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Category: blog EN

Feb 14, 2022

Let Me Stake Those Tokens for You – How is Crypto Staking as a Service to Clients Regulated?

When Bitcoin introduced the world to blockchain technology in 2009 and enabled decentralized transactions, the validation of blockchain transactions worked via the so-called Proof-of-Work consensus mechanism (PoW). Since then, not only the market prices of Bitcoin and other cryptocurrencies massively increased, but the underlying technology of crypto assets has also developed at an astonishing pace. The PoW consensus mechanisms are nowadays rarely used for newly developed blockchain infrastructures. The most popular consensus mechanisms right now are the so-called Proof-of-Stake consensus mechanism (PoS), which are superior to PoW systems, especially in terms of energy efficiency. The discovery of new transaction blocks in PoS systems does not depend on an investment of computing power, but instead on the mere holding of units of the respective blockchain. Nowadays, it is usually not even necessary to transfer the respective crypto assets to another blockchain address in order to partake in the mining process of a PoS system. The participation in the mining process works in many of those systems via a simple delegation of the respective crypto assets to a server which acts as a so-called Mining-Node in the respective blockchain system (delegated Proof-of-Stake, dPoS).

Staking Participation as a Service can be Reasonable in Specific Circumstances

Even though the delegation of crypto assets in dPoS systems is usually done by the respective bearer of the crypto assets via the wallet software and usually without a lot of effort, there is still a need for service providers who provide their clients with a service for partaking in dPoS-staking. Especially in cases in which the crypto investor wants to or must keep the crypto assets in the custody of a third-party, a crypto custody service provider who also manages the dPoS staking of the respective crypto assets and thereby the generating of rewards in the form of block rewards is required. There are situations conceivable in which crypto investors grant power of attorney for their crypto wallets to service providers and commission them with the management of their crypto assets. How are these kinds of services regulated in Germany?

Crypto Staking for Third Parties may qualify as Crypto Custody Service

Service providers who safeguard crypto assets for their clients and who also dispose over the associated private keys are regulated as crypto custody institutes pursuant to the German Banking Act (KWG) if they offer the custody services to German customers and if they operate this business on a commercial or at least on a professional scale. Should these service providers not only safeguard the crypto assets of their customers but also delegate them in order to participate in dPoS mining, they generally also fulfil the second alternative of the legal definition of crypto custody business, the management of crypto assets for others. BaFin defines the term “management” in the sense of this provision as the exercising of rights resulting from a crypto asset. The suitability of a crypto asset to partake in dPoS mining is a characteristic of the crypto asset itself. A good argument can therefore be made to view the suitability to dPoS staking as a right resulting from the crypto asset, even more so because BaFin emphasizes the broad interpretation of the term in its published administrative practice. BaFin has not yet published anything regarding its opinion and interpretation for the abovementioned case, so that a close coordination with the supervisory authority for service providers intending to offer the aforementioned service is advisable. Should BaFin not assume the management alternative, e.g. because a right has to be assertive versus a third party and that is not the case when receiving block rewards from a decentralized functioning system, a qualification of the activity as financial portfolio management could also be considered.   

Staking Crypto Assets of Clients in dPoS-Staking as Financial Portfolio Management

The staking of customer crypto assets in dPoS-mining in order to generate block rewards can also be qualified as financial portfolio management. According to the legal definition in the KWG and the German Investment Firm Act (WpIG), financial portfolio management means the management of individual or multiple patrimonies which are invested in financial instruments for others with discretion. Crypto assets are financial instruments according to the KWG and the WpIG. A credit balance in crypto assets on a client´s wallet can be a patrimony in the sense of the provision. The wording of the provision does not provide any arguments to assume that financial portfolio management requires the prior acquisition or disposition of the financial instrument. The financial instrument that is already present can therefore simply be used to generate a profit. The decisive factor will be whether the service provider effectively takes over the management of the respective client’s patrimony.  

Attorney Lutz Auffenberg, LL.M. (London)

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    Feb 07, 2022

    Not Your Keys, Not Your Cryptos – Can Legal Ownership be Established for Crypto Tokens?

    On January 12th, 2009, Satoshi Nakamoto initiated the first Bitcoin transaction. Since then, the blockchain technology rapidly rose in popularity and distribution. Not only Bitcoin, but also numerous other cryptocurrencies gained a lot of users since this first crypto transaction over 13 years ago. This tremendous success is most likely based on the technical feature of blockchain units to grant to the respective holder an absolute power of disposition. From a technical point of view, the person disposing over the associated private key to the current blockchain address is the only one being able to initiate a transaction of blockchain units to another blockchain address. But is this factually safe bearer position reflected in German civil law?    

    Legislator Primarily Focuses on the Regulatory Aspects of Cryptocurrencies

    Right from the beginning, the discussion and legislative actions regarding the legal handling of cryptocurrencies in Germany primarily revolved around and focused on the handling of cryptocurrencies with regards to financial supervisory law. BaFin, as the competent authority issued a public statement in 2013 in which it qualified Bitcoin and comparable blockchain units as units of accounts and therefore as financial instruments in the sense of German banking regulations. The former German Federal Government, which according to its coalition treaty intended to turn Germany into a blockchain hotspot, followed suit in 2020 when it introduced crypto assets as a new category of financial instruments into the German Banking Act (KWG). Further regulatory measures in the financial supervisory sector followed with the introduction of crypto securities in the Electronic Securities Act (eWPG) and the Crypto Asset Transfer Regulation. Whereas, when it comes to regulating blockchain units under civil law, the German legislator has up to now been rather reluctant. Solely for the aforementioned crypto securities – which are to this date only issuable in the form of tokenized bonds – there are civil regulations with regards to the possibility of transferring them to the bona fide transferee and the option to establish ownership. For other kinds of blockchain tokens, there have not been any specific civil law rules in Germany since 13 years now.      

    Ownership Under German Civil Law Only Possible on Tangible Items

    The German civil law has not yet entirely arrived at the digital age. The basis for the German civil law is the German Civil Code (BGB) which went into effect on January 1st, 1900. Even though the BGB has been regularly updated and extended, e.g. by introducing consumer protection regulation, so that parts of it comprehend phenomena of the digital era, ownership rights are still solely regulated in the part that regulates property law and therefore relate primarily to tangible items. Blockchain units such as Bitcoins, Utility Tokens or NFTs are intangible and therefore the establishment of ownership rights in the sense of the German civil law on them is generally not possible.

    Would Ownership Rights Be Suited for Crypto Tokens?

    Bearers of blockchain tokens are obviously not completely unprotected under the current law. Blockchain units are – at least according to the prevailing opinion in literature – qualified as other intangible assets, so that claims for damages can for example also be targeted at the transfer of crypto tokens. Since the property law relates to tangible items, it regulates cases that require the tangibility of the item. E.g. the owner of an item has the right to defend himself against an unauthorized removal of his item. This provision is not suited for tokens which exist exclusively virtually. The German property law on the other hand also regulates that the ownership of an object can be transferred to the acquirer without any potential third-party rights, if the acquirer blamelessly did not know of the associated third-party rights. Just as a bona fide acquirer may effectively acquire ownership of an object, if the seller was not authorized to transfer the ownership of the object. Comparable legal mechanisms for crypto tokens would surely lead to more legal certainty for everyone involved. An application by analogy of the property law to crypto tokens would only make sense in certain partitions of the problem. It would therefore be better, if the German legislator on the way to a German blockchain-hotspot created specific civil law provisions for blockchain tokens which are tailored to the technical specifics and the respective market needs of the industry.

    Attorney Lutz Auffenberg, LL.M. (London)

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      Jan 24, 2022

      Offering Counterfactual Wallets – Can That be Regulated as Crypto Custody Business?

      Crypto wallets are essential for the participation of users in the crypto market. They are therefore also of utmost importance to providers of crypto services and often a central building block in the operation of the respective business model. The traditional design – one private key per wallet – allows access to the crypto assets held in the wallet only to those individuals that dispose over the associated private keys. In business models which include wallet services, the private keys regularly remain with the provider while the user is left to interact with the provider via his login information for instructing the provider to dispose over the crypto assets held in the wallet. The central risk for providers in this context is the loss of the private keys. A loss of the associated private keys makes it impossible to dispose over the crypto assets on the respective wallet. Private keys of traditional wallets may be recovered using a so-called seed which can also potentially be lost. The provider will generally be liable and obligated to compensate his client in cases, in which he loses both the private key and the seed.

      Counterfactual Wallets – Smart Contract Wallets on the Blockchain

      Counterfactual wallets are smart contracts executed on a blockchain. As such they offer certain advantages over traditional crypto wallet software. Notably with counterfactual wallets, the private keys which are required to initiate a crypto transaction are not associated with the wallet, as is generally the case with traditional wallet software. Counterfactual wallets instead provide the option to replace lost or compromised private keys. Another advantage of counterfactual wallets is the possibility to guarantee that only the current version of the wallet is being used. The latest version of a counterfactual wallet will automatically be retrieved from the underlying smart contract. Should the code of that smart contract be updated or expanded, all counterfactual wallets based on that smart contract immediately receive an update, e.g. to eradicate security gaps or enhance functionality. The aforementioned option to recover access to counterfactual wallets can e.g. be achieved via a so-called social recovery feature. In this process, a group of other participants of the blockchain is automatically defined, which can change the private keys to the respective crypto wallet upon request of the wallet owner via majority decision. These participants, who are also known as “guardians”, never have access to the private keys of the crypto wallets to which they can alter the private keys, because they do not know each other and, from a technical perspective, there are only fractions of the private keys of the counterfactual wallet stored with them.    

      Can the Offer of Counterfactual Wallets Be a Regulated Crypto Custody Service?

      According to the wording of the law, crypto custody services which are subject to authorization can be given in three scenarios: the custody, management or safeguarding of crypto assets or private cryptographic keys. BaFin has not yet published its opinion on whether or not the operation of counterfactual wallets is subject to any or all of these alternatives and if the operation of counterfactual wallets can be qualified as crypto custody services. The decentralized design could be an argument against an authorization obligation of providers of counterfactual wallets. On the other hand, counterfactual wallets also work with private keys which must be stored, managed and safeguarded against unauthorized usage by third parties. In the case of crypto services with integrated wallet services, this task is always fulfilled by the operator for the clients. With counterfactual wallets, there is furthermore the task to determine guardians. The operator would need to request a social recovery, should it be necessary, and he would also need to correctly store, manage and safeguard the new private keys. The fact that counterfactual wallets are not executed within the central IT-structure of the operator but via a smart contract on a blockchain is irrelevant with regards to the handling of associated private keys. Therefore, the operation of counterfactual wallets for clients will most likely in most cases be a form of crypto custody service and therefore subject to authorization. 

      Rechtsanwalt Lutz Auffenberg, LL.M. (London)

      Rechtsreferendar Gabriel Aslan

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        Jan 17, 2022

        Assignment Restrictions for Security Tokens – Will That Still be Possible in Future?

        In Germany, it is possible to issue bearer bonds in accordance to the Electronic Security Act (eWPG) without securitization in form of so-called crypto securities since last summer. The German legislator thereby created the option to grant owners of security tokens a legal position comparable to the ownership position of owners of paper documents. Acquirers of crypto securities can become legal owners of said crypto also if the seller was not the owner, as long as the acquirer blamelessly did not possess any knowledge of the sellers missing authorization. When it comes to crypto securities, the eWPG stipulates that the rights resulting from the bond are inseparably connected with the token representing them. Next to this, businesses continue to have the possibility to issue security tokens without the use of the options provided by the eWPG. This may e.g. make sense if the issuer does not wish to involve a central registry administrator, which is compulsory to be involved in issuances of crypto securities. In these cases, a legal mechanism has to be created which ensures the inseparable connection of the rights stemming from the bonds with the tokens, just like prior to the eWPG coming into effect.

        Secure Merging of Rights and Token Via Assignment Restriction

        Connecting factor for the connection of investor rights with a token in case of a tokenized bond are the terms and conditions of the bond, commonly also referred to as Token Terms. These Token Terms contractually regulate the rights and obligations of the issuer and investors. Token Terms inter alia contain provisions concerning the rate of return, duration, possible subordination agreements and rights of cancellation. Token Terms of tokenized bonds which are not designed in accordance to the eWPG may include provisions stipulating that token bearers may only assign their tokens to third parties, if they simultaneously assign all rights and obligations stemming from the bond to the assignee of the tokens. This mechanism ensures that token and investor rights and obligations as defined in the respective Token Terms are always allocated to the same person. In order for the mechanism to work reliably, token bearers additionally have to be obligated by the Token Terms to not assign the rights of the security token in any other way as explained above – e.g. without the simultaneous assignment of the token itself.        

        New Consumer Protection Law Complicates the Inclusion of Assignment Restrictions in Token Terms

        The obligation of security token bearers to only dispose of the rights of the tokenized bond via token transaction on the underlying blockchain and only en bloc, constitutes a restriction of the assignment right of the investor. As of October 1st, 2021 the German consumer protection law contains a protective provision according to which clauses in general terms and conditions that restrict the assignment of claims of monetary nature versus the user of the clause may be invalid. Token Terms are designed and worded for a multitude of investor contracts and are therefore always general terms and conditions. According to the explanatory memorandum the new provision – contrary to its wording – is not intended to only be applicable to clauses that entirely eliminate the option to reassign a claim but also to clauses merely restricting it. Assignment restrictions in Token Terms could therefore be affected in the future by this new legal regulation. This whole complex is only relevant to security tokens which are distributed to private investors, because the new provision takes no effect on contracts between professional parties.

        Better Arguments for Inapplicability in Security Token Terms

        The new legal regulation is intended to protect consumers versus businesses and prevent the restriction of the general assignment right of contractual parties via general terms and conditions. The right to assign claims to third parties is a manifestation of the general principle of contractual freedom and therefore an essential civil liberty which should not and cannot be taken away from consumers without good cause. However, the new legal regulation is a provision with margin of discretion. This means that if good reasons are given that argue for the assignment restriction and the rights of the consumers are not unjustifiably restricted, an assignment restriction can still be vaild. Generally, the assignment restriction in Token Terms benefits all involved parties. Issuers can rely on the fact that the token bearers are also the bearers of the bonds. Investors can be sure that the acquired security tokens are really connected to the investor rights of the tokenized bond. Assignment restrictions are therefore instrumental in the creation of legal certainty for all involved parties and they do not restrict consumer rights unreasonably. In the end, the civil courts will have to decide on a case by case basis on the effectiveness of assignment restrictions in general terms and conditions. The specific wording of the restriction and the entire design of the Token Terms will be the decisive factors in cases relating to security token offerings.  

        Attorney Lutz Auffenberg, LL.M. (London)

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          Jan 03, 2022

          DeFi Business Model Crypto Lending – Is It Regulated?

          Decentralized Finance (DeFi) has enjoyed a steady increase in popularity over the last two years. The term describes the trend to change from centralized financial markets, which are controlled by banks and financial service providers to completely decentralized financial markets, which do not necessitate any centralized intermediaries in order to grant users access to banking and financial services. This becomes possible by using smart contracts on adequate blockchain infrastructures such as Ethereum, Aave or Compound. Such smart contracts act as decentralized programs which are fueled by activity on the underlying blockchain and which will independently execute specific and predetermined actions. Users have the option to interact with these smart contracts – e.g. by transferring crypto tokens to specific crypto wallets – and thereby trigger activities of the smart contracts. Designs like these provide the possibility to automate a number of services of the finance sector. One example for this is crypto lending, in which users may receive loans in cryptocurrencies.       

          How Does Crypto Lending Work?

          Crypto lending is basically what the name promises: the granting of loans in cryptocurrencies. Crypto lending in the DeFi sector works without a central institution like a bank as a lender. Users may interact with a smart contract and thereby request a loan in cryptocurrency, which will be granted automatically should the specific user fulfill the requirements laid out in the conditions of vesting of the smart contract. The exact conditions of vesting depend on the individual programming of the specific smart contract. The currently existing crypto lending platforms primarily require the provision of sufficient collateral in the form of other cryptocurrencies. Due to the extreme volatility of the crypto market, the required collateral usually exceeds the equivalent of the loan considerably. Taking up a loan via crypto lending is therefore really only sensible in situations where the borrower is in need of short-term liquidity in a specific cryptocurrency and at the same time is not willing or able to sell his other crypto holdings. Taxation issues for example may make such an approach sensible. On the other hand, crypto lending is not yet suited for the temporary increase of purchasing capacity, e.g. for financing real estate, because of the necessity to provide so much collateral. This might change in a timely manner, especially in the light of the announcement of the new German Federal Government in the coalition agreement that it will commission a study to analyze the feasibility of a blockchain-based land registry. Depending on the specifics, a blockchain-based land registry may provide the option to provide collateral for crypto loans in the form of mortgages. Users obviously also have the option to provide cryptocurrencies to the crypto lending smart contract, which will then be granted as loans to third parties. They usually receive very generous interest payments in the form of cryptocurrencies from the smart contract, if they choose to do so. Liquidity risks identical to those that traditional banks have to bear arise, should the pledged collaterals of the borrowers also be lent out.  

          Is Crypto Lending Subject to Authorization?

          The great advantage of DeFi is the option to design financial services in a decentralized way. Therefore, there is usually no entity which would act as an operator and thereby as provider of the loan when it comes to smart contracts which settle crypto lending operations. For the purpose of financial supervision, these smart contracts are scrutinized and examined in order to figure out if there is an identifiable administrator or leading developer behind the creation of the smart contract. Those may, in specific cases, be addressees of an authorization obligation. It is also conceivable that users which provide a smart contract with cryptocurrencies in order to receive an interest payment thereby perform an activity which is subject to authorization. Irrespective of the question, if there is a responsible operator or not, regulatory obligations to obtain authorization can only be applicable if the specific activity itself is regulated. The credit business, which is subject to authorization according to the German Banking Act (KWG) only relates to loans that are granted in legal tender and is therefore not applicable to the transfer of crypto assets by way of loan. In specific cases, the administrator of the respective smart contract could be qualified as a crypto custodian and therefore be subjected to authorization because he receives, manages and safeguards crypto assets. Users providing cryptocurrencies to a smart contract based crypto lending operation on the other hand usually have no knowledge of the identity of the borrower. They therefore act solely to receive interest payments and have no intention to provide a service to a third party. They will therefore hardly be subject to authorization. 

          Attorney Lutz Auffenberg, LL.M. (London)

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            Dec 20, 2021

            Trading Platform for Security Tokens – Can a Stock Market Listing be an Alternative to a BaFin Authorization?

            In Germany, the operation of exchanges for traditional financial instruments as well as for crypto assets has ever since been subject to authorization. If trading on the exchange takes place in form of an automated matching and settlement of buy and sell orders, the exchange will generally qualify as a multilateral trading facility which requires the operator to obtain an authorization as an investment firm pursuant to the German Securities Institute Act (WpIG). The regulatory requirements for the operators of multilateral trading facilities are strict and the granting of the required authorization as well as the ongoing supervision to ensure compliance to all regulatory obligations are carried out by BaFin and the German Central Bank. On the other hand, operators of exchanges in the sense of the German Stock Exchange Act are not considered investment firms. The processing of applications for authorization as well as the ongoing supervision in these cases is not carried out by BaFin and the German Central Bank, but instead by the authorities which are declared competent in the respective federal state, usually the federal states ministry of economic affairs. In this context the question arises, if the application for an authorization to operate a stock exchange enables the operation of a crypto exchange.

            Crypto Assets not Tradable on Stock Exchanges while Security Tokens are

            It is legally defined which assets are tradable on stock exchanges. According to the German Stock Exchange Act security exchanges and commodity exchanges are possible options. While on commodity exchanges exclusively commodities such as metals, ores, agricultural products, electricity or other fungible commodities or futures related to the aforementioned are permitted to be traded, it is permitted to trade securities of all kinds such as stocks, debt instruments as well as derivatives of the aforementioned on security exchanges. Traditional cryptocurrencies such as Bitcoin or Ether are neither securities nor commodities in the required sense and are therefore not tradable on stock exchanges in the sense of the German Stock Exchange Act. This does however not apply to security token, which are tokenized securities. Tokenized bonds and stocks or tokenized derivatives would therefore be tradable on stock exchanges should the operator fulfill the technical requirements for the trading itself.

            What are the Requirements to Operate a Stock Exchange in Germany?

            Stock exchanges in the sense of the German Stock Exchange Act are required to be institutions under public law with partial legal capacities, to which the administrative provisions of the German Stock Exchange Act are applicable. Stock exchanges are operated by stock exchange operating companies which can be companies under private law. The operation of a stock exchange requires the authorization of the competent state authority. In order to obtain such an authorization, it is required to show to the state authority that the stock exchange disposes over sufficient financial means. The actual amount required is dependent on the volume of the intended business. In addition to that, the stock exchange operating company has to develop a sustainable business plan and it has to dispose over fit and proper managers and reliable shareholders. Furthermore, it has to be ensured that the stock exchange operating company can provide the technical operation of the exchange and that it has in place a sufficient risk management. Moreover, rules of the exchange that adhere to the stipulated requirements of the German Stock Exchange Act are also required.  The German Stock Exchange Act stipulates additional specific obligations for stock exchange operating companies, such as the implementation of a trade monitoring unit and a stock exchange council. The design of fees and charges are also not at the free discretion of the stock exchange operating company. The schedule of fees has to be approved by the stock exchange supervisory authority. In total, the operation of a stock exchange in the sense of the German Stock Exchange Act is not significantly less complex or costly than the operation of a multilateral trading facility.

            Attorney Lutz Auffenberg, LL.M. (London)

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              Dec 13, 2021

              Digital Operational Resilience Act – What Does DORA Hold in Store for the Crypto Industry?

              One essential component of the cybersecurity strategy of the European Union is the adoption of the Digital Operational Resilience Act (DORA). DORA is intended to improve the IT security of businesses in the European Union. The EU Commission submitted a draft proposal for the regulation already in September 2020 which has been accepted by the EU Council in the meantime. The EU Commission, the Council and the European Parliament will therefore negotiate the final form of the DORA regulation in their trilog-negotiations over the next couple of months. DORA as a EU regulation will be directly applicable to all affected market participants. Those are primarily financial companies such as banks and insurance companies, investment firms and payment institutions. According to the current draft proposal, DORA will nevertheless also be applicable to providers of crypto services, issuers of crypto assets and specific other tokens with asset-like properties. The crypto industry will have to adapt their business models to the new regulation. DORA is expected to go into effect in 2024. 

              Which Obligations Will DORA Impose on Businesses?

              DORA is intended to improve the resilience of financial businesses against external attacks on the IT and aigainst other IT-related risks. The ever increasing digitalization within the financial industry and the resulting need for a continuously functioning IT of financial businesses justifies the implementation of uniform minimum standards regarding the IT security of financial businesses for the entirety of the European Union. DORA intends to obligate affected businesses to regularly participate in IT stress-tests and it will stipulate specific minimum requirements regarding the handling of IT-related risks and IT incidents as well as a uniform regulation regarding the designs of the internal risk-management of the affected businesses. Financial businesses often outsource their IT systems and therefore also the IT security management to third-party service providers. These service providers will also have to implement the requirements stipulated by DORA. 

              How Will DORA Affect Crypto Businesses?

              IT security aspects are essential to the crypto service industry. The loss or the accidental disclosure of private keys for crypto assets of clients regularly implies the realization of the maximal business-related risk for businesses from the crypto industry. Therefore, DORA is intended to be applicable to crypto service providers and token issuers alike. Which actual businesses and issuers will insofar fall under the the scope of DORA will be determined by the Markets in Crypto Assets Regulation (MiCAR) of the European Union, which currently is also in its draft state. This regulation will define crypto service providers as e.g. providers of custody services for third parties regarding crypto assets, as operators of crypto exchanges, operators of other crypto exchange services and as providers of advisory or brokerage services related to crypto assets. Issuers of crypto tokens are also intended to be subjected to the stipulations of DORA, if their tokens are in any way connected to assets or rights for the token holder. As a result, the vast majority of the crypto industry will have to adhere to the new stipulations. The industry will therefore have to oblige to a lot more administrative obligations, but DORA will surely also lead to a further and welcome professionalization of European crypto businesses.

              Attorney Lutz Auffenberg, LL.M. (London)

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                Dec 06, 2021

                European Crowdfunding Service Provider Regulation: Alternative for Token Offerings Without Prospectus?

                The European Crowdfunding Service Provider Regulation (ECSPR) (Regulation (EU) 2020/1503) went into effect on the 10th of November 2021. It provides issuers with the possibility to issue token in the form of tokenized financial instruments with a volume of up to 5 million euros in the EU. There is no necessity to publish a BaFin approved prospectus or securities information sheet (WIB). This however requires the utilization of a licensed crowdfunding service provider. The service provider has to provide a special platform for the offer. The new regulation thereby provides a valid alternative, especially for smaller projects to the traditional issuance. Those would usually include a security prospectus or a WIB. The possibility to conduct the issuance without a prospectus or any other offering-documentation is not the only potential advantage for issuers which intend to offer their tokens with a crowdfunding service provider.

                No Subordination Requirement for Offers Pursuant to the Crowdfunding Service Provider Regulation

                In its scope of application, the ECSPR takes precedence over certain other regulations of the financial supervisory law. An example would be the German Banking Act (KWG). Tokenized debenture bonds are often issued with a qualified subordination clause so that their issuance and the procurement of funds from investors does not qualify as deposit business for the issuer. The qualified subordination of the investors serves to eliminate the unconditionality of the repayment claim of the investors. This is a legal requirement of the deposit business. All this is unnecessary for offers pursuant to the ECSPR. Tokenized financial instruments can therefore be designed in an even more attractive way for investors.

                Cross-Border Offers with a Simple Investment Information Sheet Pursuant to ECSPR

                The issuer of tokenized investment products offered via a crowdfunding service provider must create an investment information sheet for the offer. This is a maximum of six pages long. The information contained in such investment information sheet must be checked for completeness, correctness and clearness by the crowdfunding service provider. There is no need for approval by BaFin. Should the crowdfunding service provider also offer its services in other member states, the investment information sheet must be made available to investors in either the official language of the respective member state. Alternatively in a language accepted by the competent authority of the respective member state. Should these requirements be fulfilled, the offer may take place in more than one member state of the EU.

                Attorney Dr. Konrad Uhink

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                  Nov 29, 2021

                  The Crypto Asset Transfer Regulation – The Last Paper Tiger of the Grand Coalition?

                  The grand coalition passed the Crypto Asset Transfer Regulation of the Federal Ministry of Finances nearing the end of its tenure of office in late September 2021. It thereby subjected the crypto industry to yet another piece of regulation. The regulation intends for comprehensive obligations for crypto service providers which are involved in transactions of crypto assets. These obligations are similar to those of the European Funds Transfers Regulation (EU/2015/847) which stipulates obligations for payment service providers. According to the latter, banks and other payment service providers are obligated to collect, store and submit detailed information concerning payors and payees of transactions of fiat-money in which they are involved. The reason for the grand coalition to pass this regulation is their aspiration to implement the recommendation of the Financial Action Task Forces (FATF). This with the intention to transpose the so-called Travel Rule into respective national law. The Travel Rule has been published already in 2019. The FATF recommends their members to obligate crypto asset service providers that are involved in crypto transactions to collect, store and submit data related to the payor and payee of the crypto transaction.

                  Crypto Asset Transfer Regulation Went into Effect Despite Fierce Criticism of the Industry

                  During the very short consultation period of just two and a half weeks, fierce criticism was raised by the German crypto industry. This in the end could not stop the transposition of the ministries’ draft and the Crypto Asset Transfer Regulation went into effect. One major criticism was the fact that it would be impossible for the affected crypto asset service providers to implement measurements to fulfil the obligations in such a short period of time. After all the regulation went into effect on the first of October 2021. While the collection, storage and transfer obligations resulting from the EU Funds Transfers Regulation for payment service providers of traditional fiat payment transactions is taken into account by the respective Core Banking Systems (CBS) used by the individual payment service providers and technical solutions exist within these CBS, as of now there are no technical support tools in existence for the implementation of the Crypto Asset Transfer Regulation and the obligations stipulated by it. The time period of six days between the passing of the regulation and it going into effect was simply too short for developing. Another very valid criticism was the fact that the EU commission presented it’s draft bill concerning the expansion of the obligations from the EU Funds Transfers Regulation to crypto asset transfers in the summer of 2021 – and thereby prior to the Crypto Asset Transfer Regulation going into effect. It was therefore obvious from the moment in which the Crypto Asset Transfer Regulation went into effect that the German regulation will be a short-term solution until the European regulation goes into effect. Therefore, German crypto service providers are at this moment at a severe disadvantage compared to their European competitors, because they have to fulfil the additional administrative obligations resulting from the Crypto Asset Transfer Regulation.

                  BaFin Provides Form for Making Use of Exemption

                  The Ministry of Finance included a transitional regulation into the Crypto Asset Transfer Regulation in order to provide the market participants with the option to correctly fulfil the obligations from the Crypto Asset Transfer Regulation. According to the exemption, affected crypto asset service providers which were already involved in crypto transactions prior to the first of October 2021 may inform BaFin until the 30th of November 2021 that they are guiltlessly unable to completely or partially comply with the regulation. BaFin provided a form for this last week. The appendix of the form also contains the information, that a justification for the utilization of the exemption has to be provided until December 31st, 2021. According to the appendix, a valid reason and justification is e.g. the lack of a technical implementation possibility. Crypto asset service providers have to verify that they are indeed investing serious effort to find a technical solution, e.g. by joining professional associations that are working on a technical solution. Crypto asset service providers may be exempt from the obligations of the Crypto Asset Transfer Regulation for up to twelve months. An extension for another twelve months is possible according to the regulation. The complete utilization of the transitional regulation could mean that German crypto asset service provides may not have to fulfil the German Crypto Asset Transfer Regulation at all, depending on the speed of the European legislator. Should the revised version of the EU Funds Transfers Regulation go into effect within the next two years it will take precedence over any national regulations. It is therefore possible that the Crypto Asset Transfer Regulation of the grand coalition turns out to be an expensive and useless paper tiger. Only businesses which become active after the notification period is over will be directly affected and they will have to fulfil the obligations of the regulation immediately.

                  Attorney Lutz Auffenberg, LL.M. (London)

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                    Nov 22, 2021

                    NFTs as Crypto Assets – Are Non-Fungible Tokens Regulated Financial Instruments?

                    Non-Fungible Tokens are the talk of the town. It is no exaggeration to call what has taken hold of the crypto community for almost a year now a hype. The special feature of NFTs is that they are individually definable tokens which can be transferred directly between users on a compatible blockchain. Prior to the emerging of NFTs, crypto tokens were usually created via smart contracts in a predetermined quantity and they also were identical in terms of the underlying issuance and therefore fungible. From a technical point of view, NFTs therefore allow for the digital, tokenized representation of individual objects. Currently, examples for NFTs can be found especially in the art business, where the tokenization of pieces of art has become an ever-growing trend. There are also a lot of NFTs that can be found on the internet which are merely connected via a link with a video or a sound file, e.g. with a certain song or an interview. The idea behind is that the ownership of the NFT shall represent the authorization for the usage of the content which is connected to the individual NFT. The individually applicable national civil law determines if and how this is legally possible. Within the German jurisdiction, especially operators of exchanges for NFTs often are exposed to the question whether the individual tokens do qualify as financial instruments in the regulatory sense.

                    Trading Activities with Financial Instruments May Trigger Authorization Obligations

                    Blockchain tokens are based on blockchain technology, just like Bitcoin and comparable cryptocurrencies. Because BaFin very early qualified cryptocurrencies as financial instruments, the question arises, if blockchain tokens such as NFTs also generally qualify as financial instruments in Germany. At the latest since 2013, BaFin is of the opinion that Bitcoin and comparable units are units of account which are a category of regulated financial instruments in Germany. In early 2020, the German legislator introduced crypto assets as a new type of financial instrument into the German Banking Act (KWG). Commercial activities with blockchain tokens may qualify as a regulated activity if the respective tokens qualify as financial instruments. If so, market participants that are intending to conduct such activity require a prior authorization by BaFin. Conducting an activity which is subject to authorization without BaFin’s authorization is a criminal offense. Especially, trading financial instruments in a professional extent – e.g. as the operator of an exchange – can trigger authorization obligations.

                    Can NFTs be Units of Account or Crypto Assets?

                    BaFin defines units of account as alternative means of payment which are used by virtue of private-law agreements or customary exercise in multilateral settlement accounts. NFTs generally do not fulfill the payment characteristic of the aforementioned definition. This is due to their individual design, which makes them unsuited as a means of payment. A qualification of NFTs as units of account will therefore almost never be viable. In comparison, the legal definition of crypto assets is not limited to a payment characteristic. A qualification of specific objects as crypto assets may also be viable, if the objects in question serve investment purposes. This cannot be categorically ruled out with NFTs. NFTs have enjoyed a substantial increase in market values over the last couple of months. Should in certain cases the motivation for the creation of an NFT be based on the mere intention to generate monetary gains by trading the token, the NFT may actually qualify as a crypto asset, because in these cases the investment purpose is the driving reason behind the creation of the NFT. Of course, all the other legal requirements of the definition of crypto assets must also be fulfilled for triggering the regulation.

                    Attorney Lutz Auffenberg, LL.M. (London)

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                      Nov 08, 2021

                      What are IDOs and Which Regulatory Obligations may be Applicable to Initiators?

                      The option to sell self-created crypto tokens to investors as a means to procure capital has grown ever more popular with companies at the latest since the end of 2017. There are different types of these so-called token sales. The probably best known type is the so-called Initial Coin Offering or ICO which also kicked off the hype concerning token sale events in late 2017. In this process, companies create their own crypto tokens via smart contracts on suitable blockchain infrastructures which they subsequently sell to interested investors. If tokens are connected to security-like rights, e.g. a claim on return or participation rights, the public offering of them may qualify as a so-called Security Token Offering (STO). About two years ago, various international crypto exchanges also began to expand their range of services to include so-called Initial Exchange Offerings (IEOs). In this process, the involved crypto exchange does not only offer the token issuer the technical programming of the subsequently offered tokens, but also a listing of the tokens on the exchange to enable interested investors to directly acquire and trade the tokens. Probably the newest type of token sale is the so-called Initial DEX Offering (IDO). Token issuers thereby utilize a Decentralized Exchange (DEX) as the connected trading venue for the initial public offering and possibly also for the secondary trading of the tokens instead of a centralized crypto exchange.

                      How Do IDOs Work?

                      The token issuer offers his tokens during an IDO to investors via a decentralized exchange platform.  These so-called DEX are autonomously, decentralized, on suitable blockchains via smart contracts functioning programs which are not directly operated by any specific entity. The last feature is the decisive difference to centrally designed crypto exchanges. The later are always operated by a specific and responsible operator which matches supply and demand through his services and which will facilitate the settlement of contracts in cases in which a contract is agreed upon. With DEX, the matching of offeror and investor as well as the settlement of crypto transactions is performed automatically via an accordingly programmed smart contract. Token offerors as well as investors may independently interact with the smart contract and may acquire or sell tokens via the DEX from or to other trading participants of the DEX. Trading participants of a DEX provide a blockchain address with which they intend to participate in the decentralized trading. Token issuers are therefore able to offer their tokens by listing a blockchain address on the DEX which contains the offered tokens as a credit balance. In order to acquire the crypto tokens, investors may then transfer other cryptocurrencies with an amount equivalent to the intended investment amount to a blockchain address provided by the issuer to the DEX. The DEX will then automatically transfer crypto tokens equivalent to the investment amount to the investor.

                      Which Regulatory Obligations May Be Triggered by an IDO?

                      Even though the actual trading on a DEX is performed in a decentralized way and without a clearly responsible operator, the participants may nevertheless be addressees of regulatory obligations. Should the offered tokens e.g. qualify as securities in the sense of the EU Prospectus Regulation, a security prospectus or other required documentation has to be provided by the issuer for the first public offering. Regarding the DEX itself, the initiators of the platform might be subject to authorization obligations, depending on their specific contribution to enable the DEX for operation. Should the initiator of the DEX for example reserve administrative rights that enable him to influence the trading on the DEX or should transactions on the DEX trigger transaction fees for the benefit of the initiator, a case for the regulatory responsibility of the initiator could well be made. In summary, there are therefore no real regulatory simplifications for the issuers of tokens via IDOs compared to other types of token sale events. For the initiators of the DEX, the question of profiting from regulatory simplifications depends on the actual autonomy of the DEX and on the connection of the initiator to the operation of the DEX, for example through the reception of transaction fees stemming from the trading activities on the platform.   

                      Attorney Lutz Auffenberg, LL.M. (London)

                      I.  https://fin-law.de

                      E. info@fin-law.de

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