There are many ways to design a crypto exchange. In all variants, the defining feature of a crypto exchange is bringing together the buy and sell orders of the exchange users. Even platforms that do not feature any automated order matching or do not become direct contract party of their customers regarding the selling or buying of cryptocurrencies but rather focus on relaying those users to each other are operating a business which, according to the administrative practice of BaFin, offers financial services and therefore requires BaFin’s authorization. Besides applying for an own authorization from BaFin, crypto brokers also have the legal possibility to operate their business under a regulatory liability umbrella of a German financial institution possessing BaFin’ authorization to act as an investment broker. The crypto broker then acts as a tied agent of the licensed institution.
WHAT EXACTLY DOES A CRYPTO BROKER DO?
The crypto broker brings together the supply and demand regarding the trading of cryptocurrencies and is limited to this service. Users of the crypto exchange get the opportunity to publish offers to purchase or sell cryptocurrencies on the platform. Interested possible counterparties can answer these offers via the platform and engage in negotiations with the user that published the offer. The crypto broker therefore acts as an intermediary making the published offers accessible to suitable interested parties. In this version of a crypto exchange the operator of the exchange never enters directly into an agreement regarding the actual trading of cryptocurrencies. This holds true even if the operator stores the cryptocurrencies in question until all fees and the complete acquisition price are paid. The key characteristic of this exchange type is that the potential business partners are directly dealing with each other and therefore know about their identities. This is the main difference to the multilateral crypto trading facility.
WHAT ARE THE MAIN REQUIREMENTS THAT HAVE TO BE MET IN ORDER TO OBTAIN A BAFIN APPROVAL TO ACT AS AN INVESTMENT INTERMEDIARY?
BaFin’s authorization to act as investment broker is tied to a relatively small starting capital requirement as long as the applicant at no point in time has legal ownership of his client’s money or securities and as long as he does not engage in proprietary trading. BaFin demands the applicant to show 50,000 euros equity capital to be at the disposal of the applicant. Alternatively, a liability insurance that covers at least 1,500,000 euros in pecuniary losses per insurance year and 1,000,000 euros per insured event is also sufficient. Investment brokers that simultaneously are regulated insurance brokers benefit from further facilitations. Furthermore, the crypto broker has to submit a sustainable business plan which conclusively shows the economic and regulatory planning and the business management system of the crypto broker’s company to BaFin. At least one fit and proper company director is another requirement that must be met. As long as the crypto broker only offers his services in relation to classic cryptocurrencies like Bitcoin, Litecoin or Ethereum qualifying as units of account and therefore as financial instruments, the special requirements of MiFID II will not be applicable. If the exchange offers intermediary services also in regard to security tokens, the strict regulations regarding securities trading will additionally have to be fulfilled.
HOW DOES THE CONNECTION TO A REGULATORY LIABILITY UMBRELLA WORK?
There are numerous financial service providers in Germany that specialize in providing their regulatory liability umbrella to investment advisors and brokers. This specialization however is not necessarily required for connecting tied agents. Every licensed financial service provider can cooperate in this way with a crypto broker as long as he confirms towards BaFin that the crypto broker is professionally qualified and reliable. Furthermore, he has to ensure that the crypto broker conducts his business in accordance with banking regulatory law. The supervisory obligations as well as the liability towards the clients of the crypto broker then apply to the financial service provider providing the regulatory liability umbrella. In this scenario, the crypto broker as a tied agent does not need a BaFin authorization himself for operating his crypto exchange platform.
Attorney Lutz Auffenberg, LL.M. (London)