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Category: blog EN

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)

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    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)

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      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)

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        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)

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          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)

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            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)

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              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)

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                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)

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                  Sep 05, 2022

                  Securities Information Sheet (WIB) for Security Tokens – Can BaFin Delay the Approval Until the Start of the Token Sale?

                  It has been known since 2019 at the latest that also under German securities law company-issued tokens can be classified as securities if they are generally tradable and rights similar to securities are associated with them. Moreover, since the Electronic Securities Act (eWpG) came into effect in Germany in the summer of 2021, with crypto securities there is also a specific form of tokenized securities expressly provided for in the law. For BaFin, public offerings of security tokens have therefore not been a rarity for some time now. To the extent that the publication of a securities information sheet (WIB) is required for such issuance, BaFin must decide on the approval of the WIB prior to publication. Since 2019, BaFin has already reviewed a large number of WIBs for security token offerings. The authority often seems to have problems in cases where the planned token sale is planned to take place several weeks or even months after the approval. In such cases, BaFin often refers to its administrative practice, according to which an approval may not be given too early prior to the start of the offer in order to ensure that the information in the document is up-to-date.

                  Delay of Approval by BaFin Without Legal Basis

                  BaFin’s administrative practice is not tenable from a legal perspective. The task of BaFin under the German Securities Prospectus Act (WpPG) is to verify whether the minimum information and instructions that are required by law are completely included in the securities information sheet and in the prescribed order. In addition, BaFin must verify that the issuer’s last annual financial statement is not older than 18 months at the time of approval. In this respect, the determination date of the annual financial statements is decisive. If there is a guarantor for the token issue, BaFin must also check whether the annual financial statements of the guarantor are up-to-date. BaFin does not carry out any further review of the actuality of the information in accordance with the German Securities Prospectus Act. There is no statutory provision according to which the offer of a security token on the market must start immediately after the permission has been granted.

                  Actuality of the Information in the WIB Ensured by Supplement  Obligation

                  Of course, it is of high importance for potential investors that the information contained in a WIB is up-to-date and that it provides a reliable basis for an investment decision. The actuality of the information is, however, also ensured without further review obligations of BaFin by the fact that issuers of securities and thus also of security sokens are obligated to immediately supplement or correct every new circumstance as well as every important inaccuracy in the information published in a WIB. The update must be made in the form of a supplement, which must also be approved by BaFin prior to its publication. In this respect, the obligation to check that the information is up-to-date does not lie with BaFin, but with the issuer, who may also be liable to investors if this obligation is not complied with. Consequently, the German Securities Prospectus Act also stipulates that every WIB must contain a note stating that the accuracy of the content of the securities information sheet is not subject to review by BaFin. Contrary to Bafin’s administrative practice, the approval of a WIB can therefore also be granted well before the start of the offering. However, issuers must note that WIBs are only valid for a maximum of one year.

                  Attorney Lutz Auffenberg, LL.M. (London)

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                    Aug 15, 2022

                    Establishing New Blockchain Technologies – Non-Profit Corporations as the Best Legal Form?

                    It is widespread assumption amongst founders of new blockchain technologies that the creation of a non-profit foundation, a non-profit private limited company (gGmbH) or a business company (gUG) is the correct legal form for the implementation of the project. There are indeed numerous examples of projects that chose this route. The Ethereum Foundation, established in 2014, is most likely one of the most successful examples. However, it has to be taken into account that it has its registered seat in Zug and is subject to Swiss law. The most famous example within the German jurisdiction is most likely the IOTA Foundation which has its registered seat in Berlin and which had its non-profit status recognized. There may be sound reasons to use a non-profit corporation in order to facilitate the mass adaptation of a new technology but depending on the actual intentions and interests of the founders, a non-profit corporation may also not be suited at all.

                    How Can a Corporation Be Recognized as Non-Profit?

                    The German Tax Code defines the circumstances under which a corporation may be recognized as a non-profit corporation. This option is given where a corporation pursuits charitable causes. The pursuit of charitable causes by a corporation is defined by the German Tax Code as activities of the corporation which are aimed to altruistically facilitate the general public in material, intellectual or moral aspects. The facilitation of the general public cannot be assumed if the recipients are predetermined as is e.g. the case with family foundations. The law also includes an exclusive catalogue of eligible areas. Next to religion, art, culture, sports and numerous other areas, science and research as well as consumer protection are eligible non-profit areas which also make the most sense with regards to new blockchain technologies. Finally, the non-profit status can only be recognized, if the corporation acts in an altruistic way. This specifically requires the corporation to solely allocate its resources to its statutory purposes and that members and shareholders do not receive a profit share or other contributions.

                    When is the Recognition as a Non-Profit Sensible for Blockchain Initiators?

                    The successful recognition as a non-profit saves taxes. Non-profit corporations are e.g. exempt from inheritance, gift and property tax. Donations and membership fees are also tax exempt for non-profit corporations. Nonetheless, the foundation of a non-profit corporation for blockchain projects is only sensible if the initiators do not intend for a commercial use of the corporation. A recognized non-profit corporation for the facilitation of a new blockchain technology will therefore have to make use of its resources to e.g. facilitate the development of the core software, to facilitate educational programs with regards to the actual utilization of the technology and the mass adaptation of it. Purely commercial activities which aim at generating profits such as the operation of a crypto exchange or the operation of a crypto custody service may not be carried out.

                    Non-Profit as Savior from BaFin Authorization Requirements?

                    It is a common and widespread misconception that non-profit corporations are not subject to BaFin authorization requirements. Even though the authorizations as regulated in the German Banking Act (KWG) and the German Investment Firm Act (WpIG) will only be required, if a provider operates a regulated activity in Germany and commercially which will generally not be the case with non-profit corporation. As an alternative to the requirement of a commercial conduction of the business, both regulatory regimes will also be applicable in case that the service provider objectively requires a professional business setup for the activity. This may be the case if carrying out the activity requires professional structures such as an orderly accounting or the employment of staff. The authorization requirement of the financial regulatory law does therefore not exclude the recognition of a corporation as non-profit.

                    Attorney Lutz Auffenberg, LL.M. (London)

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                      Aug 08, 2022

                      MiCAR and NFTs – Are Non-Fungible Tokens Subject to MiCAR?

                      Cryptocurrencies such as Bitcoin, Ether or Ripple are characterized by the fact, that there are numerous of the individual type. They are designed identically in the sense that one Bitcoin equates to another one exactly in value, which is why they can be used as units of account. This is different with Non-Fungible Tokens (NFT). Those are created via smart contracts on compatible blockchains and are each of individual character. NFTs can therefore not be used as units of account, but instead for the digital representation of individual objects or rights. The future Markets in Crypto Assets Regulation (MiCAR) that has recently been agreed in the wake of the trialogue negotiations between the EU Commission, EU Parliament and the European Council originally intended to create a reliable regulatory framework for the entire crypto market in Europe including NFTs. Nonetheless, the final wording of MiCAR now does not intend for a regulation of NFTs, because crypto assets which are not fungible are exempt from the scope of the new regulation.

                      Confusion Concerning the Applicability of MiCAR on NFTs

                      Even though the final wording of MiCAR does not intend for the regulation of NFTs, the EU Commission only agreed to the wording under the condition that NFTs which are generally not subject to MiCAR may be subject to the regulation in individual cases in which the tokens are part of a collection. What a collection exactly constitutes is neither defined nor substantiated in the wording of MiCAR. It is likely that the EU Commission had cases in mind in which an issuer issues multiple NFTs that merely differ in small details from each other, but which apparently are part of an overall emission. Examples would include NFT-based collectors’ cards of players of a professional sports team or a series of NFT-based pictures, which basically all display the same motive with just little variations in the motive or the used colors. Unfortunately, there is no official clarification of the term collection from the EU Commission or any other institution yet, which could ensure a homogeneous interpretation of the term throughout Europe. It is therefore currently unclear which specific NFTs might possibly benefit or suffer from the advantages or disadvantages of MiCAR in the future. The respective competent national authorities will have to position themselves regarding this question and they will need to amend their applicable administrative practices once MiCAR goes into effect. As a result, an international hotchpotch regarding the regulation of NFTs is impending, which MiCAR was originally intended to abolish.

                      ESMA Needs to Define the Term Collection

                      Since the final wording of MiCAR has been determined, the European Securities and Markets Authority (ESMA) is now called to elaborate recommendations concerning technical standards and guidelines. These should ensure an homogeneous interpretation of the new provisions by the competent national supervision authorities throughout Europe. In the technical standards to be elaborated, ESMA will have to determine clearly and in explicit terms how it defines the term of a collection in this context. Prior to the publication of technical standards for a new EU regulation, ESMA always conducts a public consultation in which it allows for market participants and experts to voice their opinions to all relevant aspects of the respective technical standard. The NFT industry should use this opportunity to work towards a suitable and practical administrative practice concerning NFTs within the regulatory regime of MiCAR in order to avoid a new European hotchpotch in this matter. 

                      Attorney Lutz Auffenberg, LL.M. (London)

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                        Aug 01, 2022

                        Insolvency of Crypto Custodians – What Happens to the Clients Crypto Assets?

                        With increasing demand for crypto custody services, the question of what happens to client’s crypto assets in the event of a crypto custody service provider’s insolvency arises. The subject receives even more attention in light of the recent events surrounding international crypto custodians informing their clients, that the safeguarded crypto assets would in case of insolvency be part of the insolvency estate of the respective crypto custodian and that therefore the insolvency risk of the crypto custody service provider is bourne by the clients. This in turn, the question raises of how the German law handles this subject. The question is more complex from a legal point of view than it appears at first glance.

                        Crypto Assets Are Part of the Insolvency Estate of the Crypto Custodian

                        As a digital representation of value that can used for payment or investment purposes, crypto assets will become part of the insolvency estate in the event of an insolvency of the debtor according to German insolvency law. The insolvency estate is comprised of the entirety of the debtor’s assets at the time of the opening of the procedure as well as of the assets which the debtor gains during the procedure. Crypto tokens are assets in the required sense and as such they will generally also be part of the insolvency estate of the debtor. However, the assets that are eligible for being part of the insolvency estate are limited to objects that could also be subjected to foreclosure proceedings. According to the majorities’ view in German legal literature, crypto assets can be subject to foreclosure proceedings and are therefore generally eligible for being part of an insolvency estate. The consensus stops when it comes to the question of which foreclosure provisions exactly are applicable. This is because the German law in its foreclosure provisions differentiates between the execution in movable physical objects, in immovable assets and in claims. Crypto assets cannot be qualified as neither movable nor immovable objects. The courts have not yet positioned themselves in this matter. The legal literature also did not position itself with regards to the exact way of solving this problem, nevertheless all proposed solutions come to the conclusion that by utilizing some sort of analogy, foreclosure of crypto assets is legally possible.

                        No Right of Segregation in Case of Insolvency of Crypto Custodians

                        This primarily results in uncertainties for crypto custodians. Without any further legislative action, clients of crypto custody service providers in Germany must assume today, that their crypto assets would be part of the insolvency estate of their crypto custodian in case of insolvency. In contrast, bearers of securitized securities which are safeguarded by depository banks have a legal right to segregate their securities from the insolvency estate of the depository bank, should it fall into insolvency. This is because securitized securities are subject to German property law and custody clients are regarded as the owner of these securities even if they use custody services of a depository bank. However, this is different with crypto assets and other tokens, as they are not considered to be objects in the sense of the German property law and it is therefore impossible to establish ownership of them in the sense of the German property law. There is therefore no legal basis for a segregation right in case the custody service provider becomes insolvent.

                        Creating Certainty for Crypto Custody Service Providers and Clients

                        According to the current legal situation, clients of crypto custody service providers have no right to segregate their crypto assets from the insolvency estate of the crypto custodian should it become insolvent. Instead, the crypto assets of custody clients would become part of the insolvency estate of the crypto custodian resulting in the fact, that custody clients would qualify as insolvency creditors and merely receive a quota of the countervalue of their crypto assets back from the insolvency estate. The legislator should therefore as quickly as possible amend the German insolvency law and introduce a right for clients of crypto custody service providers to segregate their crypto assets from the insolvency estate of the crypto custodian. Especially with regards to the high volatility of the crypto market where massive price crashes are by no means rare, a corresponding legislative initiative would be an urgently required measurement.

                        Attorney Lutz Auffenberg, LL.M. (London)

                        Ref. jur. Hanumsha Beluli

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