The Need to Distinguish Between Security and Non-Security Virtual Assets
With the recent enactment of the Virtual Asset User Protection Bill in South Korea, there is a need to lay out criteria for determining whether virtual assets qualify as securities, says Kim Ja-bong, a senior research fellow at the Korea Institute of Finance, in his report titled “The Implications of Determining Which Virtual Assets Constitute Securities and Investor Protection” released on Saturday.
The implications of the Virtual Asset User Protection Act
The Virtual Asset User Protection Act — which will take effect in July of next year — aims to protect customer assets, establish regulations against unfair trading practices, and enforce penalties. Notably, it will target virtual assets that are not securities, deeming it necessary for regulators to determine if virtual assets qualify as securities or not in order to enforce the bill. Assets with characteristics of securities will fall under the jurisdiction of the Capital Markets Act.
Therefore, if the Virtual Asset User Protection Act does not provide sufficient investor protection, issuers may be incentivized to issue non-security assets rather than security assets to avoid the regulations of the Capital Markets Act. This further necessitates the act of distinguishing between virtual assets that are securities versus those that are not.
Determining if a virtual asset is a security or not
There are two approaches to do this, according to Kim: the passive approach, which avoids considering a virtual asset as a security whenever possible, and the active approach, which treats a virtual asset as a security whenever applicable.
He argues that it is better to focus on whether an investment contract qualifies as a security if it is considered an investment contract, rather than simply selecting a specific approach.
Furthermore, the nature of virtual assets renders them unbound by national borders, so it is necessary to establish assessment criteria that correspond with international standards, such as those used in the US and Europe.
This is especially important because if the criteria differ from international standards, there is a risk of domestic investors suffering damages due to an issuer’s pursuit of regulatory arbitrage between countries.
Equitable recognition and potential for security tokens
According to Kim, the importance of determining whether virtual assets are securities lies in ensuring that security tokens receive the same recognition and trading treatment as traditional securities such as stocks. With such a measure, security token offerings can serve as an efficient and reliable method for raising funds. Although there may be concerns that such a regulation may hinder the development of virtual assets, it may well be an opportunity for security tokens to be qualified and trusted as high-quality financial instruments just like existing securities, Kim claims.
Even for virtual assets that are not considered securities, there are many types of assets that are financial in nature, such as e-money tokens — therefore, it is necessary to actively protect investors in non-security virtual assets through financial regulations such as reinforcing disclosure obligations, which is being done in the EU through the Markets in Crypto-Assets Regulation (MiCA).
Empowering regulators for enhanced investor protection and market integrity
Kim underscored that investor protection and healthy growth of the virtual asset market are made possible mainly through expanding regulators’ authority to protect economic interests and prevent damages. The author also suggested institutional reforms that grant regulators substantial authority, which would enhance their ability to protect investors effectively and provide compensation for damages.
He added that regulators should also have the authority to enforce liability for damages or impose civil penalties for unfair trading practices conducted using classified information.
