Since the prices of Bitcoin, Ether, Litecoin and other cryptocurrencies are approaching new all-time highs these days and more and more institutional investors are interested in including relevant positions of cryptocurrencies into their investment portfolios, also the daily trading volume of the crypto market is increasing accordingly. The 24-hour trading volume over the last couple of days has been constantly between 150 and 200 billion USD, with an upward trend noticeable. The increased interest of investors in the crypto market also means increased business for service providers that provide their customers access to the crypto market and enable them to trade crypto assets. Where such service providers trade crypto assets from and to their own books, the German banking regulatory law generally calls for the service providers to be BaFin authorized for either proprietary trading or financial commission business. But what is the difference between those two forms of financial trading and which variant is better suited for the crypto business?
PROPRIETARY TRADING CAN BE GIVEN BY ECONOMICAL SELF AND THIRD PARTY INTEREST
Proprietary trading, which is subject to authorization is conducted by those, that acquire or dispose of financial instruments in their own name and for their own account and that additionally fulfill certain specific requirements of the German Banking Act (KWG). Trading cryptocurrencies can be qualified as proprietary trading, because of the fact that cryptocurrencies are generally qualified as crypto assets and therefore as financial instruments in Germany. For example acting as a so-called Market Maker, meaning someone that continually offers and acquires crypto assets at trading venues for self-determined prices, or as a so-called Systematic Internalizer, meaning someone, that systematically and in an organized manner conducts trading with crypto assets outside of trading venues, can be qualified as proprietary trading. Additionally, proprietary trading may be given where a service provider offers his customers the trading of crypto assets, which the service provider conducts for its own account and in a substantial way. Proprietary traders enter directly into agreements with their trading partners as a contractual counterpart. Even though it is subject to discussion, if the obligation to obtain authorization for proprietary trading always requires a service-character, BaFin has not in all cases deemed such as necessary requirement.
FINANCIAL COMMISSION BUSINESS ONLY WITH TRADES ON THE CUSTOMER’S BEHALF
Financial commission business may be given in cases of trading operations concerning crypto assets, even if the trader acts in his own name. The difference to proprietary trading lies in the fact, that the financial commission business always requires the trade to have economic effect for the account of someone other than the trader, meaning the economic consequences of the trade will always hit the customer and never the service provider. This is the case, if a service provider acquires or disposes of crypto assets because of a client order. This may for example make sense where the service provider has better market access than the customer and can therefore get better prices for the customer. The service provider in this case acts in his own name on the markets but because of the contractual agreement between the service provider and the customer, the economic consequences will be applied to the customer.
WHICH VARIANT IS BETTER SUITED FOR CRYPTO TRADING?
It cannot be generalized which of the two variants is better suited for crypto trading. The decisive factor to answer this question is the specific business model in the individual case. Business models in which crypto assets are traded with a pure economic self-interest cannot qualify as financial commission business. If each trade on the other hand is based on a client order, the design of the service as a financial commission business seems preferable, since holdings in crypto assets, that belong to the service provider himself, have to be matched in accordance with the CRR-equity quotas with the corresponding equity, no matter if the service is designed as proprietary trading or financial commission business. Additionally, the financial commission business does not require the establishment of a crypto portfolio to match the client demand at all time.
Attorney Lutz Auffenberg, LL.M. (London)
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