South Korea is reassessing its framework for digital asset governance in response to a series of significant data breaches and compliance failures within its rapidly expanding cryptocurrency market.
Authorities suspect the North Korea-linked hacking group Lazarus is responsible for the $32 million theft from South Korea's largest crypto exchange, Upbit, which occurred on November 28. This marks the second instance of Lazarus hacking Upbit, following a previous theft of approximately $41 million in 2019.
This hack occurs as regulators from the Financial Services Commission (FSC) are on the verge of implementing the most stringent anti-money laundering (AML) reforms since 2008. Korean officials have expressed concerns that criminals are exploiting regulatory loopholes at a pace that outstrips the ability of regulators to close them. The primary apprehension is that cryptocurrencies are being utilized to evade taxes, launder funds, and move money outside of regulatory oversight.
"President Lee Jae Myung's administration is adopting a more assertive stance on digital asset regulations," stated So-Ye Yoon, a finance attorney at Dentons Lee law firm in Seoul. "Regulators appear committed to bringing virtual asset providers under more rigorous control, aligning with the administration's objectives."
Extensive Violations Uncovered
South Korea's AML watchdog is preparing to impose sanctions on several major cryptocurrency exchanges after discovering widespread deficiencies in their AML safeguards. The Korean Financial Intelligence Unit (KoFIU) reported that it conducted 18 months of on-site inspections at the country's leading platforms, identifying millions of compliance failures.
Dunamu, the operator of Upbit, is facing severe repercussions. On November 7, the company was fined an unprecedented $25 million, linked to 8.6 million violations of transaction reporting rules. KoFIU also documented 5.3 million shortcomings in customer due diligence procedures, 3.3 million instances where trading was permitted before verification was finalized, and 15 unreported suspicious activities.
KoFIU indicated that other major exchanges exhibited similar deficiencies and may also face penalties as the regulator intensifies its oversight of the virtual asset sector.
Navigating Regulatory Gray Areas
So-Ye Yoon noted that the recent inspections of Virtual Asset Service Providers (VASPs) represent the first large-scale on-site inspections conducted by KoFIU.
"While these inspections would be standard for traditional financial institutions, VASPs are not currently categorized as traditional financial institutions under the existing regulatory framework," So-Ye explained.
According to So-Ye Yoon, this development could signify a broader effort to harmonize the governance and risk-control obligations of crypto trading platforms with those of banks and securities firms.
Addressing Travel Rule Loopholes
South Korea has also taken steps to close what officials have described as one of the most exploited vulnerabilities in its system. This loophole allowed criminals to split transfers into amounts below one million won to circumvent identity verification requirements. The government has announced that it will now mandate identity verification for all crypto transactions, regardless of their size, thereby eliminating the anonymity of micro-transfers.
KoFIU officials will be granted the authority to freeze accounts prior to obtaining court approval if they suspect funds are connected to serious criminal activities. The government asserts that this measure is essential to prevent illicit funds from being moved across borders instantaneously.
As part of this comprehensive regulatory overhaul, South Korea intends to block access to cryptocurrency exchanges deemed "high-risk" and operating overseas. On November 28, FSC Chairperson Lee Ok-won stated that domestic regulations have limited efficacy if users can transfer assets to platforms operating outside the country's regulatory jurisdiction.
Increased Scrutiny on Self-Custody
Dr. Deokyoon Ko, CEO of the blockchain startup Nonce Lab, commented that real-name verification, the Travel Rule, and continuous monitoring are raising the entry barriers for participants in the crypto space.
The recent cyberattack has intensified the pressure on an industry already under significant scrutiny. The AML obligations for VASPs have become substantially more stringent, to the extent that compliance costs are reportedly impacting smaller exchanges disproportionately, according to Dr. Ko.
"Instead of completely avoiding cryptocurrencies, many Korean users are opting for self-custody as a means to maintain control over their assets without being subject to centralized compliance requirements."
However, South Korea's national tax agency is planning to conduct physical searches for users suspected of holding crypto assets offline. Korean authorities are now viewing offline storage, traditionally considered a secure method against seizure, as a viable target for enforcement actions.
South Korea's primary financial regulator, the FSC, is undergoing a significant internal reorganization. The agency plans to reassign staff and adjust its organizational structure to enhance operational efficiency, particularly concerning virtual asset providers.
The FSC is responsible for maintaining market stability, advancing South Korea's financial policy, and overseeing the Financial Supervisory Service (FSS). In September, the FSC narrowly avoided consolidation with the FSS as part of the Lee administration's initiative, following criticism regarding a lack of transparency in Korea's stock markets.
According to local reports, the FSC has indicated that its workload has increased, while budget constraints prevent the hiring of additional staff. A review, scheduled for completion in April of the following year, aims to redesign the FSC's structure and reallocate personnel to achieve greater output with existing resources.
Specifically, the agency plans to streamline operations, redefine responsibilities, and reorganize departments to improve its oversight capabilities.
"The FSC has approximately 342 staff members. This is a relatively small number for an agency responsible for policy formulation, and they are tasked with addressing all these emerging issues," commented So-Ye Yoon, a finance attorney at Dentons Lee law firm in Seoul.
For Seoul, the message is unambiguous: digital assets are no longer merely financial instruments but represent a matter of national security that the government can no longer afford to leave unprotected.