As U.S. Treasury Secretary Janet Yellen, the Central Bank of Nigeria and India’s Parliament have demonstrated, governments and regulators around the world are wary about the rise of cryptocurrency. South Korean authorities are no exception. Lee Ju-yeol, the governor of the Bank of Korea, said before a parliamentary committee last month that bitcoin “has no intrinsic value” and that he “doesn’t understand why the value is so high.”

While the Korean government doesn’t seem bent on banning crypto, it is certainly intent on regulating it. The effect may be monopolization by South Korea’s largest exchanges at the expense of smaller competitors. 

One critical piece of legislation is called the “Act on Reporting and Using Specified Financial Transaction Information,” aka the Financial Transaction Reports Act (FTRA), which requires virtual asset service providers to register with financial authorities and comply with anti-money laundering (AML) regulations. The FTRA was amended to restrict crypto trading in March of last year, but it only went into effect on March 25, 2021. It’s critical because it causes all sorts of bureaucratic and administrative complications for crypto exchanges that wish to enter the market or simply survive.

Starting March 25, all cryptocurrency exchanges are required to register with the Financial Intelligence Unit (FIU) of the Financial Services Commission (FSC). The FIU will then file the registration with the FSC, which must approve the registration before it becomes official. So while the government is packaging it as a “registration process,” the FSC is actually becoming the unofficial state licensor of the Korean crypto industry.

Until the FTRA was amended by the National Assembly, South Korea had no specific legal language to define or describe crypto trading. Cryptocurrency wasn’t (and still isn’t) officially recognized as a financial asset, so there was no way to regulate it as such. Pretty much anyone who wanted to could set up an exchange and was not required to register with any authorities.

The FTRA is South Korea’s nod to the Paris-based Financial Action Task Force (FATF). It’s basically Seoul’s way of telling the world, “We comply with the FATF’s AML guidelines.” Legislators now define cryptocurrencies as “virtual assets” and crypto exchanges as “virtual asset service providers.” A VASP has been defined as any business that facilitates sales, purchases, exchanges and transfers of crypto that involve fiat. This includes exchanges, custodies and brokers. Interestingly enough, peer-to-peer (P2P) platforms and crypto consultants (people who just provide information) do not qualify as VASPs, mostly because they don’t deal directly with fiat. 

That’s the keyword: fiat. So long as a Korean’s bitcoin or ether or dogecoin is never converted to Korean won, the government doesn’t seem to care about it. Until we see the day when people actually use crypto as an everyday form of payment to the point that it rivals or supplants cash, the government probably won’t try to tax crypto in its native form.

Officially, the government’s concerns about crypto are rooted in money laundering or “protecting” consumers.

But perhaps what’s really grabbed the authorities’ attention is the explosive increase in crypto trading volume over the past few years. The nation’s crypto trade is dominated by four major exchanges: Bithumb, Upbit, Korbit and Coinone. (I’ll now refer to these as the Big 4.) In just January and February of this year, the Big 4 saw 445 trillion won (US$391.7 billion) in trading volume. For some context, their cumulative trading volume for the entire year of 2019 was 488 trillion won ($394.3 billion). The Big 4’s daily trading volume for these two months averaged at 8 trillion won ($7 billion), nearly a fourfold increase from the same period in 2017. 

Some of you may be thinking: OK, exchanges have to register with authorities. So what? Just register and if you’re legit you’ll get approved. As long as you’re not doing anything shady you shouldn’t have anything to worry about, right? 

In theory, yes. In practice, most likely not.

There are certain conditions an exchange must meet in order to have its registration “approved” by the FSC. By far the most important of these conditions is the need to form partnerships with local commercial banks.

Before the FTRA amendment, users on crypto platforms could register under various user names and deposit cash into a company bank account to purchase intra-platform credits that could be used to purchase crypto. These company accounts are referred to as “hive accounts” because a single account houses multiple users. While a thorough investigation would eventually reveal who deposited how much from which account, a hive account makes it much more difficult to keep track of who’s who.  

The FTRA update, however, requires users to register under their real names and link their personal bank accounts. In other words, goodbye hive accounts. This necessitates partnerships with commercial banks, meaning the new legislation gives banks the ultimate authority to determine which exchanges survive. Some crypto purists won’t be happy about this because it essentially negates one of the foundational principles behind crypto: freedom from traditional financial institutions.

But in South Korea, banks have the authority to determine whether or not a VASP meets AML standards. Every bank has its own criteria, which are not made public, but there are two universal conditions: VASPs must differentiate between native assets and customer deposits, and they must have their information security management systems (ISMS) certified by the Korea Internet and Security Agency (KISA). ISMS certification has proven to be time-consuming and costly. It usually entails a hefty consulting bill and expensive hardware. While this may not be a problem for the Big 4, it could be a barrier to smaller and mid-sized exchanges and startups.

But here’s the kicker: The Big 4 already have partnerships with commercial banks, which have been reluctant to partner with smaller exchanges. Banks are naturally conservative and averse to risk, so they tend to prefer major players over the little guys.

So if an exchange wants to become legit, it needs a bank partnership. Because banks have the ultimate say in who gets those partnerships, they have the ultimate say in which exchanges survive.

"Crypto startups that aren't on a major corporate scale will have a hard time getting their ISMS certified, acquiring bank partnerships and meeting other conditions for VASP registration," said Ku Tae-eon, an attorney with the strategic consulting firm Tek & Law, at a conference co-hosted by CoinDesk Korea in November. Ku argued that the revised FTRA will shrink the nation’s crypto industry. He has called for separate legislation specific to crypto.

But even the Big 4 seem on edge. Bithumb, the biggest of the four, recently began delisting dark coins in what looks like a campaign to seem more “legitimate.” Trading for three dark coins (cryptocurrencies that offer greater anonymity) on Bithumb ceased on March 24, a day before VASP registration began. Coincidence? Probably not.

The registration deadline is Sept. 24. Any VASP that fails to register or has its registration denied will be shut down. Sure, it could continue operating as a P2P platform, but the majority of Korean traders will likely flock to the Big 4 for the same reason most people look to Google for searches even if there are other options: it’s just more convenient. Plus, the average Korean investor (especially newcomers) will most likely want to use fiat for their crypto purchases.

Naturally, industry insiders are predicting the Big 4 (out of an estimated 200) will ultimately be the only crypto exchanges with fiat on-ramps. CoinDesk Korea’s Park Geun-mo and Kim Dong-hwan cautiously predict that maybe one or two could be added to the list at most. “Until September rolls around there’s no way to tell what will actually happen, but it doesn’t look good for the smaller exchanges,” Park told me.

Once their hive accounts are stripped away, smaller exchanges will struggle to survive because it’s virtually impossible for them to secure partnerships with banks. Banks will probably deem their AML systems unfit. As banks ultimately bear responsibility if any funds are used for money laundering or terrorism financing, there’s no reason for them to risk partnering with a smaller exchange.

The bottom line is that after Sept. 24, it’s going to become that much harder for an outsider to build up the specs to compete against the Big 4 or even qualify as a registered VASP. Furthermore, any up-and-coming cryptocurrency that seeks to have a significant impact on the Korean market will have to get listed on the Big 4. There have been reports of Busan Bank holding talks with five other exchanges about potential partnerships, but things are still up in the air. A source at Busan Bank has made it clear to CoinDesk Korea that “considering partnerships and making them actually happen are totally separate things.”

While Busan Bank is a regional bank and isn’t as big as national names like Shinhan or Woori, it’s still a commercial bank that would help legitimize an up-and-coming exchange. 

On March 16, the FSC issued a “warning” to crypto traders to “check the registration status” of exchanges and to “determine whether an exchange will be sustainable in the long term” before creating an account and using the platform. This is being read as a de facto declaration that a significant number of exchanges will be shut down. It may as well read: “Don’t bother trading crypto unless it’s on the Big 4.”

As if a signal of things to come, OKEx Korea recently announced it will shut operations next month, citing unsatisfactory profits and the difficulty of forming a bank partnership.

Funny enough, Korea’s crypto ecosystem could end up mirroring South Korea’s overall economy, where a small number of conglomerates comprise a majority of economic productivity. According to the Korea CXO Institute, 64 chaebols (family-owned conglomerates) comprised 84% of the country’s GDP but only 10% of jobs in 2019.  

Of course, there’s a silver lining. The average investor will certainly benefit from crypto becoming institutionalized and going mainstream. Services on the Big 4 will probably get much more convenient and more accessible as time goes on. But much as how I can basically choose between LG or Samsung when buying a refrigerator, average Korean retail investors will most likely be trading their crypto on the Big 4.