customers for using these deposits, considering their operating profits and costs.

To bolster security against potential cyber threats and hacks, the Act requires that over 80% of users’ virtual assets be stored in cold wallets. This is a substantial increase from the previous requirement of 70% for acquiring an ISMS certificate under existing financial transaction laws. Cold wallets, being offline, offer a more secure storage option for digital assets, thereby significantly reducing the risk of cyberattacks.

Responsibilities of VASPs According to FSC

The FSC has also outlined responsibilities for VASPs in terms of crisis management. VASPs must have insurance or mutual aid arrangements or accumulate reserves to cover incidents such as hacking or system failures. These measures are intended to ensure accountability and enhance the resilience of the virtual asset ecosystem.

Additionally, the Act sets guidelines for disclosing material nonpublic information, tailored to the unique characteristics of the virtual asset market. It also restricts VASPs from arbitrarily blocking deposits and withdrawals, providing a framework that upholds user rights and ensures market integrity.

The Virtual Asset User Protection Act in South Korea is a notable development in the global context of digital finance. It illustrates the country’s commitment to creating a balanced regulatory environment that fosters innovation while safeguarding the interests of investors and users in the crypto market. As such, it sets a significant precedent for other nations grappling with the challenges of regulating digital assets and cryptocurrencies.

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