Since BaFin qualifies Bitcoins and comparable cryptocurrencies as financial instruments, the operating of a crypto exchange requires the operator to be BaFin licensed. But what are the requirements to fulfill in order to acquire such license and what are the conceptual design options that businesses have for meeting these requirements while at the same time tailoring their exchange to the performance of their business? The first part of FIN LAW´s “Building a Crypto Exchange” blog series discusses the three major possibilities for regulatory designs of crypto exchanges in Germany. In the upcoming weeks the follow-up blogs will go into greater detail regarding the regulatory prerequisites for obtaining the above-mentioned licenses.
ACTIVE ADVERTISING TO GERMAN CUSTOMERS REQUIRES BAFIN LICENSE
A common misconception is that BaFin is only competent for exchanges that are registered in Germany. In reality, BaFin, as the German financial watchdog, is also the competent supervisory authority for all crypto exchanges that act from outside of Germany but actively target German markets and customers. The authority interprets its competence very broad and intervenes e.g. in case a service provider operates a German website, hosts roadshows in Germany or gives interviews in German magazines presenting the businesses’ services to the German public.
1. VARIANT: THE MULTILATERAL CRYPTO TRADING FACILITY
The most common way of running a crypto exchange outside of Germany is to operate trading platforms that work by an automated matchmaking system pairing the users’ buy and sell orders. Characteristic for these exchanges is that the matchmaking process does not reveal the parties’ identities which is why they do not know who they enter into an agreement with. The German Banking Act (KWG) defines a multilateral trading facility as a system that brings together two parties’ buying and selling interests in financial instruments within the system and in accordance with preset, non-discretionary rules in a way that leads to a sales contract between the two parties. The execution, meaning the transfer of coins or tokens to the buyer and the transfer of the acquisition price to the seller, is processed automatically by the operator of the facility. The users therefore must at all times dispose of a sufficient balance of cryptocurrency respectively fiat currency with the operator of the trading facility so that the trade can be settled.
2. VARIANT: THE CRYPTO EXCHANGE BUREAU
A comparatively easy way to design a crypto exchange is the sale of cryptocurrencies from the operators’ own stockpile. In this case the operator of the exchange becomes the contracting partner of the customer and owes him fulfillment of the contract meaning either the transfer of cryptocurrencies to the customer in exchange for fiat money or vice versa. From a regulatory point of view this constitutes either proprietary trading or a financial commission business. A financial commission business can be given if the operator only buys or sells the cryptocurrency in question from or to the international markets on basis of a customer’s order.
3. VARIANT: THE CRYPTO BROKER
A version of a crypto exchange already tested in Germany is the crypto broker design. Users of these exchanges can issue offers to buy or sell cryptocurrencies via the platform. The users then interact and enter into contracts with each other directly. The operators of these exchanges are not contractual partners of the customers but rather act as an intermediary to them bringing together the potential contractual partners. In contrast to the multilateral crypto trading facility the users know the identity of their contractual partner in this version of a crypto exchange.
LISTED CRYPTOCURRENCIES INFLUENCE THE REGULATORY REQUIREMENTS AS WEL
Additionally, the nature of the listed cryptocurrencies on the exchange influences the regulatory requirements that have to be met. Generally spoken, the requirements tend to be lower if the exchange lists “classic” cryptocurrencies such as Bitcoin or Litecoin and they get higher if the exchange lists e.g. security tokens.
The regulatory conception of crypto exchanges is complex and any detail can potentially influence the requirements that have to be met. A competent legal advisory is therefore the basis of every successful project. In the upcoming weeks FIN LAW will publish further parts of the blog series “Building a Crypto Exchange” illustrating the supervisory details of the specific variants of crypto exchanges.
Attorney Lutz Auffenberg, LL.M. (London)