South Korea's Financial Supervisory Service has abruptly switched from an on-site check to a formal inspection over a large-scale bitcoin mispayment incident involving crypto exchange Bithumb.

Attention is also focused on the wider market impact, as the outcome could lead to a review of record-keeping and asset custody standards across crypto exchanges.

According to financial authorities and the financial sector on Feb. 10, the watchdog gave Bithumb advance notice on Monday that it would begin an inspection and launched the formal inspection from Tuesday.

The upgrade comes three days after it began an on-site check on Feb. 7, the day after the incident occurred.

The watchdog signalled an intensive inspection, including deploying additional personnel, given the seriousness of the case.

An FSS official said, "We view this matter extremely seriously," and stressed that it would "deal strictly with acts that undermine market order."

Financial authorities are focusing in particular on how a volume far exceeding Bithumb's actual bitcoin holdings came to be paid out.

Centralised exchanges, or CEXs, such as Bithumb operate through "ledger trading", in which coins deposited by customers are held in the exchange's own wallets, and trades are not recorded directly on the blockchain each time but instead only ledger balances are changed.

As of the third quarter of last year, Bithumb held about 42,000 bitcoins. Of those, 175 were held by the company and the rest were entrusted by customers. Bithumb's current bitcoin holdings are estimated to have increased to about 46,000.

Despite that scale of holdings, the watchdog is treating as a key inspection item how 620,000 bitcoins, 13 to 14 times its actual holdings, were paid out.

In and outside the industry, there is talk that it may have violated the Virtual Asset User Protection Act, which requires a virtual asset service provider to effectively hold virtual assets of the same type and quantity as those entrusted by users.

Another financial authorities official said, "This is an issue that could shake trust across the virtual asset market," adding, "The inspection will also examine whether the structure allows the 620,000 mispaid coins to be withdrawn at once."

Authorities also plan to closely examine Bithumb's internal control system.

They are expected to identify system loopholes that allowed coin payouts with a single click by one staff member and to check whether a monitoring system comparing ledger volumes with actual holdings (balances) is functioning properly.

Financial authorities say they will use the inspection results as a task for improvement in discussions on the second phase of virtual asset legislation.

Lee Chan-jin (이찬진), head of the FSS, said at a press briefing on Monday, "If we cannot properly resolve the ghost coin problem, how can (the virtual asset market) be incorporated into the institutional system?" He added, "Reflecting the inspection results, tasks that must be strongly supplemented in the second phase of legislation have been identified."

As shortcomings in internal controls have emerged, some say calls to limit major shareholders' ownership stakes in crypto exchanges to 15 to 20 percent have gained further momentum.

[Yonhap News Agency]