When Bitcoin introduced the world to blockchain technology in 2009 and enabled decentralized transactions, the validation of blockchain transactions worked via the so-called Proof-of-Work consensus mechanism (PoW). Since then, not only the market prices of Bitcoin and other cryptocurrencies massively increased, but the underlying technology of crypto assets has also developed at an astonishing pace. The PoW consensus mechanisms are nowadays rarely used for newly developed blockchain infrastructures. The most popular consensus mechanisms right now are the so-called Proof-of-Stake consensus mechanism (PoS), which are superior to PoW systems, especially in terms of energy efficiency. The discovery of new transaction blocks in PoS systems does not depend on an investment of computing power, but instead on the mere holding of units of the respective blockchain. Nowadays, it is usually not even necessary to transfer the respective crypto assets to another blockchain address in order to partake in the mining process of a PoS system. The participation in the mining process works in many of those systems via a simple delegation of the respective crypto assets to a server which acts as a so-called Mining-Node in the respective blockchain system (delegated Proof-of-Stake, dPoS).
Staking Participation as a Service can be Reasonable in Specific Circumstances
Even though the delegation of crypto assets in dPoS systems is usually done by the respective bearer of the crypto assets via the wallet software and usually without a lot of effort, there is still a need for service providers who provide their clients with a service for partaking in dPoS-staking. Especially in cases in which the crypto investor wants to or must keep the crypto assets in the custody of a third-party, a crypto custody service provider who also manages the dPoS staking of the respective crypto assets and thereby the generating of rewards in the form of block rewards is required. There are situations conceivable in which crypto investors grant power of attorney for their crypto wallets to service providers and commission them with the management of their crypto assets. How are these kinds of services regulated in Germany?
Crypto Staking for Third Parties may qualify as Crypto Custody Service
Service providers who safeguard crypto assets for their clients and who also dispose over the associated private keys are regulated as crypto custody institutes pursuant to the German Banking Act (KWG) if they offer the custody services to German customers and if they operate this business on a commercial or at least on a professional scale. Should these service providers not only safeguard the crypto assets of their customers but also delegate them in order to participate in dPoS mining, they generally also fulfil the second alternative of the legal definition of crypto custody business, the management of crypto assets for others. BaFin defines the term “management” in the sense of this provision as the exercising of rights resulting from a crypto asset. The suitability of a crypto asset to partake in dPoS mining is a characteristic of the crypto asset itself. A good argument can therefore be made to view the suitability to dPoS staking as a right resulting from the crypto asset, even more so because BaFin emphasizes the broad interpretation of the term in its published administrative practice. BaFin has not yet published anything regarding its opinion and interpretation for the abovementioned case, so that a close coordination with the supervisory authority for service providers intending to offer the aforementioned service is advisable. Should BaFin not assume the management alternative, e.g. because a right has to be assertive versus a third party and that is not the case when receiving block rewards from a decentralized functioning system, a qualification of the activity as financial portfolio management could also be considered.
Staking Crypto Assets of Clients in dPoS-Staking as Financial Portfolio Management
The staking of customer crypto assets in dPoS-mining in order to generate block rewards can also be qualified as financial portfolio management. According to the legal definition in the KWG and the German Investment Firm Act (WpIG), financial portfolio management means the management of individual or multiple patrimonies which are invested in financial instruments for others with discretion. Crypto assets are financial instruments according to the KWG and the WpIG. A credit balance in crypto assets on a client´s wallet can be a patrimony in the sense of the provision. The wording of the provision does not provide any arguments to assume that financial portfolio management requires the prior acquisition or disposition of the financial instrument. The financial instrument that is already present can therefore simply be used to generate a profit. The decisive factor will be whether the service provider effectively takes over the management of the respective client’s patrimony.
Attorney Lutz Auffenberg, LL.M. (London)