Japan's DeFi Regulation Bill — "Regulatory Capture" to
The Japanese government's move to legislate comprehensive KYC/AML regulations for DeFi by 2026 could establish a new standard for crypto asset regulation by the world's third-largest economy, potentially triggering a global regulatory chain reaction.
── Understand in 3 points ─────────
- • The Japanese government is reportedly considering submitting a new bill in early 2026 that includes strict KYC (Know Your Customer) and AML (Anti-Money Laundering) regulations for DeFi projects.
- • The Financial Services Agency (FSA) began reviewing the regulatory framework for crypto assets and DeFi in the latter half of 2025, with a view to fully implementing the FATF (Financial Action Task Force) Travel Rule.
- • Domestic crypto asset exchanges are concerned about increasing system modification costs for KYC/AML compliance, raising the risk of smaller exchanges withdrawing from the market.
── NOW PATTERN ─────────
Japan's strengthening of DeFi regulation is a structural pattern resulting from the complex interplay of "regulatory capture," where existing financial institutions and major exchanges guide the regulatory process to their own benefit, a "backlash" from the Web3 promotion policy, and "path dependency" from the regulatory tightening cycle since 2014.
── Probability and Response ──────
• Base case 55% — Publication of specific bill drafts, developments in amendment discussions within the ruling party, FSA's call for public comments, parliamentary deliberation schedule, announcement of major exchanges' response policies
• Bull case 20% — Policy recommendations from the LDP's Digital Society Promotion Headquarters, submission of crypto asset tax reform bill to the Diet, announcement of expanded application of regulatory sandbox, trends in overseas crypto asset companies entering Japan
• Bear case 25% — Occurrence of a large-scale hacking incident, shift in media tone, FSA's emergency statement, reports on consideration of ISP-level access restrictions, restrictions on Japanese users by major DeFi protocols
📡 THE SIGNAL — What Happened
Why it matters: The Japanese government's move to legislate comprehensive KYC/AML regulations for DeFi by 2026 could establish a new standard for crypto asset regulation by the world's third-largest economy, potentially triggering a global regulatory chain reaction.
- Policy — The Japanese government is reportedly considering submitting a new bill in early 2026 that includes strict KYC (Know Your Customer) and AML (Anti-Money Laundering) regulations for DeFi projects.
- Regulation — The Financial Services Agency (FSA) began reviewing the regulatory framework for crypto assets and DeFi in the latter half of 2025, with a view to fully implementing the FATF (Financial Action Task Force) Travel Rule.
- Market Impact — Domestic crypto asset exchanges are concerned about increasing system modification costs for KYC/AML compliance, raising the risk of smaller exchanges withdrawing from the market.
- User Trends — The risk of users leaving due to stricter regulations has been pointed out, with hashtags like "JapanExit" and "OverseasDEXMigration" rapidly increasing on X.
- International Comparison — The EU has fully implemented MiCA (Markets in Crypto-Assets Regulation) by the end of 2024, and Japan's regulations will follow suit.
- Industry Reaction — The Japan Cryptoasset Business Association (JCBA) has issued a statement that "excessive regulation hinders innovation" and called for dialogue with the industry.
- Taxation — As regulatory tightening progresses in parallel with discussions on crypto asset tax reform (transition to separate taxation, reduction of tax rate to 20%), questions are being raised about policy consistency.
- Technology — Due to the decentralized nature of DeFi protocols, technical implementation of KYC obligations is difficult, and the utilization of on-chain ID (decentralized identity) technology is being discussed.
- Politics — Following the political situation after the 2025 House of Councillors election, conflicts between Web3 proponents and regulation hardliners have surfaced within the ruling party.
- FATF — In its October 2025 mutual evaluation, FATF assessed Japan's crypto asset regulations as "partially compliant" and recommended regulatory development in the DeFi sector.
- Market Size — Japan's domestic crypto asset trading volume reached approximately 35 trillion yen in 2025, with DeFi-related trading volume increasing by approximately 150% year-on-year.
- Security — Crypto asset-related fraud and hacking damages in Japan in 2025 are estimated to exceed 50 billion yen, serving as a rationale for stricter regulations.
To understand Japan's move to strengthen DeFi regulation, it is necessary to look back at the complex history of Japan and crypto assets. Japan has consistently taken a pioneering stance in crypto asset regulation globally.
The Mt.Gox incident in 2014 was one of the largest events in the history of crypto assets worldwide. When this Tokyo-based exchange lost approximately 850,000 BTC and collapsed, the Japanese government keenly felt the need for crypto asset regulation. Triggered by this incident, the revised Payment Services Act was enforced in April 2017, making Japan the first country in the world to introduce a registration system for crypto asset exchanges. At this point, Japan championed the philosophy of "promoting innovation through regulation."
However, the Coincheck incident in January 2018 (a leak of NEM worth approximately 58 billion yen) demonstrated that the registration system alone was insufficient. In response, the FSA significantly strengthened its inspection system and strictly cracked down on unregistered operators. From this period, the focus of Japan's crypto asset regulation began to shift from "promotion" to "protection."
The 2019 amendments to the Payment Services Act and the Financial Instruments and Exchange Act introduced regulations on margin trading and custody services, along with the standardization of crypto asset terminology (from "virtual currency" to "crypto asset"). At this stage, DeFi was not yet a primary concern for regulators.
The turning point was the DeFi Summer from 2020 onwards. Protocols like Uniswap, Aave, and Compound grew rapidly, making the model of providing financial services without centralized intermediaries a reality. Access to these protocols from Japan also surged, confronting regulators with the fundamental question of "who should be regulated."
The international context is also crucial. FATF published "Updated Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers" in 2021, indicating that DeFi protocols should also be brought under the regulatory net. The EU adopted MiCA (Markets in Crypto-Assets Regulation) in 2023 and fully implemented it by the end of 2024. In the US, the SEC has strengthened its stance on subjecting DeFi protocols to securities law, taking multiple enforcement actions.
Amidst these international regulatory trends, Japan has sought its own position. The Web3 white paper published in 2023 positioned crypto assets and blockchain technology as pillars of its growth strategy, indicating a direction towards deregulation. However, after receiving criticism in FATF's 2025 mutual evaluation that "DeFi regulation is insufficient," the policy pendulum began to swing back towards stricter regulation.
The DeFi Regulation Study Group established within the FSA in the latter half of 2025 has been working at an exceptional pace, compiling the outline of a bill in just six months. This is driven not only by external pressure to respond to FATF's recommendations but also by significant security concerns, such as crypto asset theft by North Korea's Lazarus Group (estimated damages exceeding 200 billion yen in 2025 alone).
Furthermore, domestic political dynamics in Japan cannot be overlooked. With the ruling party maintaining a stable majority in the 2025 House of Councillors election, the passage of financial regulation bills is in a relatively favorable environment. Meanwhile, a fierce tug-of-war continues between Web3 proponents within the Liberal Democratic Party (LDP) (a group centered around Digital Minister Masaaki Taira) and regulation hardliners backed by the FSA.
These complex factors combined have led to the emergence of the DeFi regulation bill in 2026. This is not merely a domestic policy issue but a historical turning point that will determine Japan's position in shaping global crypto asset regulatory standards.
The delta: Against the backdrop of FATF's 2025 mutual evaluation recommendations and the increasing severity of cyber theft by North Korea, the Japanese government has shifted its policy to integrate DeFi into the existing financial regulatory framework. This has brought the dichotomy of "Web3 promotion" and "regulatory tightening" to the forefront of policy, and the very structure of Japan's crypto asset market is poised to change.
🔍 BETWEEN THE LINES — What the Reports Aren't Saying
Officially, "investor protection" and "FATF compliance" are cited as reasons for stricter regulation. However, reading between the lines, the FSA's true aim is to "normalize" its jurisdiction over the crypto asset sector. If DeFi continues to remain a regulatory void, it impacts the FSA's raison d'être. Furthermore, it is no coincidence that the timing of regulatory tightening overlaps with the three megabanks' serious entry into digital asset businesses. A regulated DeFi market is the only field where existing financial institutions can enter, leveraging their compliance infrastructure. In short, this regulation is designed not "to protect DeFi" but "to integrate DeFi into the logic of traditional finance."
NOW PATTERN
Regulatory Capture × Backlash × Path Dependency
Japan's strengthening of DeFi regulation is a structural pattern resulting from the complex interplay of "regulatory capture," where existing financial institutions and major exchanges guide the regulatory process to their own benefit, a "backlash" from the Web3 promotion policy, and "path dependency" from the regulatory tightening cycle since 2014.
Intersection of Dynamics
The three dynamics of "regulatory capture," "backlash," and "path dependency" mutually reinforce each other, determining the direction of Japan's DeFi regulation.
First, "path dependency" defines the basic framework of regulation. The "intermediary regulation" paradigm established since Mt.Gox serves as the starting point for considering DeFi regulation, significantly limiting regulatory design options. Designing regulations within this paradigm is overwhelmingly advantageous for major exchanges and financial institutions with existing regulatory compliance infrastructure.
Here, "regulatory capture" comes into play. Major exchanges and financial institutions package regulatory designs favorable to themselves with legitimate arguments like "investor protection" and "AML measures," exerting influence over the regulatory review process. Their opinions are valued by regulators as "practical knowledge," and as a result, the voices of decentralized participants in DeFi become relatively smaller.
The "backlash" acts as a catalyst, accelerating this process. Reports of North Korean cyber theft and DeFi scams create a social atmosphere that justifies stricter regulation, effectively silencing cautious voices against it. Coupled with external pressure from FATF recommendations, a political momentum of "now is the time for regulation" is formed.
At the intersection of these three dynamics, a powerful convergent force emerges, pushing "DeFi into the existing financial regulatory framework." As a result, Japan's DeFi regulation risks prioritizing consistency with existing systems over technical effectiveness, potentially leading to a situation where "regulations exist but do not function (do not lead to actual risk reduction)." While the formal existence of regulations maintains international credibility, it is highly likely to create a "regulatory paradox" where DeFi users effectively flow to overseas platforms and continue to operate outside the regulatory net.
📚 PATTERN HISTORY
2017: Introduction of Japan's Crypto Asset Exchange Registration System
Regulatory Capture + Path Dependency
Structural similarities with the current situation: Major exchanges participated in regulatory design, leading to the exclusion of smaller operators. High registration requirements became barriers to entry, leading to market oligopoly. Simultaneously, compliance costs were passed on to transaction fees, resulting in Japanese users bearing globally high fees.
2018: Enforcement of EU General Data Protection Regulation (GDPR)
Backlash + Regulatory Capture
Structural similarities with the current situation: GDPR, introduced under the guise of privacy protection, allowed large tech companies to absorb compliance costs while imposing a fatal burden on small and medium-sized startups. This created the paradoxical effect of ultimately strengthening the market dominance of existing giants like Google and Meta.
2020: China's Comprehensive Crypto Asset Ban
Backlash + Path Dependency
Structural similarities with the current situation: China implemented extreme regulations with a comprehensive ban on mining and trading, but as a result, miners relocated overseas, and Chinese citizens continued to access DeFi via VPNs. A classic example of the "regulatory paradox"—where overly strict regulations paradoxically create an unmonitorable situation.
2023-2024: Phased Implementation of EU MiCA Regulation
Regulatory Capture + Structural Shift
Structural similarities with the current situation: After MiCA's implementation, the European crypto asset market saw a temporary decrease in trading volume, but market restructuring progressed, centered around large companies that complied with regulations. Meanwhile, many DeFi protocols responded with "geoblocking" to geographically restrict access for EU users, leaving questions about the effectiveness of the regulations.
2024: US SEC vs. Uniswap Labs Lawsuit
Path Dependency + Regulatory Capture
Structural similarities with the current situation: The SEC attempted to apply the framework of securities law to DeFi protocols, but this proved technically and legally difficult and became protracted. The limitations of regulating DeFi with existing legal frameworks were highlighted, accelerating discussions about the need for dedicated legislation.
Patterns Revealed by History
The greatest lesson from historical patterns is that the approach of "extending existing regulatory frameworks to new technologies" consistently produces three outcomes. First, the market dominance of large players with regulatory compliance capabilities is strengthened (regulatory capture effect). Second, technical means to circumvent regulations develop, reducing regulatory effectiveness (regulatory paradox). Third, regulated entities move outside the jurisdiction, making the initially intended "protection" unattainable (geo-arbitrage).
From China's comprehensive ban to the EU's MiCA and the US SEC's enforcement, while each country's approach differs, common patterns are observed in the outcomes. Whether Japan's DeFi regulation will follow the same path depends on the precision of regulatory design and the depth of technical understanding. However, considering Japan's current situation where path dependency and regulatory capture act simultaneously, it is highly likely that the path of least resistance, "extending existing frameworks," will be chosen. History suggests that this approach ends in a result where "formal compliance is achieved, but substantial risk reduction is not."
🔮 NEXT SCENARIOS
The FSA will submit a DeFi regulation bill to the Diet in 2026, but it will be submitted in a significantly amended form from the initial draft due to adjustments with Web3 proponents within the ruling party. The core of the bill will impose registration and KYC obligations on front-end operators of DeFi protocols, but a "phased approach" will be adopted, exempting fully decentralized protocols (those without a front-end or specific operators).
Deliberations in the Diet will take place during the extraordinary session in autumn 2026, but discussions on technical points are expected to be protracted, making passage within the year a delicate situation. It is highly likely that it will be passed at the very end of the session in December 2026, or carried over to the ordinary session in 2027.
As for market impact, Japanese DeFi-related tokens will experience temporary selling pressure upon the bill's submission, but the market will gradually stabilize once the adoption of a "phased approach" is confirmed. Major exchanges will strengthen their KYC compliance, and while compliance costs will increase, they will remain at a level that allows for business continuity. Some smaller exchanges (around 5-8 companies) will be forced to withdraw or merge. Some DeFi users will migrate to overseas platforms, but this will not lead to a large-scale outflow. The effectiveness of the regulations will be limited, and technical means to circumvent them will continue to exist.
Implications for Investment/Action: Publication of specific bill drafts, developments in amendment discussions within the ruling party, FSA's call for public comments, parliamentary deliberation schedule, announcement of major exchanges' response policies
The political influence of Web3 proponents is stronger than expected, leading to significant amendments to the DeFi regulation bill, making it strongly "innovation-promoting." Specifically, elements such as the expansion of "regulatory sandboxes" (experimental regulatory grace period systems), phased compliance obligations for DeFi protocols (setting grace periods for smaller protocols), and the allowance of innovative KYC methods utilizing on-chain ID technology will be included.
Simultaneously, long-standing crypto asset tax reform (transition from comprehensive taxation to separate taxation, reduction of tax rate to 20%) will be realized, presented as a package of regulatory tightening and tax incentives. This balanced approach will attract international attention, and Japan will be evaluated as a model case for "balancing regulation and promotion."
The market impact will be extremely positive, with overseas crypto asset projects beginning to consider establishing Japanese subsidiaries, and the Japanese crypto asset market will be revitalized. Tax reform will lead to an increase in domestic crypto asset holders and an expansion in the number of DeFi users. Japan will strengthen its position as an "Asian crypto asset hub," becoming competitive with Singapore and Hong Kong. However, the realization of this scenario requires both the political power of Web3 proponents and a flexible response from FATF, making its probability limited.
Implications for Investment/Action: Policy recommendations from the LDP's Digital Society Promotion Headquarters, submission of crypto asset tax reform bill to the Diet, announcement of expanded application of regulatory sandbox, trends in overseas crypto asset companies entering Japan
A large-scale North Korea-related crypto asset hacking incident directly hits Japanese exchanges and DeFi users, rapidly shifting public opinion towards stricter regulation. The FSA retracts its initial phased approach and submits a more comprehensive and stringent regulatory proposal. Specifically, elements such as restrictions on access to unregistered DeFi protocols from Japanese IP addresses (ISP-level blocking), regulation of crypto asset self-custody, and prior reporting obligations for DeFi transactions above a certain amount will be included.
This strict regulation will be swiftly passed by the Diet, and industry opposition will be suppressed in the face of "national security necessity." After implementation, Japan's DeFi-related trading volume will sharply decline, and many DeFi projects will exclude Japanese users through geoblocking. Domestic crypto asset exchanges will also see their profits deteriorate due to increased compliance costs, leading to a contraction of the entire industry.
Technically savvy users will circumvent regulations through VPNs and decentralized front-ends, limiting the effectiveness of the regulations, while general users will exit the crypto asset market. As a result, Japan will be labeled a "crypto-unfriendly country," accelerating the outflow of blockchain-related talent and companies overseas. This scenario could mark the beginning of "lost years" for Japan's crypto asset industry.
Implications for Investment/Action: Occurrence of a large-scale hacking incident, shift in media tone, FSA's emergency statement, reports on consideration of ISP-level access restrictions, restrictions on Japanese users by major DeFi protocols
Key Triggers to Watch
- Publication of FSA DeFi Regulation Study Group's Final Report: April-June 2026
- Cabinet Decision and Submission of DeFi Regulation Bill to the Diet: June-September 2026
- FATF's Follow-up Review of Japan: Second half of 2026
- Occurrence of a large-scale crypto asset hacking incident (trigger event): Constant monitoring
- Developments in Diet Deliberations on Crypto Asset Tax Reform Bill: 2026 Ordinary Session (January-June)
🔄 TRACKING LOOP
Next Trigger: Publication of FSA DeFi Regulation Study Group's Final Report (scheduled for April-June 2026) — A crucial milestone that will clarify the specific scope and strength of the bill's regulations and determine the direction of market and industry reactions.
Continuation of this pattern: Tracking Theme: Japan DeFi Regulation Legislation Process — Next milestone is FSA Study Group's final report (2026 Q2), followed by Cabinet decision and submission to the Diet (2026 Q3).
🎯 ORACLE DECLARATION
Prediction Question: Will a bill including DeFi-related KYC/AML regulations be passed by Japan's Diet by December 31, 2026?
Judgment Deadline: 2026-12-31 | Judgment Criteria: Determine whether a new law stipulating KYC/AML obligations for DeFi protocols or their operators has been passed and enacted by both houses of the Diet (House of Representatives and House of Councillors) by December 31, 2026. This applies to new legislation or major legal amendments passed by the Diet, not amendments through existing ordinances or ministerial orders.
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