Initial meeting

Category: blog EN

Jan 09, 2023

Europe goes Crypto (Part V) – The E-Money Token According to MiCAR

With the EU Regulation on Markets in Crypto Assets (MiCAR), the European Union will create a uniform EU-wide definition of crypto assets in the future. From the time MiCAR is expected to come into force in the second half of 2024, crypto assets will thereafter be regulated as a digital representation of a value or a right which may be transferred and stored electronically, using distributed ledger technology or similar technology. In addition to this very broad and general definition of crypto assets, the MiCAR also provides definitions for specific forms of crypto assets in its final text. One of these specific forms will be e-money tokens. MiCAR defines these as a type of crypto asset that seeks to achieve stable value by referencing an official currency. Such e-money tokens have existed for some time and play a central role in international crypto markets. For example, Tether’s USDT and joint venture Center’s USDC, which reference the U.S. dollar, currently rank third and fourth, respectively, in terms of market capitalization. The BUSD of the crypto group Binance, which is also referenced to the US dollar, ranks seventh in terms of market capitalization and is thus also a top ten crypto asset.

E-Money in the EU Regulated So Far Only by the E-Money Directive

E-money has already been regulated in the European Union since 2005 through the Electronic Money Directive. The E-Money Directive defines electronic money as electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions and which is accepted by a natural or legal person other than the electronic money issuer. The EU Directive stipulates that electronic money may only be issued in the European Union by authorized credit institutions or by electronic money institutions. The e-money business in the European Union is thus a strictly and specifically regulated area of business. According to its wording, the e-money definition in no way precludes e-money from being issued via a blockchain solution. An entity that issues blockchain units that meet the e-money definition of the E-Money Directive will therefore, in principle, be deemed to be an e-money institution within the meaning of the Directive and will need to comply with the regulatory requirements for its business. In particular, such a company will have to obtain an authorization as an electronic money institution to the extent that it wishes to direct its business to the European market. If, on the other hand, a crypto asset lacks one of the prerequisites of the e-money definition, for example because there is no identifiable issuer, the regulatory regime of the E-Money Directive is generally not applicable.

E-Money Tokens to be Considered Traditional E-Money According to MiCAR

MiCAR’s definition of e-money tokens is significantly broader than the E-Money Directive’s definition of e-money. As a result, not all e-money tokens necessarily meet the definition of e-money under the E-Money Directive. Nonetheless, in this regard, MiCAR stipulates that e-money tokens under MiCAR should be treated as e-money under the E-Money Directive. This equation is not without problems, because according to the MiCAR definition of e-money tokens, the existence of an issuer, as seen, is not a mandatory requirement. Even e-money tokens without an issuer would be crypto assets and thus, for example, a suitable subject of regulated crypto asset services. The e-money definition of the E-Money Directive, on the other hand, requires that e-money must be a claim on the issuer. Following this approach, almost all of the requirements of the E-Money Directive relate to the rights and obligations of e-money issuers. MiCAR’s equation of decentralized created e-money tokens with traditional e-money is therefore meaningless. Nevertheless, MiCAR also stipulates that e-money tokens may only be offered by credit institutions or e-money institutions and that all holders of e-money tokens must be granted a claim against the issuer. In contrast, e-money tokens that do not provide for claims against the issuer are to be prohibited. Nevertheless, such prohibited e-money tokens will also be crypto assets within the meaning of MiCAR and may to that extent be subject to crypto asset services.

Atty. Dr. Lutz Auffenberg, LL.M. (London)

I.  https://fin-law.de

E. info@fin-law.de

subscribe to Newsletter

    Contact

    info@fin-law.de

    Dec 19, 2022

    BaFin Authorization for Crypto Asset Services – Is MiCAR Worth the Wait?

    The provision of services related to crypto assets has long been regulated under financial supervision law in Germany. Service providers offering financial commission business or proprietary trading activities relating to crypto assets in Germany, for example, require a BaFin authorization in accordance with either the German Banking Act (KWG) or the German Investment Firm Act (WpIG). The mediation of supply and demand regarding the conclusion of contracts for crypto transactions or the operation of exchange platforms for crypto assets are also subject to authorization as investment brokerage or as the operation of a multilateral trading facility under the KWG or WpIG. Companies wanting to offer such services in the future are currently confronted with the question of whether it is even worth applying to BaFin for a corresponding authorization. This is because the new EU Regulation on Markets in Crypto Assets (MiCAR) will introduce an independent authorization regime for crypto asset service providers as of its validity 18 months after promulgation in the official journal of the EU. In about two years at the latest, it will therefore be a viable option to apply to BaFin for authorization to provide crypto asset services under MiCAR anyways. Crypto trading activities will then generally be regulated under the MiCAR regulations.

    Application for Authorization in Accordance with KWG or WpIG Still Reasonable

    Applying for authorization in accordance with the KWG or the WpIG is still reasonable in many cases for companies that plan to provide crypto asset services. On the one hand, ambitious companies with coherent business models regularly lack the time to wait for the new MiCAR to become applicable. In addition, under the MiCAR rules, companies will not need an additional authorization pursuant to MiCAR if they already have a corresponding authorization pursuant to the European securities regulation relating to financial instruments. As a result, investment firms authorized to engage in financial commission business and proprietary trading, for example, will also be permitted to provide these activities with respect to crypto assets within the meaning of MiCAR without having to apply for an additional MiCAR authorization. As a result, German investment firms will also be able to use their authorizations with respect to crypto assets immediately upon MiCAR becoming effective throughout Europe. BaFin authorizations granted under German supervisory law will thus also be passportable in the area of crypto asset services in the future. Special features exist for the financial services of crypto custody and crypto securities registry management, which are only nationally regulated in Germany under the KWG. While crypto custody business in the sense of MiCAR should in any case be able to be provided by investment firms with a license for the custody of financial instruments, crypto securities registry management refers solely to the registry management to crypto securities according to the German Electronic Securities Act (eWpG). Therefore, crypto securities registry management services can be exclusively authorized by BaFin under the KWG also in the future.

    MiCAR Authorization Will Not Be Sufficient for Specific Business Models

    In specific cases, even a MiCAR authorization may not be sufficient for certain business models. This will be the case, for example, if a company offers services relating to tokenized securities within the meaning of European securities regulation under the second EU Markets in Financial Instruments Directive (MiFID2). This is because financial instruments within the meaning of MiFID2 are specifically not intended to be regulated by MiCAR. This will also apply if a financial instrument covered by MiFID2 is tokenized, i.e. transferable on a blockchain. Therefore, companies intending to trade tokenized financial instruments as defined by the MiFID2 regulation will still require a financial regulatory authorization pursuant to the KWG or the WpIG for this purpose. An authorization according to MiCAR, on the other hand, will not be suitable for the implementation of such business models. As a result, applying for an authorization pursuant to the KWG or the WpIG in Germany is still worthwhile in most cases for companies with business models relating to crypto assets.

    Atty. Lutz Auffenberg, LL.M. (London)

    I.  https://fin-law.de

    E. info@fin-law.de

    subscribe to Newsletter

      Contact

      info@fin-law.de

      Dec 12, 2022

      Europe goes Crypto (Part IV) – Will BaFin-authorized Companies Need a MiCAR Authorization?

      The Markets in Crypto Assets Regulation (MiCAR) will impose authorization requirements on crypto asset service providers in the future. For example, operators of crypto trading platforms, other crypto exchange providers and crypto custodians will have to obtain authorization from the competent national supervisory authority – in Germany, BaFin – prior to commencing their business operations. In Germany, the obligation to obtain authorization from BaFin for the operation of many crypto asset business models has long existed based on national law because the German legislator gave crypto assets the status of a financial instrument. However, current regulation in Germany requires crypto asset service providers to obtain a license  as a credit or financial institution under the German Banking Act (KWG) or the German Investment Firm Act (WpIG). European law does not follow this approach and will continue to not regulate crypto assets as financial instruments as defined by the European financial market directives and regulations. While markets in financial instruments will continue to be regulated via the MiFID2 Directive, MiCAR will regulate markets in crypto assets, which do not qualify as financial instruments in the sense of MiFID2. But what does this separation imply for German banks and investment firms that have crypto asset-based business models and hence have obtained an authorization pursuant to the KWG or the WpIG?

      MiCAR Provides Exemptions for Credit Institutions and Investment Firms

      Authorized credit institutions will not require any further authorization for offering crypto asset services pursuant to the new MiCAR. In this respect, MiCAR stipulates that they will only have to notify their national authority – i.e. BaFin in Germany – at least 40 days in advance of commencing the respective business that they intend to provide crypto asset services with pursuant to MiCAR. There will also be facilitations for investment firms. Under MiCAR, these firms will be authorized to provide those crypto asset services that they are already permitted to provide in connection with financial instruments according to their existing authorization. Investment firms will also have to notify the competent authority 40 days prior to providing crypto asset services in order to use this exemption. MiCAR explicitly specifies which specific crypto asset services pursuant to MiCAR correspond to which specific investment services pursuant to MiFID2. In this respect, it is advantageous for the interpretation of MiCAR that it is systematically closely based on the systematics of MiFID2.

      Will German Crypto Custodians Also Benefit from the Exemption?

      In this context, the fact that crypto custodians in Germany are not regulated as investment firms in the sense of the WpIG, but as financial services institutions pursuant to the KWG, poses problems. The crypto custody business is a national regulatory specialty of the German legislator without a legal basis in MiFID2 or any other European Directive. In this respect, the question arises whether German crypto custodians will also be able to claim the exemption for investment firms provided for in MiCAR. With regards to crypto custody, the wording of MiCAR merely refers to the ancillary securities service of custody and administration of financial instruments, from the facts of which, however, the German legislator has expressly excluded units of account and crypto assets in the WpIG. According to the wording of MiCAR, the exemption should therefore not apply to German crypto custodians. However, it must also be taken into account in this context that MiCAR and MiFID2, as European laws, hierarchically take precedence over national laws and national laws cannot be used to interpret European regulations. In addition, it can be assumed that authorized German crypto custodians will be better positioned with respect to the fulfillment of the regulatory requirements for crypto custody provided for by MiCAR than securities institutions that also hold financial instruments in custody as an ancillary service. If interpreted appropriately, German crypto custodians should also be allowed to take advantage of the exemption provided by MiCAR. In any case, BaFin will have to comment and position itself in this regard in due time prior to the MiCAR coming into force. The German legislator will also be able to contribute to the solution of this problem by making the necessary adjustments to national law for the implementation of MiCAR anyway.

      Atty. Lutz Auffenberg, LL.M. (London)

      I.  https://fin-law.de

      E. info@fin-law.de

      subscribe to Newsletter

        Contact

        info@fin-law.de

        Dec 05, 2022

        Europe goes Crypto (Part III) – The MiCAR White Paper

        In order to provide the European crypto market with more security and professionalism, the Markets in Crypto Assets Regulation (MiCAR) of the European Union will not only impose authorization and compliance obligations on crypto-asset service providers but will also focus on issuers and offerors of crypto-assets. Prior to public offerings as well as listings of of crypto assets on crypto trading platforms, it shall be required in the future that the responsible persons or companies prepare a white paper, which is required to have a legally prescribed minimum content, prior to the start of the offering or listing. In addition to increasing the transparency of Initial Coin Offerings (ICO) and other token sales, the MiCAR legislator expects this to also significantly strengthen the accountability of providers of new crypto assets, which has been lacking until now. The white paper provisions of MiCAR are strongly modeled after the mechanisms known from securities prospectus law.

        What will Offerors of Crypto Assets be Required to Disclose in the White Paper?

        Offerors of crypto assets will need to provide potential investors with sufficient information via the white papers to enable them to make the right investment decision for their needs. For this purpose, it is first of all necessary that they provide information about themselves in their capacity as offerors or responsible person for a listing or – if deviating from this – about the issuer of the crypto assets to be offered or listed. This includes information about their legal form, their contact details and the Management Body of the company and, in the case of listings, also about the operator of the trading platform. In addition, sufficient information must be provided on the crypto asset project upon which the offer is based, and details must be published on the type and procedure of the offer or listing. The white paper must also specifically state which rights and obligations are associated with the crypto assets and which technology is the basis of the crypto assets to be offered or listed. White papers must also provide information about the risks associated with the crypto assets. Finally, offerors must present disclosure in the white paper as to whether the consensus mechanism underlying the crypto assets has any environmental or climate impact. According to MiCAR, the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) shall develop technical standards on the individual minimum requirements in the coming months in order to provide the market with specific guidance on what information must be provided in detail in white papers.

        What Additional Requirements Do MiCAR White Paper Offerors Need to Fulfill?

        In addition to the minimum content information, offerors of crypto assets will have to include an explicit statement in the white paper to be published that the white paper has not been approved or authorized by any authority and that the provider is solely responsible for the content of the white paper. This disclosure requirement derives from the liability regime provided under MiCAR for defective white papers. Offerors who fail to publish the information required under MiCAR in the white paper, or publish it incompletely or misleadingly, are liable to investors for compensation for any resulting damages. Although white papers do not have to be approved by authorities, they must be filed by the offeror with the competent authority in each member state in which the offer or listing will be available. MiCAR instructs that white papers are to be written in the language of the offeror’s home member state or in a language customary in the sphere of international finance.

        Atty. Lutz Auffenberg, LL.M. (London)

        I.  https://fin-law.de

        E. info@fin-law.de

        subscribe to Newsletter

          Contact

          info@fin-law.de

          Nov 21, 2022

          Europe goes Crypto (Part II) – How Much DeFi is in MiCAR?

          Distributed ledger technologies (DLT) such as blockchain are not only suitable for centrally operated business models – this has already been evident for many years and is becoming increasingly interesting. Decentralized exchange platforms – i.e. without a central service provider appointed to handle the transaction – have been around since the mid-2010s. Currently, more and more experts are claiming that the bankruptcy of the crypto exchange FTX could have been prevented by more decentralization. Even if the risks such as human error, personal greed and counterparty risks, which apparently materialized in the FTX case, are rather minor problems on fully decentralized exchange platforms, it must of course not be overlooked that other risks such as operational and technical risks could lead to similarly high damages here. Ever since the EU Commission published its first draft of the new Markets in Crypto Assets Regulation (MiCAR) in the summer of 2020, there has been discussion about whether and to what extent MiCAR should also regulate providers of decentralized business models and the area of Decentralized Finance (DeFi). Since the final version of MiCAR has been agreed upon in October, this question can now be answered.

          MiCAR is not Supposed to Regulate DeFi in Principle

          MiCAR is designed to regulate service providers and operators. This approach seems bizarre, especially since DLT and blockchain are in fact decentralized technologies. Nevertheless, a large number of companies have established themselves in the crypto market, especially in the years up to 2020, offering their customers services such as custody and administration, exchange or trading services related to crypto assets. They provide these services on the basis of customer contracts concluded between them and the customers and thus as centrally acting providers. These crypto asset service providers are now required by MiCAR to comply with numerous obligations such as, in particular, the obligation to obtain an operating license and to fulfill due diligence obligations. Initial providers or issuers of crypto assets are likewise to be regulated by transparency and disclosure obligations. However, decentralized offerings, where there is no clearly identifiable provider, are not to be subject to the provisions of MiCAR. The legislator clarifies this in recital 12a MiCAR by stating that crypto asset services that are provided in a completely decentralized manner without an intermediary should not fall within the scope of MiCAR. Similarly, it states the same with respect to crypto assets that are not issued by an identifiable issuer.

          Extent of Decentralization Decisive for Application of MiCAR

          However, recital 12a MiCAR leaves a loophole open. In the last sentence of the recital, it clarifies that crypto asset service providers that offer their services in relation to decentrally issued crypto assets will of course still be covered by the MiCAR provisions. In all other respects, however, it will depend on the specific degree of decentralization of a crypto asset service as to whether MiCAR applies to an individual or a company. This is because not every service described as decentralized is a true DeFi business model. For example, if a company has the administrator rights to a smart contract executed on a blockchain through which an exchange designated as “decentralized” is operated, that company may be considered the operator of that exchange platform in a specific case. Another relevant indication will be whether a company or person receives trading fees or other benefits directly or indirectly from users of such a DeFi exchange. The assessment must be made in the individual case on the basis of the specifics of each case. If, after taking into account all the circumstances of the individual case, the service proves to be only partially decentralized, a possibly identifiable initiator or operator may nevertheless be subject to the provisions of MiCAR.

          Attorney Lutz Auffenberg, LL.M. (London)

          I.  https://fin-law.de

          E. info@fin-law.de

          subscribe to Newsletter

            Contact

            info@fin-law.de

            Nov 14, 2022

            Europe goes Crypto (Part I) – The MiCAR Authorization

            The final text of the new Markets in Crypto Assets Regulation (MiCAR) has been finalized since the beginning of October 2022. It is expected that the new EU regulation will go into effect at the end of 2022 or the beginning of 2023 and will take legal effect directly vis-à-vis all market participants in the European Union 18 months later. MiCAR will then regulate the custody and administration of crypto-assets on behalf of third parties, the operation of trading platforms for crypto-assets, the exchange of crypto-assets for funds or other crypto-assets, the execution of orders for crypto-assets on behalf of third parties, the placing of crypto-assets, the provision of transfer services for crypto-assets on behalf of third parties, the reception and transmission of orders for crypto-assets on behalf of third parties, and the provision of advice and portfolio management on crypto-assets as crypto-asset services. Providers of crypto-asset services will then have to apply for a MiCAR license from the competent authority in their home country – in Germany, this will be BaFin. But what requirements will crypto-asset service providers have to fulfill in order to obtain a MiCAR authorization?

            What Requirements Must Crypto-Asset Service Providers Fulfill to Obtain a MiCAR Authorization?

            Even though the business models that will be regulated by MiCAR in the future are precisely those that are not already covered by European financial market regulation, the requirements for obtaining a MiCAR authorization are very closely modeled after those for financial institutions under MiFID II. To obtain a MiCAR authorization, crypto-asset service providers must have their registered office and at least one member of the management body within the European Union. They must also disclose to BaFin comprehensive information about their company and the owners behind it, as well as the intended members of the management body, who must be of sufficiently good repute and possess appropriate knowledge, skills and experience. Like financial institutions, crypto service providers will in the future have to prove that they have a proper and adequate business organization. They must be able to demonstrate internal control mechanisms, contingency plans and secure IT systems, as well as sufficient risk management and a money laundering prevention and compliance organization that meets the legal requirements. Additionally, they are required to have a professional complaint management system in place and to strictly segregate client funds and client crypto-assets from their own assets. In the MiCAR authorization application, crypto-asset service providers will also have to describe their specific business model in detail, possibly submitting sample customer contracts. In addition, crypto-asset service providers will be required to have sufficient capital resources. The minimum amount required is 150,000 euros for operators of trading platforms for crypto-assets, 125,000 euros for operators of crypto-asset custody and exchange providers, and otherwise 50,000 euros or – if higher – one quarter of the previous year’s fixed overhead costs on an annual basis. The exact requirements for the business organization to be maintained by crypto-asset service providers are to be developed by ESMA in cooperation with EBA in technical standards 12 months after MiCAR goes into force.

            Short Deadlines Provided in MiCAR Authorization Procedures

            MiCAR authorization procedures will differ from authorization procedures of financial institutions and investment firms, particularly with regards to the processing periods provided for by law. BaFin will have to inform applicants within 25 working days whether a MiCAR application is complete. If proof or information is still missing, BaFin must set a deadline for subsequent delivery. BaFin will have 40 working days to review the content of a complete MiCAR authorization application. It must then reject or approve the application. In the case of authorization applications from financial institutions or investment firms, the law only stipulates that BaFin must issue a decision within six months of the submission of a complete application, which often leads to subsequent requests shortly before the six-month period expires. In this context, the short processing periods under MiCAR should lead to more expeditious processing of MiCAR authorization applications by BaFin.

            Attorney Lutz Auffenberg, LL.M. (London)

            I.  https://fin-law.de

            E. info@fin-law.de

            subscribe to Newsletter

              Contact

              info@fin-law.de

              Nov 07, 2022

              Security Token Offerings in Times of Inflation – More Tokenized Equity Products Are Needed

              By now, many investment products can be tokenized in Germany. Most security tokens are tokenized profit participation rights, i.e. bond products that grant the token holder a right for interest and repayment of the invested amount against the token issuer at the end of the duration. Such tokens are interesting products, especially in times when central bank interest rates are low and opportunities to earn returns are rare. Currently, however, the global economy is facing a turning point. Inflation is exceeding 10% monthly at times, and central banks are responding with substantial key interest rate hikes. To remain attractive in the face of inflation rates, bond products must promise investors very high returns. In some cases, therefore, issuers of tokenized profit participation rights promise additional participation in their corporate profits. What is really interesting for investors in these times, however, is the acquisition of genuine company shares in order to be able to participate directly in an increase in the value of the company in which they are investing. But which company shares can actually be tokenized and issued via a security token offering in Germany?

              Tokenization of Stocks is Legally Possible

              In the summer of 2021, the German legislator had created the possibility under civil law to issue bearer bonds as crypto securities with the Electronic Securities Act (eWpG). Since then, the rights from such crypto securities can be linked to crypto tokens in the same way as securitized securities, so that the respective holder can assert them against the issuer. It is true that the legislator plans to extend the scope of application of the eWpG to stocks. Currently, however, there is only a draft paper of the Federal Ministry of Finance in place, according to which an inclusion of stocks in the eWpG is planned. However, tokenization is already possible under current law, at least for registered stocks in Germany. Tokenized registered stocks do not yet enjoy the advantages of, for example, the possibility of acquisition in bona fide and free of encumbrances. However, they can still be issued with legal effect if the statutes of a stock corporation are drafted accordingly. Bearers of such stock tokens have the legal status of a shareholder of the respective issuer.

              Limited Partnership Shares Can Also Be Tokenized

              Another possibility of tokenizing company shares already exists today for limited partnership shares. In this case, token holders would participate as limited partners in a limited partnership. As such, they would only be liable up to the amount of their contribution, but as partners they would participate in any increase in the value of the limited partnership’s business proportionately to the amount of their share. It is true that limited partners must in principle be entered in the commercial register, which could significantly complicate the transferability of tokenized limited partnership shares. However, limited partnership shares can also be held by a trustee, who would then be entered in the commercial register instead of the investors.

              Attorney Lutz Auffenberg, LL.M. (London)

              I.  https://fin-law.de

              E. info@fin-law.de

              subscribe to Newsletter

                Contact

                info@fin-law.de

                Oct 24, 2022

                The Reward Model – The Solution for Tokenization of Assets?

                The Tokenization of cars, art objects or other tangible assets can offer many advantages. A token representing a person’s full entitlement to an item could simply be transferred between individuals and companies without the need for a physical handover of the item on site. However, ownership of property cannot be effectively linked to a token under German private law. Under the current legal situation, German property law mandatorily links ownership to the object itself. In order to transfer the ownership of an object, it is required that the seller and the acquirer firstly agree on the transfer of ownership and secondly hand over the object. It is possible that in individual cases the handing over of the object can also be performed in a fictitious way to the effect that it does not necessarily have to actually take place and it is sufficient, for example, that the claim for handing out the object is assigned by the transferor to the transferee. However, the connection of the property’s ownership right with the object itself instead of with a token cannot be changed legally in a discretionary way. Another problem is posed by private international law, according to which it cannot be ensured that German private law is always applicable in a legal relationship. This can lead to undesirable legal consequences if, for example, the token is sold or acquired by a holder who is, for example, a U.S. citizen or a Japanese citizen.

                Tokenization of Tangible Assets via the Reward Model

                For many business models, a solution can be the so-called reward model. In German private law, the reward model regulates situations in which someone promises a reward to an undefined group of people if they fulfill certain conditions. The classic example of a promise for a reward is a person’s promise, made publicly by posting a notice, to pay a reward to the person who returns a lost item to him. The reward model can often also be used in tokenization models. For example, the owner of an object can issue a token that he or she can sell to interested persons. At the same time, he or she publishes a reward offer promising that he or she will transfer ownership of a particular object to whoever transfers the token back to him or her. In this model, the token can basically be transferred freely across national borders from bearer to bearer on a secondary market. The respective token bearer always has the option of exchanging the token with the issuer for ownership of the object. The token itself is neither associated with a right of ownership nor with a real legal claim for transfer of ownership under German private law. The respective holder is only entitled to exchange the token for ownership with the token issuer because of the issuer’s offer. The legal relationship arising in the context of such an exchange can be entered into by the issuer under German law, so that the problem of the law applicable under private international law can also be solved.

                What is Required for an Effective Reward?

                In principle, the reward model is only suitable in cases where the issuer of the token also holds ownership of the object to be tokenized. Consequently, the issuer must itself keep the tokenized tangible assets on its own balance sheet and, if necessary, physically store them until they are obtained by a token holder. With regards to the legal effectiveness of the reward offer, careful drafting is required. It must be ensured that all legal obligations associated with the transfer of ownership can be met. For example, for the purchase of tokenized wine bottles, the reward offer conditions should include that the redeeming token holder is of the minimum legal age and provides a deliverable address. In addition, conditions for the payment of shipping costs can be set out in the reward offer conditions. The applicability of German private law should also be ensured – if desired. As a result, the reward model provides an attractive opportunity to link a tangible asset with a token in a legally secure manner.

                Attorney Lutz Auffenberg, LL.M. (London)

                I.  https://fin-law.de

                E. info@fin-law.de

                subscribe to Newsletter

                  Contact

                  info@fin-law.de

                  Oct 18, 2022

                  Utility Tokens in MiCAR – What Are the Differences to the Current German Regulation?

                  18 months after its coming into effect, the Markets in Crypto Assets Regulation (MiCAR) will be directly applicable law in the European Union. Market participants will then have to comply with the regulatory requirements of the new regulation. The regulation takes a comprehensive approach and attempts to regulate all conceivable types of tokens. Therefore, both initiators and providers of crypto tokens as well as numerous service providers operating business models relating to crypto tokens will have to fulfill regulatory obligations under MiCAR in the future. In order to capture the widest possible variety of known token types, MiCAR utilizes the umbrella term crypto assets. The definition of the term in essence merely requires the token to be a digital representation of a value or right that is electronically transferable and storable using distributed ledger technology (DLT). In addition to the umbrella term, MiCAR also defines specific forms of crypto assets such as e-money tokens, asset-referenced tokens, and utility tokens. In MiCAR’s understanding, the latter are crypto assets that grant digital access to a good or service available via DLT and which are accepted only by their issuer.

                  German Definition of Crypto Assets Does Not Include Utility Tokens

                  In Germany, crypto assets are already regulated as financial instruments under the German Banking Act (Kreditwesengesetz, KWG) and the German Investment Firm Act (Wertpapierinstitutsgesetz, WpIG) since January 1, 2020. However, the national legal definition differs significantly from that of MiCAR and only recognizes exchange, payment or investment purposes as a use case for crypto assets. It can also be inferred from the explanatory memorandum to the introduction of crypto assets as financial instruments, that utility tokens should generally not be subjected to the German definition of crypto assets. However, this may have to be assessed differently in individual cases should the utility token also be intended to serve investment purposes. This may be the case if an issuer of utility tokens allows the token to be used within its business model, but at the same time actively works towards making the token tradable on crypto exchanges and holds out the prospect to token acquirers that there may be price gains in the future.

                  Which Obligations May Arise from MiCAR in Connection with Utility Tokens?

                  Obligations under MiCAR primarily may arise for issuers of utility tokens and for crypto service providers offering services related to utility tokens. Issuers of utility tokens, like issuers of other crypto assets, will be required to prepare a whitepaper prior to the public offering of their tokens, which must present key information about the token, the issuer and the project behind it. Unlike other token types, however, the public offering will not be allowed to last longer than 12 months if the service behind it is not yet usable. Crypto asset service providers, as with other crypto assets, will have to perform due diligence on their customers when offering their services with relation to utility tokens. However, the issuance of utility tokens itself is not a crypto service for the respective issuer in this context. Therefore, utility token issuers do not need a authorization according to MiCAR. This is to be assessed differently for crypto service providers that support the issuance of utility tokens, for example through custody solutions, placement services or consulting services. This is the main difference between MiCAR and the current German supervisory law, which does not include utility tokens as financial instruments and therefore does not require authorization for service providers involved in utility token issuances.

                  Attorney Lutz Auffenberg, LL.M. (London)

                  I.  https://fin-law.de

                  E. info@fin-law.de

                  subscribe to Newsletter

                    Contact

                    info@fin-law.de

                    Oct 10, 2022

                    Crypto-Asset Services in MiCAR – Which Activities will be Subject to Authorization under MiCAR?

                    Even though the official publication in the Official Journal of the European Union is still pending, the final version of the future Markets in Crypto Assets Regulation (MiCAR) of the European Union is in existence since the end of September 2022. The new regulation will for the first time create a single regulatory framework for crypto-related business models at the European level, which will allow crypto service providers to conduct their business on the basis of the same regulations across Europe. MiCAR does not require implementation by member states. 18 months after coming into force, the new regulations will be directly applicable to market participants and will have legal effect without the need for further involvement of the national legislators. A core element of MiCAR is the regulation of crypto-asset services, which may not be provided without obtaining an authorization of the competent supervision authority in advance. But which activities will be regulated under this term as requiring authorization in the future?

                    MiCAR Provides Conclusive Catalog of Crypto-Asset Services

                    MiCAR will positively and conclusively regulate which activities are considered crypto-asset services and will thus be subject to the newly created authorization requirements. Specifically, the custody and administration of crypto assets for third parties, the operation of a trading platform for crypto assets, the exchange of crypto assets for legal tender as well as for other crypto assets, the execution of client orders for and placement of crypto assets, the acceptance and transmission of orders for crypto assets for third parties as well as the provision of advice on crypto assets will be activities subject to authorization throughout the EU in the future. For the interpretation of the terms, MiCAR offers definitions in each case. According to MiCAR, custody and administration means the secure storage of private keys or other necessary means for third parties, which are required to access crypto assets. Advice on crypto assets refers to offering or making personalized recommendations regarding the use of crypto services. All exchange services relating to crypto assets, whether for fiat money or other crypto assets, will be regulated activities in the future. In contrast, the exchange of crypto assets for items other than fiat money or crypto assets will not be explicitly covered. In summary, crypto-asset services under MiCAR are noticeably modeled closely after the activities that are regulated under the current investment services regulation under the second Markets in Financial Instruments Directive (MiFID II) in the securities sector.

                    Only Activities Related to Crypto Assets can be Crypto-Asset Services.

                    A mandatory requirement for the classification of an activity as a crypto-asset service will be that it relates to crypto assets within the meaning of the MiCAR definition. This definition is formulated very broadly and covers almost all digital representations of value that are based on distributed ledger technology and which can be transmitted and stored electronically. However, it does not cover digital representations of value that also qualify as financial instruments within the meaning of MiFID II, as electronic money under the Second E-Money Directive or as deposits. In this respect, MiCAR will only regulate activities for which more specific regulation does not already exist at the European level.

                    Attorney Lutz Auffenberg, LL.M. (London)

                    I.  https://fin-law.de

                    E. info@fin-law.de

                    subscribe to Newsletter

                      Contact

                      info@fin-law.de

                      Sep 26, 2022

                      KYC And Crypto Securities Registrar – Who Must be Screened by the Registrar?

                      Since the Electronic Securities Act (eWpG) came into force, the operation of crypto securities registers is a financial service requiring authorization in Germany. Anyone who takes over the operation of the legally required register for issuers of crypto securities must therefore have a corresponding authorization from BaFin. As regulated financial institutions, crypto securities registrars are thus also obligated parties under the German Money Laundering Act (GwG), which requires them to apply the due diligence requirements stipulated by anti-money laundering regulations. This includes identifying and verifying their customers and any beneficial owners that may be associated with them, as well as clarifying the purpose of the business relationship and continuously monitoring the business relationship, including the transactions carried out in the course of it. But when exactly and in relation to whom must crypto securities registrars apply these due diligence obligations?

                      Generally Four Triggers for Obligations to Exercise Due Diligence Under Anti-Money Laundering Law

                      Under the GwG, obligated parties must essentially apply due diligence measures in four situations provided for by law. First, they must be applied when a business relationship is established. In addition, they must be fulfilled on a transaction-by-transaction basis as part of the continuous monitoring of the business relationship. In the case of crypto transactions, however, the obligation to apply them also is given without an existing business relationship if their equivalent value at the time of the transaction exceeds 1,000 euros and the transactions were carried out by so-called occasional customers. Additionally, those obliged under money laundering law must take action if there are grounds for suspicion with regards to money laundering or terrorist financing. Finally, the GwG requires the application of due diligence in cases where an obligated party has doubts as to the accuracy of the information collected regarding the identity of the contracting party, a representative or a beneficial owner. In all cases, however, the obligation to apply due diligence measures relates to situations in which a potential or existing customer is acting.

                      Who Does the Crypto Securities Registrar Need to Monitor?

                      It makes sense to align the money laundering prevention obligations of institutions with respect to potential or existing customers. On the one hand, obligated parties must collect information from the persons or companies to be verified, which is difficult without customer contact. On the other hand, the obliged entities cannot comply with the legal order not to execute a transaction without successful due diligence and terminate the business relationship, in cases in which it may be impossible to fulfill their due diligence obligations without a customer relationship in the broadest sense. Customers of crypto securities registrars are primarily the issuers of crypto securities. They must commission the crypto securities registrar to maintain the register and enter into a contract with them. The investors of crypto securities, on the other hand, do not necessarily have a contractual relationship with the crypto securities registrar. It is of course possible for the crypto securities registrar to enter into a contractual agreement with the respective investors of the registered crypto securities as well. However, this is not mandatory by law. The core task of the crypto securities registrar is the proper maintenance of the register for the issuer. In this respect, the role of being an investor of a particular crypto security merely constitutes information which must be entered into the register. However, this does not necessarily establish a direct customer or business relationship between the crypto securities registrar and the investor.

                      Does This Mean Crypto Securities Registrars Never Must Verify Investors of Crypto Securities?

                      A business relationship may of course also arise between the registrar and the investors of registered crypto securities. Such a relationship is established in particular if a contract is concluded between the parties, for example in the form of general terms and conditions. An Individual case in which the investor asserts a legal right against the crypto securities registrar could also give rise to a business relationship. An example would be the request for an extract from the register in text form. In such a case, the registrar will also have to verify the investor according to anti-money laundering law.

                      Attorney Lutz Auffenberg, LL.M. (London)

                      I.  https://fin-law.de

                      E. info@fin-law.de

                      subscribe to Newsletter

                        Contact

                        info@fin-law.de

                        Sep 12, 2022

                        Yield Farming – Does BaFin Take an Interest in Liquidity Providers?

                        Decentralized Finance (DeFi) has been opening up numerous new sources of income for players in the crypto market in the last few years. While the generation of passive income in the crypto market at the beginning of the last decade required the acquisition and operation of powerful mining rigs for participation in proof-of-work-mechanism, today the mere delegation of one’s own crypto assets to a dPoS validator is sufficient to earn proportional block rewards in the consensus mechanism of proof-of-stake. Another way of generating passive income via DeFi protocols is the so-called yield farming. Here, interested crypto users can temporarily provide their crypto assets to a smart contract known as a liquidity pool and receive a reward in return. The yield is achieved by allowing liquidity-seeking crypto users to borrow crypto assets from the liquidity pool. To ensure repayment, borrowers must provide sufficient collateral in other cryptocurrencies. These types of loans are therefore not suitable for raising capital on a temporary basis, but only for raising short-term liquidity in a specific crypto value. Yield farming is thus attractive to both retail investors and institutional liquidity providers. But does the provision of crypto assets for yield farming in individual cases also require an authorization from BaFin?

                        Obligation to Obtain Authorization Pursuant to KWG and WpIG Only for Domestic Commercial Activities

                        The performance of activities regulated under the German Banking Act (KWG) or the German Investment Firm Act (WpIG) is only subject to authorization if it takes place in Germany and on a commercial scale or to an extent that requires a professional business setup. BaFin always considers the domestic connection to be given if the service provider has its registered seat in Germany. If the service provider operates from abroad, the domestic reference may be given if its offer is specifically directed at German customers. In the case of yield farming, the domestic connection is therefore deemed to exist if the liquidity provider is domiciled or has its registered seat in Germany. However, if the Liquidity Provider operates from abroad, it will rarely be possible to assume that he or she is actively offering its services to German customers, as he or she merely provides its crypto assets to a decentralized smart contract and not to a specific customer. Nor does the liquidity provider himself take care of any marketing to specific borrowers. A commercial activity can be assumed if the yield farming is performed not only temporary and with the intention of making a profit, which will be the case for most Liquidity Providers.

                        Crypto Loans Not a Regulated Lending Business Pursuant to the KWG

                        In general, the granting of loans is regulated in the KWG as a banking business requiring authorization. However, the permissive element of the lending business in the KWG only refers to money in the traditional sense and not to crypto assets. For this reason, the activity as a liquidity provider cannot constitute a lending business pursuant to the KWG. Additionally, there is the problem that the provision of crypto assets to liquidity pools and thus to decentralized smart contracts takes place on a DeFi platform. Liquidity providers therefore do not have a specific contractual partner that could be considered their borrower. Other activities which would otherwise be subject to authorization in the KWG and the WpIG are also not applicable in case of the temporary provision of crypto assets to liquidity pools. The contribution of one’s own crypto assets to yield farming projects is therefore possible without BaFin authorization, at least according to German supervisory law.

                        Attorney Lutz Auffenberg, LL.M. (London)

                        I.  https://fin-law.de

                        E. info@fin-law.de

                        subscribe to Newsletter

                          Contact

                          info@fin-law.de

                          to top