One Month After the Korean Act on the Protection of Virtual Asset Users: What's Changed?
AVAIL
TL;DR
- South Korea's Act on the Protection of Virtual Asset Users was implemented in July 2024. It enhances investor protection, mandates interest payments on deposits, and strengthens anti-fraud measures.
- The effects on the market include fierce competition between exchanges and crypto projects reviewing their internal control capabilities, but price manipulation incidents such as the $AVAIL case still remain.
- In the long-run, South Korea's regulatory model may influence global regulations, foster new compliance-related businesses, and attract more investors by increasing market stability and transparency.
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1. Key Takeaways from the New Cryptocurrency Regulation
The Korean government's approach to regulating virtual assets has evolved considerably since the initial ban in 2018, culminating in the integration of virtual assets into the current regulatory framework. A pivotal moment in this transition was the enactment of the Act on the Protection of Virtual Asset Users on July 19, 2024, which underscored a heightened emphasis on investor protection.
This regulatory shift was driven by persistent issues of arbitrage, fraud, and illegal solicitation, which the existing anti-money laundering-focused framework failed to address adequately. Incidents involving illegal rebate practices exposed significant regulatory gaps, highlighting the critical issue of "Fairness" within the Korean virtual asset market and underscoring the need for enhanced investor protection.
In response, the Act on the Protection of Virtual Asset Users aims to safeguard domestic virtual asset investors and promote market integrity. The legislation encompasses four key provisions:
- Clarifies the scope of crypto assets: Defines crypto assets as "electronic representations of economic value" and excludes some assets, such as NFTs and CBDCs, from regulation.
- Mandatory payment of interest earnings from customer deposits: The law requires cryptocurrency operators to pay interest earnings from customer KRW deposits to customers.
- Requirement to purchase insurance and accumulate reserves in case of accidents: The law strengthens the protection of customer assets by requiring insurance and accumulating reserves in case of accidents such as hacking and failures.
- Strengthening regulation of unfair trading behavior: Specific penalties have been established for insider trading and market manipulation, prohibiting the suspension of deposits and withdrawals without just cause, and requiring cryptocurrency operators to establish a system for monitoring and reporting suspicious transactions.
These measures are intended to enhance the transparency and stability of the cryptocurrency market and protect users. However, certain ambiguities persist that require further improvements in the future. Against this backdrop, it is crucial to examine how the market has evolved in the month since the law's enactment.
2. Impact: One Month into the New Regulation
Of the four key points of the newly enforced Act on the Protection of Virtual Asset Users, the most significant impact on the South Korean cryptocurrency market has been 1) the mandatory interest payment and 2) the strengthening of regulations against unfair trade practices.
The mandatory payment of interest income has forced crypto operators to distribute interest on customer deposits to investors, which was previously their source of revenue. The tightening of regulations on unfair trading behavior is expected to have a significant impact on market health and transparency. Unfair trading behaviors that have been practiced by many investors are now subject to strong regulation. Of course, not all unfair trading practices are eliminated, but efforts to eradicate them are ongoing.
2.1. Interest rate wars on exchanges
The mandatory payment of interest is unique in the global cryptocurrency market. While it is common to pay interest on stablecoin deposits, paying interest on fiat deposits is a global rarity. This is due to Korea's unique on/off ramp method.
In South Korea, trading KRW on exchanges requires obtaining a "real-name account" with a bank under the Specified Financial Information Act (Special Account Act). Unlike other countries that use various methods, including linking to real-name accounts, South Korea mandates direct real-name account linking as the sole method to trade crypto on centralized exchanges. This requirement makes the payment of interest on deposits inevitable.
Source: Tiger Research
On July 19th and 20th, shortly after the enforcement of the Act on the Protection of Virtual Asset Users, South Korea's top five exchanges engaged in a fierce interest rate competition. Starting with an initial 1% interest rate announcement, the rate was increased to 2% within a day, and Bithumb temporarily announced a 4% interest rate.
This competition may stem from past experiences with real-name accounts. Bithumb, the market leader at the time, chose Nonghyup Bank, a traditional bank that was relatively difficult to open accounts non-face-to-face. Upbit, on the other hand, selected KBank, a digital bank that allowed for quick, non-face-to-face account opening, which has played a significant role in its current dominance. For Bithumb, which has seen its market ranking fluctuate due to regulatory changes in the past, this aggressive move of setting high interest rates represents a strategic effort to regain its leading position.
Currently, the benchmark interest rate in South Korea is 3.50%, while the average interest rate for a deposit account at a regular bank is 2.07%, and the average interest rate for a CMA account at a securities company is 3.14%. In comparison, exchanges are competing quite aggressively with higher interest rates.
Source: Dunamu
This competition is feasible because the financial burden has been shifted to the banks linked to the exchanges, not the exchanges themselves. As of last year, Upbit's customer deposits amounted to $2.9 B, and with an interest rate of 0.1% from KBank, it is estimated to have earned approximately $29.2 M in interest income alone.
However, with the implementation of the new law, the cost burden for KBank will increase dramatically as exchanges raise their interest rates. At a 2% rate for Upbit, the interest expense would increase nearly twentyfold. This structure allows exchanges to offer significant benefits to customers without incurring substantial costs themselves.
Given Upbit's 2023 revenue of $0.89 B, the interest income, although substantial, represents a small percentage of the total revenue. Therefore, exchanges are leveraging this strategy to attract and retain customers effectively.
2.2. $AVAIL, 1,335% Gap in Korea only
Source: Kaiko
While cryptocurrencies typically experience a "kimchi premium" after being listed on local exchanges, $AVAIL saw an unusually large price gap.
Source: Bithumb
The price difference between Bithumb and Bybit reached a staggering 1,335%. One user acquired $AVAIL via X (formerly Twitter) from overseas investors who did not have access to domestic exchanges and then sold it in bulk on Bithumb for a significant profit.
Source: Subscan
Our analysis of transactions associated with the mystery user revealed that 113 addresses transferred 1.2 million $AVAIL and were repaid 2.49 million $AVAIL in return, averaging a 2.07x return per user. Mystery User earned approximately $760,000 in revenue through arbitrage fees.
The incident highlighted several critical issues related to the Act on the Protection of Virtual Asset Users, including price manipulation, market disruption through large-scale selling, and the responsibility of exchanges to monitor irregular transactions. Additionally, it raised legal concerns about the sale of coins on behalf of foreigners without access to local exchanges and the potential for money laundering.
Ultimately, this case emphasizes not only the importance of strict regulation but also enforcement. We need more than just institutionalization; we need enforcement that effectively sanctions such behavior.
2.3. Internal control policies in full swing
Since the enforcement of the Act on the Protection of Virtual Asset Users, numerous token issuance projects and exchanges have been reviewing their internal control policies through legal assessments and advancing their compliance measures. Projects with tokens, in particular, often have access to the same or more information than those within exchanges. Consequently, projects operating in Korea are striving to adapt to the new regulatory environment and prevent unfair trading behavior. However, they still face significant challenges in ensuring the effectiveness of their internal control policies.
A key issue is that many projects lack a dedicated compliance team, making it difficult to implement professional and systematic internal controls. Additionally, the inherent nature of blockchain technology complicates the identification of individuals based solely on wallet addresses. This presents challenges in identifying and sanctioning those responsible for unfair trading behavior. Currently, the primary response consists of imposing sanctions during the on/off ramp phase of an exchange after an issue has occurred, which is a reactive rather than proactive approach.
Despite these challenges, projects are actively working to strengthen internal controls in various ways. They are developing systems to detect and analyze anomalous transactions and conducting training programs for employees to raise awareness about suspicious trading and the importance of complying with applicable laws and regulations. Furthermore, they are consulting with legal and compliance experts to enhance their internal policies and collaborating with exchanges to ensure swift responses to anomalous transactions.
These efforts are still in their early stages, and it is premature to judge their overall effectiveness. However, they are viewed as an important first step towards increasing transparency and trust in the cryptocurrency markets. As technology advances and regulations are refined, more effective internal controls are expected to be implemented, contributing to a more secure and trustworthy environment for virtual asset users.
3. Impact on the Korean and Global Markets
The implementation of the Act is expected to bring about significant changes in the Korean cryptocurrency market and beyond from a global perspective. South Korea's regulatory model will serve as an important reference for other countries, and its unique policies, such as the mandatory payment of interest on deposits, will attract global attention. This can not only influence regulators in other countries to design regulations tailored to their own circumstances but also bring new topics to the global regulatory standardization debate.
The crypto industry ecosystem is also likely to undergo significant changes. New business models around compliance are expected to emerge, such as transaction monitoring solutions and consulting services to assist with regulatory compliance. Existing projects will respond to the regulations by strengthening internal control systems and increasing transparency, which could lead to overall industry maturation.
While some concerns have been raised that these regulations might stifle market growth, in the long run, they could act as a catalyst to bring more investors into the market. Greater investor protection and market stability will increase confidence in the cryptocurrency market, thereby promoting healthy growth.
Going forward, it will be important to continuously monitor the effectiveness of the regulations and the market's response, and to adapt flexibly to technological advancements and market changes. This will give South Korea the opportunity to take a leading position in the global cryptocurrency market. Consequently, the implementation of the Act is expected to have a significant impact not only on the domestic market but also on the global cryptocurrency ecosystem, presenting both new challenges and opportunities.
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