The Japanese government is planning to introduce a regulatory framework that allows startups to raise funds through crypto assets, alongside traditional financial instruments. This initiative aims to boost the country’s startup ecosystem, and improve the state of innovation and investment in the Web3 and Blockchain space. In this blog, we explore the potential benefits of this proposed framework, with a focus on creative industry firms, and discuss potential incentives for investors to adopt this strategy. We discuss challenges like crypto taxation and market volatility that must be addressed in order to ensure successful implementation of this framework.
The Japanese government is reportedly planning to introduce a new regulatory framework that will allow startups to raise funds through crypto assets.[1] The forthcoming framework will be aimed at a category of funds known as Investment Business Limited Partnerships (LPS). These funds enable startups to raise capital through the issuance of conventional financial instruments such as securities and bonds. As per the proposed changes, startups will now have the option to issue crypto assets and other tokens in addition to traditional assets[2], thereby diversifying financing options available to them.
The proposed change is part of the Japanese government’s mandate to boost the country’s startup ecosystem, and to help provide increased investment opportunities to firms operating in the Web3 space. The Japanese government is increasingly shifting its focus to improve the state of innovation, and investment in the fields of Blockchain, Web3 and Metaverse, a stance that is broadly encapsulated in the Japanese Prime Minister, Fumio Kishida’s flagship economic policy for a “new form of capitalism”.[3] In a speech from May 2022, Kishida had highlighted the importance of Web3 and the Blockchain sector, recognising its potential to create new digital services as a way to combat challenges arising from Japan’s shrinking workforce, and an aging population.[4] He further said that the current state of capital and R&D investment in Japanese companies is lagging behind several developing countries, and emphasized the promotion of emerging technologies as part of a nation-wide strategy to improve the state of investments in the country.
The establishment of a framework enabling startups to secure investments through crypto assets could usher in an era where the traditional methods of securing investment are augmented or even replaced. This could be particularly beneficial for startups in the Web3 space which have been facing a ‘funding winter’ since November 2022. Globally, Web3 startups have gained significant traction in the past few years, raising total capital of USD 75 billion since 2019.[5] However, funding has gone down by 82 percent year-on-year, with 2023 seeing the lowest funding raised through venture capital since 2019, as per data from Crunchbase. While part of this can be attributed to tail events such as the FTX collapse in November 2022, Web3 startups are also facing intense competition from firms in competing sectors, such as Artificial Intelligence (AI) and Virtual Reality (VR). [6]
Moreover, a key differentiating factor of Web3 businesses, as opposed to their Web2 counterparts, is their ability to democratize content and limit the influence of intermediaries and distributors. Creative industry ventures, which frequently encounter challenges in securing early-stage funding, stand to gain from this framework of additional fundraising avenues. At the same time, this framework also poses benefits to investors that are not present in traditional financial markets. We discuss these aspects in detail below -
Impact on Global Startup Ecosystem
Access to capital through crypto assets could democratize the global startup ecosystem, creating a level playing field that can foster greater innovation. Traditional sources of funding are largely limited to bank/non-bank loans, grants from the government, private equity or an Initial Public Offering (IPO). Each of these methods have strict eligibility criteria, and can be highly competitive in nature. Santoso (2020)[7] gives the example of startups involved in the creative economy business, which are particularly exposed to issues related to financing. Several Web3 startups working in the music industry or the art industry with products such as Non-Fungible Tokens (NFTs) are examples of such businesses. These businesses have intangible creative assets, which are often considered high risk and can be difficult to predict for return on investment, making it hard to secure funding at an early stage. For such business ventures, an additional source of investment in the form of crypto assets will help reduce their dependence on traditional sources of funding. This can be particularly beneficial for countries such as India, where the creative economy contributes only 0.58% to the Gross Domestic Product (GDP), and falls considerably short of other developed and developing nations.
Future of investments
Unlike traditional bonds and stocks, crypto assets with high market capitalization such as Bitcoin and Ethereum have a high degree of liquidity, and can easily be converted into cash or other assets.[8] For businesses, this is a particularly attractive scenario as high liquidity can be vital for smooth business operations, allowing firms to cover necessary expenses in the event of a cash crunch. At the same time, this can also be beneficial for investors who will have better entry and exit opportunities. A liquid market allows buyers and sellers to transact at any time of the day, creating a continuous thread of trade and market data. Hence, investors can make an informed decision, and buy or sell their holdings at a fair price as per their analysis.[9] However, a key aspect that Japan’s crypto investment framework would need to address is the variation in crypto taxation across countries. Foreign investors could potentially be subject to dual taxation in their home country, as well as in Japan, if they invest in a startup through crypto assets.[10] This will add to investor’s compliance burden and may completely deter them from adopting this framework.
Further, using crypto assets for raising funds will consequently increase exposure of investors’s money to these markets. Several global institutions such as the Bank of International Settlements (BIS), and the International Monetary Fund (IMF) have voiced concerns regarding high degree of exposure to crypto assets, which can raise financial stability concerns and increase liquidity and credit risks in traditional financial markets. This is largely due to the highly volatile nature of these assets. Illustratively, the crypto asset market went from a market capitalization of USD 1 billion in 2010 to USD 3 trillion in November 2021, before falling to less than USD 1 trillion in July 2022.[11] In addition, the failure of the stablecoin TerraUSD (UST) and the subsequent collapse of the FTX exchange and its native token FTT led to a cumulative loss of over USD 650 billion in November 2022 and has added to the discourse of high volatility.[12] In order to protect investors from such shock events, the Japanese government will need to establish a framework for scrutinizing these assets before they are allowed to be used as investment instruments. Existing models like the BIS's prudential treatment of crypto assets for banks could serve as a starting point for establishing these norms. Striking the appropriate balance between fostering innovation and safeguarding investor interests will be crucial to ensure the enduring success of this approach.
Japan’s transformative journey and its implementation can serve as a useful case study for other nations to analyze the potential benefits and disadvantages. While there are several benefits attached to investing in startups through crypto assets, successful implementation will depend on how the country addresses the aforementioned challenges, particularly in terms of taxation and safeguarding investor’s money. Striking a balance between innovation and regulation will also be pivotal to achieve success, and could potentially reshape the future of startup financing and investments on a global scale.
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[1] Cointelegraph (2023)
[2] In Japan, crypto assets are neither considered securities nor derivatives under the Financial Instruments and Exchange Act (FIEA). However, security tokens constitute securities under the FIEA.
[3] This proposed framework intends to drive growth and wealth distribution by focusing on innovation, startups and digital transformation through public and private partnerships, and is a part of the current Prime Minister, Fumio Kishida’s economic policy framework.
[4] Speech by Prime Minister Kishida Fumio at the Guildhall in London (May, 2022)
[5] Data sourced from the Web3 Tracker by Crunchbase (Oct, 2023)
[6] Crunchbase (July, 2023). Web3 Funding Plummets as AI Steals the Show.
[7] Santoso, Sugeng. (2020). Optimizing Access to Financial Capital of Creative Economy for Startups Towards Global Competitiveness. Business Economic, Communication, and Social Sciences (BECOSS) Journal. 2. 181-189. Available at https://doi.org/10.21512/becossjournal.v2i2.6246
[8] Binance (2018). What Is Liquidity and Why Does It Matter? As per data from Coingecko, Bitcoin has a market cap of USD 546.2 billion, which makes up 47 percent of the total cryptocurrency market cap as of October 2023. Ethereum follows Bitcoin in second position, making up 18 percent of the total cryptocurrency market cap.
[9] Binance (2018). What Is Liquidity and Why Does It Matter?
[10] U.S and International tax implications for investing in Bitcoin and other cryptocurrencies. H&CO (n.d.)
[11] IMF (2022). Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets.
[12] Bank of International Settlements (Feb, 2023). Crypto shocks and retail losses.