KOREA CAPITAL MARKET INSTITUTE

Introduction

Major global economies including the US and EU are improving the regulatory framework to invigorate and internationalize the digital asset market. Prime examples of such a framework are the Proposal for the Markets in Crypto-Assets (MiCA) regulation of the EU and the Bill for the Responsible Financial Innovation Act of the US (the Lummis-Gillibrand bill). In the Asian region, key nations are also striving to nurture the digital asset market by ensuring orderly market transactions. The common feature found in those major economies is that they have implemented policy measures to activate the digital asset market by establishing a reliable regulatory framework. The US imposes strict restrictions on any fraudulent activities by applying unfair trading provisions under the Securities Exchange Act and the Commodity Exchange Act, during the process of legislation related to digital asset markets. Japan has devised regulatory measures to ban unfair digital asset trading through the reform of its Financial Instruments and Exchange Act, which has given a quick fix to a relevant regulatory gap.

Korea’s unfair trading regulation on digital assets falls behind other advanced countries, as evidenced by its absence of proper legislation and regulatory void. Currently, a fraudulent act involving digital asset transactions could be punished for fraud pursuant to the Act on Door-to- Door Sales, the Act on the Regulation of Conducting Fund-Raising Business Without Permission, the Criminal Act or the Act on the Aggravated Punishment of Specific Economic Crimes. These laws may be effective in punishing over-the-counter transactions including multi-level sales and a Ponzi scheme to some extent. However, they have limitations in combating unfair trade practices that arise from massive transactions on exchange and automated on-chain transactions executed by smart contracts. To overcome such limitations, a special fraud regulation should be established to categorize unfair trade practices in the digital asset market and alleviate the burden of proof. Hence, the digital asset law aimed at imposing unfair trade regulatory provisions should be promptly enacted. Against this backdrop, this article analyses what impedes the enactment of digital asset regulations, explores a solution to the regulatory void and presents the expected effects of the related legislation.


Factors behind delayed enactment of the digital asset law 

In Korea, more than 10 bills designed to regulate unfair digital asset transactions are currently pending in the National Assembly but the legislative process has made little progress. The first bill including provisions banning unfair digital asset trading was already proposed to the 21st National Assembly on June 16, 2020.¹⁾ Since then, the digital asset law has not been fully discussed and its legislation has been delayed for a longer period. The legislative delay is attributed to the complex and diverse nature of the digital asset market, the expertise required for digital asset transactions and the dilemma between promotion and regulation of the sector.     

The digital asset market has become larger and more complicated and undergoes dramatic changes by immediately embracing technical innovation. This trend has resulted in the rapid growth of DeFi (Decentralized Finance), the launch of new products like NFTs, and the emergence of new organizations such as the DAO (Decentralized Autonomous Organization). It seems extremely difficult to create a highly-advanced regulatory framework by applying quick changes in the digital asset market to the legislative process. The legislative limitations arising from complicated and diversified features of innovative technology industries are commonly observed in emerging technology-related sectors.²⁾ 

Furthermore, policymakers’ expertise and public understanding are required for the establishment of the digital asset law, which has also deterred prompt enactment. It is difficult for the government to recruit experts and create a dedicated body for regulating and fostering digital asset transactions within a short period. The Korean government has formed a task force team on the digital asset market for legislative and policy consultation and has continued to launch many research projects related to digital assets. Notwithstanding such efforts, several procedures and a lot of time are required to come up with a comprehensive bill that could govern the rapidly changing and technically advanced digital asset industry and market. Additionally, lawmakers who represent the will of the people also need procedures and time to gain a basic understanding of the digital asset law and accept a diversity of opinions.         

Another deterrent to the prompt enactment is the argument that the digital asset market regulation bill should include provisions to promote the digital asset market and industry. The digital asset market must be developed as it could serve as a future growth engine for the Korean economy. Major global economies have also implemented a wide range of policy measures to promote the sector but they hardly attempt to integrate regulatory and promotion measures for the digital asset market into a single bill. The EU’s MiCA regulation seeks to guarantee investor protection and maintain market credibility while bills and policies for facilitating the digital asset industry are being separately prepared. While engaging in discussions about various policy measures to improve the digital asset industry, Japan has recognized securing market credibility as a top priority and decided to address the regulatory void regarding unfair digital asset trading by revising the Financial Instruments and Exchange Act. Enacting a comprehensive digital asset industry promotion law is a time-consuming process as it necessitates public recognition of economic benefits and social value of the industry and national consensus on specific promotion measures. On the other hand, as unfair digital asset transactions cause serious social problems, the public opinion agrees on the need for regulating such practices. Hence, the need and urgency for the minimum level of digital asset regulatory measures are greater than that of promotion bills.   


How to address delayed enactment of the digital asset law

To fill a regulatory gap in the digital asset market and boost market credibility, Korea should single out provisions that are common and highly important in digital asset bills pending in the National Assembly and turn them into law by priority. In addition, it is necessary to make a priority list of legislative initiatives and formulate a legislative roadmap for harmonizing regulation with promotion measures. One of the prominent public law scholars in Korea claims that the “Fourth Industrial Revolution-related legislation should take the step-by-step approach.”³⁾ Accordingly, the digital asset market-related bills should be legislated step-by-step by giving priority to provisions that are commonly mentioned by legislators and urgently needed by the public. In this respect, the regulation on unfair digital asset trading should take priority over other measures. 

In terms of the necessity of legislation, unfair trading regulations are affected most severely by a regulatory gap in Korea’s digital asset market. As major digital assets are primarily traded on virtual asset trading platforms (the so-called virtual asset exchanges), the disclosure system (including a white paper) could be operated as part of administration of listed assets by the virtual asset exchanges. However, unfair trade practices cannot be left to self-regulation because they should be controlled by governmental forces. Major global economies including the US and Japan have established relevant statutory provisions for regulating unfair digital asset transactions, albeit with different effects, while Korea has no such provisions at all. This means unfair digital asset trading should be punished as fraud pursuant to the Criminal Act or the Act on the Aggravated Punishment of Specific Economic Crimes. But the problem lies in the difficulty of proving the corpus delicti of fraud. To punish fraud, prosecutors should prove subjective and objective elements of the fraud and the causal relationship between the offender’s deception and the victim’s misunderstanding and an act of disposition beyond a reasonable doubt. Notably, the principal suspect of the Terra/Luna crypto crash argued that he never intended to commit fraud, saying that “[t]here is a difference between failing and running a fraud”.⁴⁾ Since it was hard for prosecutors to get an arrest warrant for the suspect on charges of fraud, the warrant was issued for violating the ban on unfair trade practices under the Financial Investment Services and Capital Markets Act (the “FSCMA”). If Luna cannot be defined as a security under FSCMA, the Act would not be applicable and thus, the prosecutors will be in trouble substantiating allegations of fraud. The regulation on unfair trade practices of digital assets is needed to meet the challenges arising from such a regulatory gap.       

In terms of the commonality among legislators, the ban on unfair trade practices is found in most of digital asset bills pending in the National Assembly. These bills prohibit digital market participants from engaging in price manipulation, use of undisclosed material information and unfair trading. This suggests lawmakers may be divided on how to promote the digital asset industry, whereas they agree on the need for banning and punishing unfair digital asset transactions, regardless of social and political views.


Conclusion: expected effects of the legislation

Considering that a regulatory gap concerning unfair digital asset transactions needs to be resolved and relevant bills submitted to the National Assembly have unfair trading provisions in common, the digital asset law with such provisions should be enacted promptly. It is also notable that the US, Japan and other major economies have already established statutory provisions required to punish unfair trading of digital assets. If the digital asset law aimed at regulating unfair trade practices is enacted as the first step, the following benefits could be achieved.      

First, it would have the effect of strong ex-post enforcement against unfair trade practices that are prevalent in the digital asset market. It was reported on November 2, 2022 that the Korea Financial Intelligence Unit (KoFIU) detected price manipulation based on cross trading by domestic digital asset issuers. It is noteworthy that the “KoFIU happened to uncover the misconduct during its investigation into digital asset service providers”.⁵⁾ Given that it is a supervisory body of which the main purpose is to prevent money laundering, it is easy to imagine that there are quite a few cases that are meticulously planned and slip from the grip of the law. Also notable is the fact that the number of cases caught by authorities involving use of undisclosed material information and unfair trading is similar to or higher than that of price manipulation cases in the stock market.⁶⁾ This suggests use of undisclosed material information and unfair trading are also extensively committed in Korea’s digital asset market. Considering the prevalence of unfair trade practices in the digital asset market, the ex-post enforcement effect of the digital asset law is anticipated to be significant.          

Second, the digital asset law could help prevent unfair digital asset trading by demotivating potential offenders. Most actors of unfair trading on digital asset markets are essentially economic offenders seeking illicit gains. The offender usually commits misconduct when criminal proceeds exceed punishment costs (the possibility of being punished multiplied by the penalty level). Accordingly, the low possibility of punishment could make related misconduct become rampant. If relevant unfair trading provisions are enacted, they could proactively inhibit unfair trade practices by driving up punishment costs.    

Third, moral hazards induced by an unfair trading regulatory gap could be alleviated. Provisions regarding unfair trading serve as the minimum standard for maintaining the market order. The lack of unfair trading regulations has made market participants less aware of the minimum ethical codes to be observed in the digital asset market. The digital asset law containing unfair trading provisions is expected to strengthen market participants’ sense of ethics concerning corporate disclosure and prohibition of unfair trade practices, thereby reducing the occurrence of moral hazard-induced misconduct. If digital asset service providers draw up a code of ethics by referring to regulatory measures of unfair trading, it would bring about positive effects of setting the definite scope of the service provider’s accountability and increasing the predictability of regulations applicable to a specific practice.       

Considering the expected positive effects of unfair trade regulations specified in the proposed digital asset law, the law focusing on unfair trading should be promptly enacted. Even after the initial legislation focused on unfair trading regulation is completed, the government and the National Assembly should keep working on follow-up legislative initiatives including mandatory disclosure, regulation on service providers, self-regulation, and stablecoins. 
 

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1) The revision to the Electronic Financial Transactions act (proposed by the representative lawmaker Park Yongjin, bill number 2100590, June 16, 2020).
2) Marchant, E.G., Allenby, R.B., Herkert R.J., 2011, The Growing Gap Between Emerging Technologies and Legal-Ethical Oversight: The Pacing Problem.
3) Park, K.S., 2018, Legislative initiatives and response of the legislative branch in the Fourth Industrial Revolution era: With a focus on reform of the legislative approach and system, Journal of Law & Economic Regulation 11(2), 229-247.
4) Forkast, June 24, 2022, Terra CEO Do Kwon denies allegations of fraud (quoting Do Kwon’s interview with The Wall Street Journal)
5) Seoul Wire, November 2, 2022, “Kimchi coins” of which price has quadrupled are alleged to engage in price manipulation (quoted from KoFIU’s “Request for attention and cooperation regarding digital asset cross trading). 
6) Among a total of 274 unfair trade cases submitted for the resolution by the Securities and Futures Commission of the Financial Services Commission for five years between 2017 and 2021, use of undisclosed material information accounts for the largest proportion (43.4%), followed by illegal trading (29.6%), price manipulation (23.4%), and disturbance of market order (3.6%) (Financial Services Commission, September 23, 2022, Measures to Strengthen Capacity to Respond to Unfair Trade Practices in Capital Markets, press release, p.3).