Japan Strengthens DeFi Regulations — A Structure Where "
The move by the world's third-largest economy to impose KYC/AML obligations on DeFi will determine the direction of global crypto asset regulation and serve as a watershed moment for the life or death of Web3 innovation originating from Japan.
── Understand in 3 points ─────────
- • The Japanese government has announced a policy to strengthen KYC (Know Your Customer) and AML (Anti-Money Laundering) regulations for DeFi (Decentralized Finance) projects starting in early 2026.
- • The Financial Services Agency (FSA) is considering imposing transaction monitoring obligations on DeFi protocol operators through amendments to the Payment Services Act and the Financial Instruments and Exchange Act.
- • On X (formerly Twitter), concerns that stricter regulations will stifle innovation are widely debated, primarily among crypto industry stakeholders.
── NOW PATTERN ─────────
Japan's DeFi regulation is a structural pattern where "regulatory capture," in which the Financial Services Agency (FSA) attempts to force emerging technologies into existing financial regulatory frameworks, intersects with a "backlash" from the bureaucracy against innovation promotion measures since 2017.
── Probability and Response ──────
• Base case 55% — The FSA begins public comments on the direction of legal amendments, the LDP Web3PT proposes "gradual introduction" of regulations, major domestic exchanges announce the provision of DeFi-related services.
• Bull case 20% — The LDP Web3PT presents concrete counter-proposals, the FSA officially begins considering "gradual regulation," influential overseas DeFi projects announce entry into Japan.
• Bear case 25% — FATF points out deficiencies in crypto asset regulation during its review of Japan, a large-scale DeFi-related incident occurs domestically, reports emerge that the FSA is considering ISP-level access restrictions, major Web3 startups announce relocation overseas.
📡 The Signal — What Happened
Why it matters: The move by the world's third-largest economy to impose KYC/AML obligations on DeFi will determine the direction of global crypto asset regulation and serve as a watershed moment for the life or death of Web3 innovation originating from Japan.
- Regulatory Trends — The Japanese government has announced a policy to strengthen KYC (Know Your Customer) and AML (Anti-Money Laundering) regulations for DeFi (Decentralized Finance) projects starting in early 2026.
- Regulatory Trends — The Financial Services Agency (FSA) is considering imposing transaction monitoring obligations on DeFi protocol operators through amendments to the Payment Services Act and the Financial Instruments and Exchange Act.
- Industry Reaction — On X (formerly Twitter), concerns that stricter regulations will stifle innovation are widely debated, primarily among crypto industry stakeholders.
- International Comparison — In the EU, MiCA (Markets in Crypto-Assets Regulation) will be fully enforced by the end of 2024, and Japan's move follows this trend.
- International Comparison — In the US, the SEC is strengthening enforcement actions against DeFi protocols, aligning with Japan's regulatory policy.
- Market Environment — Domestic crypto asset exchanges in Japan already operate under strict KYC/AML regulations, and DeFi regulation is positioned as an extension of this.
- Technical Challenges — DeFi protocols are inherently decentralized structures without administrators, making it technically and legally difficult to identify "operators" who would be subject to traditional regulation.
- FATF Trends — Since 2023, FATF (Financial Action Task Force) has recommended that countries expand the definition of Virtual Asset Service Providers (VASPs), including DeFi protocols, and Japan's regulatory tightening is also a response to this international pressure.
- Industry Impact — Some Japanese Web3 startups are considering relocating to jurisdictions with looser regulations, such as Singapore or Dubai, due to the regulatory environment.
- Political Background — The Liberal Democratic Party's (LDP) Web3 Promotion Project Team advocates for a balance between regulation and innovation, but there is a difference in approach compared to the FSA's regulatory inclination.
- Market Data — The domestic DeFi-related TVL (Total Value Locked) in Japan is estimated to be around $5 billion, accounting for approximately 3-4% of the global market.
- Legal Framework — Under current law, DeFi protocol smart contracts themselves have been considered outside the scope of regulation, but the application of regulations to front-end providers and governance token holders is being debated.
The Japanese government's move to strengthen DeFi regulation is rooted in a complex interplay of the country's historical DNA of financial regulation, international regulatory trends, and bitter experiences surrounding crypto assets.
First, in a historical context, Japan was a "pioneer" in crypto asset regulation. The 2014 Mt. Gox incident — where the then-largest Bitcoin exchange in the world lost approximately 850,000 BTC — made Japanese financial authorities keenly aware of the need for crypto asset regulation. In response to this incident, Japan enacted the revised Payment Services Act in 2017, becoming one of the first countries in the world to introduce a registration system for crypto asset exchanges. This "preemptive regulation" DNA is naturally extending to the new domain of DeFi.
The 2018 Coincheck incident (NEM outflow worth approximately 58 billion yen) raised questions about the effectiveness of regulations while also justifying the FSA's path of stricter regulation. Since then, Japan's crypto asset regulation has consistently become more stringent under the banner of "user protection." With stricter registration reviews, mandatory cold wallet management, and enhanced leverage regulations, Japan's regulatory framework has grown into one of the most comprehensive in the world.
However, this strict regulatory environment led to ironic results. The Japanese market, which accounted for approximately 50% of global crypto asset transactions in 2017-2018, saw its share significantly shrink with the tightening of regulations. Many promising projects relocated to jurisdictions with looser regulations, such as Singapore, Dubai, and Switzerland. This is a classic example of "regulatory capture," where existing financial systems attempted to incorporate emerging technologies into their own frameworks, resulting in the structural paradox of innovation itself flowing out of the country.
The international context is also important. Since 2019, FATF (Financial Action Task Force) has expanded the scope of the "Travel Rule" to crypto assets, and in 2023, it recommended that countries strengthen regulations for Virtual Asset Service Providers (VASPs), including DeFi protocols. Japan, as a model student of FATF, has a history of faithfully reflecting these recommendations in its domestic laws. The current DeFi regulation is an extension of this.
The full enforcement of the EU's MiCA (Markets in Crypto-Assets Regulation) by the end of 2024 is also pushing Japan's moves. MiCA imposes comprehensive regulations on stablecoin issuers and crypto asset service providers, and its application to DeFi protocols is being considered in stages. In the US, the SEC is strengthening enforcement actions against major DeFi protocols like Uniswap, indicating that the era of DeFi as an "unregulated space" is coming to an end.
Domestic political dynamics in Japan cannot be overlooked. Since 2022, the LDP's Web3 Project Team has put forth an ambitious vision to make Japan a Web3 hub, promoting tax reforms and easing token regulations. However, the FSA's bureaucracy is traditionally conservative and tends to favor stricter regulations under the banner of "user protection." This tension between politicians and bureaucrats will determine the final form of DeFi regulation.
Furthermore, the rapid growth of the DeFi market from 2024-2025 heightened regulators' sense of crisis. The global DeFi market's TVL reached approximately $150 billion by the end of 2025, and its touchpoints with traditional finance (bridges, stablecoins, RWA tokenization) are rapidly expanding. For regulators, DeFi is no longer a "niche experiment" but an entity that can impact financial system stability. This shift in perception is the direct trigger for the current regulatory tightening.
The delta: The Japanese government's strengthening of DeFi regulation is not merely a policy change by one country but part of a global "DeFi regulatory encirclement." However, Japan's unique problem lies in the contradiction that its DNA of excessive regulation since Mt. Gox is being applied to DeFi, a decentralized technology without administrators, thereby imposing technically impossible obligations. This is a rare case where "regulatory capture" and "backlash" are occurring simultaneously, and its outcome will determine the survival of Japan's Web3 industry.
🔍 Between the Lines — What the News Isn't Saying
Officially, "user protection" and "AML/CFT enhancement" are the stated banners for regulation, but the FSA's fundamental motivation is more structural. As DeFi grows and its touchpoints with existing finance expand, the FSA's institutional raison d'être would be shaken if it fails to establish regulatory jurisdiction. Furthermore, while megabanks and major exchanges do not openly advocate for regulatory promotion, the increased barriers to entry due to DeFi regulation strengthen their market dominance, thus forming an implicit support base. What's more, it cannot be overlooked that the LDP Web3PT's "innovation promotion" stance itself might be a strategic move anticipating the distribution of vested interests after regulation — such as the operation of certification systems, consulting demand, and post-retirement positions (amakudari).
NOW PATTERN
Regulatory Capture × Backlash × Path Dependency
Japan's DeFi regulation is a structural pattern where "regulatory capture," in which the Financial Services Agency (FSA) attempts to force emerging technologies into existing financial regulatory frameworks, intersects with a "backlash" from the bureaucracy against innovation promotion measures since 2017.
Intersection of Dynamics
The three dynamics of "regulatory capture," "backlash," and "path dependency" form a self-reinforcing feedback loop in Japan's DeFi regulation.
First, "path dependency" provides the foundation for "regulatory capture." It is precisely because the "operator regulation" paradigm has been institutionally established since Mt. Gox that it becomes possible to forcibly push DeFi into the existing regulatory framework — that is, to "capture" it. If Japan had designed DeFi regulation from a "blank slate" for crypto asset regulation, a more flexible approach tailored to the technology's characteristics might have been adopted. However, given the existence of existing institutional infrastructure, the incentive to utilize it is overwhelmingly strong.
Next, "backlash" justifies "regulatory capture." The bureaucratic reaction against politically-driven innovation promotion reinforces the narrative that "regulation is indeed necessary." Each time a hacking or fraud incident occurs in the DeFi market, this narrative gains traction. And once the need for stricter regulation is recognized, the existing regulatory paradigm — namely, "operator regulation" — emerges as the default option. In other words, backlash accelerates regulatory capture through path dependency.
Furthermore, if the market dominance of existing players (centralized exchanges) is strengthened as a result of "regulatory capture," they will have an incentive to lobby for further regulatory tightening. The stricter the regulations, the higher the barriers to entry, and the stronger the oligopoly of existing players. This positive feedback loop, once initiated, has the characteristic of accelerating autonomously.
At the intersection of these three dynamics lies the question of "the future of Japan's Web3 industry." If regulatory capture progresses, DeFi will be subjugated to the logic of existing finance, and its innovative potential will be neutered. If the backlash becomes excessive, innovators will flow overseas. If path dependency is not broken, rational regulatory design tailored to the technology will not be realized. Whether Japan can escape this triple trap is the essential question for its crypto asset policy.
📚 Pattern History
2006-2010: Japan's Internet Regulation and the Galápagosization of the Mobile Phone Market
Regulatory Capture・Path Dependency
Structural similarities with the current case: The Ministry of Internal Affairs and Communications-led regulation of the mobile phone market strengthened the oligopoly of existing carriers, primarily NTT Docomo, and created a unique ecosystem called i-mode, but it delayed adaptation to the smartphone revolution. As a result of regulations protecting existing players, Japan was left behind in global technological innovation. Similarly, DeFi regulation risks isolating Japan from global DeFi innovation while protecting regulation-compliant domestic players.
2013-2015: Introduction of New York State's BitLicense System
Regulatory Capture・Backlash
Structural similarities with the current case: The BitLicense introduced by New York State in 2015 imposed strict regulations on crypto asset businesses. As a result, many startups withdrew from New York State, leaving only large companies capable of complying with the regulations. While the intent of the regulation was user protection, it effectively led to the outflow of innovation overseas. Japan's DeFi regulation has the potential to replicate this BitLicense pattern at a national level.
2018-2020: China's Comprehensive Ban on Crypto Assets and the Outflow of Mining Operators Overseas
Backlash・Path Dependency
Structural similarities with the current case: China gradually banned crypto asset transactions as a backlash against the 2017 ICO boom, and in 2021, it completely banned mining. As a result, Chinese mining operators largely flowed out to the US, Kazakhstan, Russia, and other countries. This demonstrated that excessive regulation does not eliminate an industry itself but merely relocates it outside the jurisdiction.
2020-2024: EU MiCA Regulation Development and Implementation Process
Regulatory Capture・Path Dependency
Structural similarities with the current case: The EU's MiCA regulation was fully enforced at the end of 2024 after a development period of approximately four years. During this process, lobbying by existing financial institutions and major crypto asset exchanges led to the regulation being designed in a way that favored large corporations. On the other hand, the existence of a clear regulatory framework also enhanced legal certainty for crypto asset businesses within the EU. This is an example showing that the "design" of regulation determines the outcome.
1990s: Japan's Financial Big Bang and its Limitations
Backlash・Path Dependency
Structural similarities with the current case: The Financial Big Bang in the late 1990s aimed to liberalize and internationalize Japan's financial markets, but reforms remained partial due to bureaucratic resistance and the protection of existing financial institutions. Subsequently, after the financial crisis of the 2000s, there was a backlash towards stricter regulation. This 30-year pattern is highly likely to be repeated in DeFi regulation.
Patterns Revealed by History
The patterns emerging from historical precedents are clear. First, regulations for emerging technologies are almost without exception designed in a way that favors existing players. This stems from information asymmetry between regulators and established industries, and a trust bias towards "proven" operators. Second, excessive regulation does not "eliminate" innovation but "relocates" it. As shown by China's mining ban and New York's BitLicense, regulation can change the geographical distribution of an industry, but it cannot stop technological development itself. Third, Japan's unique "backlash" pattern is extremely deep-rooted. From the Financial Big Bang to crypto asset policy, the cycle of "innovation promotion → problem occurrence → regulatory tightening → innovation stagnation" has been repeated. DeFi regulation is the latest phase of this cycle, and past patterns suggest that regulations are likely to be strengthened beyond an "appropriate level." However, as the EU MiCA case shows, the outcome can vary significantly depending on the "quality of regulatory design." Whether Japan can design flexible regulations tailored to the technology will be the key to breaking this cycle.
🔮 Next Scenarios
The FSA will submit amendments to the Payment Services Act and the Financial Instruments and Exchange Act to the Diet in the latter half of 2026, introducing regulations that subject front-end providers of DeFi protocols and major holders of governance tokens to registration obligations as VASPs. However, full enforcement will be delayed until 2027. The specific content of the regulations will include KYC obligations, transaction monitoring, and suspicious transaction reporting obligations, but the development of technical implementation guidelines will take time.
As a result, approximately 30-40% of small and medium-sized domestic DeFi projects will consider relocating their operations overseas, with some actually moving their bases to Singapore or Dubai. Meanwhile, megabank-affiliated fintech subsidiaries and major crypto asset exchanges will begin offering regulation-compliant DeFi services, forming a new category of "regulation-compliant DeFi." Overall, Japan's domestic DeFi TVL will temporarily decrease by 20-30%, but with regulatory clarification, institutional investor participation will increase, and the market will return to a recovery trajectory in 1-2 years.
In this scenario, Japan will take a "middle-of-the-road" approach to DeFi regulation, but there is a risk that sufficient dialogue with the industry will not occur during the regulatory design phase, potentially including technically difficult-to-implement requirements. As a result, while questions about the effectiveness of the regulations remain, the very fact of "having regulations" will ironically enhance Japan's international reputation.
Implications for Investment/Action: The FSA begins public comments on the direction of legal amendments, the LDP Web3PT proposes "gradual introduction" of regulations, major domestic exchanges announce the provision of DeFi-related services.
The LDP Web3 Project Team takes the lead and successfully puts an effective brake on the FSA's regulation-only policy. Specifically, instead of uniformly applying DeFi regulations, a system will be introduced to grant temporary regulatory exemptions to innovative DeFi projects through the expansion of a "regulatory sandbox." Furthermore, "gradual regulation" tailored to technical realities — distinguishing between fully decentralized protocols and those effectively centrally managed — will be adopted.
Additionally, a unique Japanese "Certified DeFi Protocol" system will be established, applying a simplified regulatory framework to protocols that meet certain technical and governance standards. This system is similar to the approaches of Singapore's MAS and Switzerland's FINMA and will be internationally recognized as an advanced regulatory model.
As a result, the inflow of Web3 talent and projects from overseas to Japan will accelerate, establishing Japan's position as a hub for DeFi innovation in Asia. Japan's domestic DeFi TVL will exceed $10 billion by the end of 2027, and related employment will significantly increase. The realization of this scenario requires both political leadership and bureaucratic flexibility, and while the probability is low, it is not impossible.
Implications for Investment/Action: The LDP Web3PT presents concrete counter-proposals, the FSA officially begins considering "gradual regulation," influential overseas DeFi projects announce entry into Japan.
The FSA introduces DeFi regulations as strict as, or even stricter than, initially planned. Specifically, all services providing access to DeFi protocols (front-ends, wallets, aggregators) will be subject to registration obligations equivalent to those for crypto asset exchange service providers, and measures to block access to unregistered services at the ISP level will be considered.
Furthermore, the political legitimacy of regulatory tightening will be strengthened, triggered by FATF's mutual evaluation of Japan pointing out deficiencies in crypto asset regulation. If a large-scale DeFi-related hacking or fraud incident occurs domestically, regulations will be further tightened with public support.
As a result, Japan's domestic DeFi ecosystem will be virtually annihilated. The majority of Web3 startups will relocate overseas, and Japan will fall into a state of "sakoku" (national isolation) for crypto asset innovation. Only major exchanges and bank-affiliated services will remain domestically, and Japan's crypto asset market will become a "monoculture of centralized exchanges." This scenario is a softer version of China's comprehensive crypto asset ban and carries the risk of damaging international trust in Japan's technology industry as a whole.
Internationally, Japan's strict regulations could influence the regulatory policies of other Asian countries (such as South Korea and Taiwan), potentially triggering a chain reaction of DeFi regulatory tightening across Asia.
Implications for Investment/Action: FATF points out deficiencies in crypto asset regulation during its review of Japan, a large-scale DeFi-related incident occurs domestically, reports emerge that the FSA is considering ISP-level access restrictions, major Web3 startups announce relocation overseas.
Key Triggers to Watch
- Start of public comments (call for opinions) by the FSA regarding DeFi regulation: April-June 2026
- Submission of amendments to the Payment Services Act and Financial Instruments and Exchange Act to the Diet: Autumn 2026 extraordinary session – 2027 ordinary session
- Publication of FATF's mutual evaluation report on Japan: 2026-2027
- Occurrence of large-scale security incidents related to DeFi domestically and internationally: As needed (will act as a catalyst for regulatory acceleration upon occurrence)
- Submission of counter-proposals for regulation by the LDP Web3 Project Team: First half of 2026
🔄 Tracking Loop
Next Trigger: Start of public comments (call for opinions) by the FSA regarding DeFi regulation — Expected April-June 2026. The specific content of the announced regulatory proposal will be the first signal definitively indicating the intensity and direction of the regulation.
Continuation of this pattern: Tracking Theme: Japan's DeFi Regulatory Legislative Process — The next milestone is the start of FSA public comments (expected first half of 2026), followed by the submission of legal amendment bills to the Diet (Autumn 2026 – 2027).
🎯 Oracle Declaration
Prediction Question: Will the Japanese government formally enforce laws or cabinet orders/ministerial ordinances imposing KYC/AML obligations on DeFi protocol operators by December 31, 2026?
Judgment Deadline: 2026-12-31 | Judgment Criteria: As of December 31, 2026, a law, cabinet order, or Cabinet Office ordinance imposing KYC/AML obligations on front-end providers or governance token holders of DeFi protocols must have been published in the Official Gazette and reached its enforcement date. The start of public comments or submission of a bill to the Diet alone will not be judged as "YES." "YES" will be judged upon actual enforcement.
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