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Category: blog EN

Nov 25, 2019

Starting Capital and Equity for Blockchain Startups – How Much must be shown to BaFin?

Operating a business model in Germany that is based on or related to cryptocurrencies requires a BaFin authorization in most cases. BaFin qualifies Bitcoin and comparable cryptocurrencies as units of account already since 2011 and as of 2020 crypto assets will be legally classified as financial instruments in the German Banking Act (KWG). Moreover, BaFin also clarified that crypto tokens can, in certain cases, be financial instruments in the form of securities, asset investments or shares in investment funds. Therefore, blockchain startups can be subject to the German Banking Act (KWG). They therefore must be BaFin authorized prior to the start of their commercial activities. The road to authorization can be long and hard and requires meticulous and thorough planning. Not only professionally competent and reliable managing directors and a sustainable business plan but also sufficient funding that is risk appropriate and that ensures operations at least in the starting phase of the business must be shown to BaFin in order to successfully apply for authorization. But are the requirements for crypto service providers the same as for traditional financial service providers?

WHAT IS THE MINIMUM STARTING CAPITAL THAT CRYPTO FINANCIAL SERVICE PROVIDERS MUST SHOW TO BAFIN?

The question of how much capital a blockchain startup must have available prior to and during operations in order to successfully apply for and maintain a BaFin authorization cannot be answered differently as for any traditional financial service providers. The amount depends on the specific kind of financial service or banking activity that the applicant intends to offer. As a rule of thumb, it can be said that businesses offering services which neither grant the service provider a right of disposition regarding customer monies or securities nor of dealing with financial instruments for own account must have available at least 50.000 Euros at any time. If the applicant shall have the right of disposition regarding customer monies and securities but does not trade financial instruments for own account, the minimum is 125.000 euros. If the company shall trade financial instruments for own account, the minimum is 730.000 euros. In this context it is important to emphasize that cryptocurrencies such as Bitcoin, Litecoin, Dash or Iota are, according to German supervisory law, considered neither as money in a legal sense nor as securities. Therefore, crypto financial service providers do not need to show more than 50.000 euros of starting capital just because they offer safekeeping services for their customer’s cryptocurrencies on own accounts on behalf of the customers. This will be especially important as of 2020 for the newly regulated crypto custody service providers. All of this does of course not apply to the safekeeping of security tokens for customers in case those qualify as securities under MiFID II and must be treated as such.

DO CRYPTO FINANCIAL SERVICE PROVIDERS HAVE TO PROVE APPROPRIATE FUNDS ACCORDING TO CRR?

The European Capital Requirements Regulation (CRR) obliges businesses falling under its provisions to have a certain equity ratio at any time on basis of extensive and complicated rules. CRR-regulated institutions are therefore obligated to constantly evaluate their equity and risk positions. They also have to maintain a sufficient equity ratio at any point in time. Luckily, CRR regulations are seldomly applicable to crypto financial service providers. Only credit institutions and investment firms are subject to the corresponding directive. Credit institutions in the required sense are businesses that take in deposits or other repayable customer funds and give out loans for their own account – activities that – according to the directive – can only be conducted with money and not with cryptocurrencies. Investment firms in the sense of the CRR are exclusively companies being regulated by the Markets in Financial Instruments Directive (MiFID II) and cryptocurrencies are not defined as financial instruments by this directive. Therefore, crypto financial service providers can only be subject to the CRR if they conduct activities that are related to security tokens, because these have to be qualified as financial instruments with regards to MiFID II.

Attorney Lutz Auffenberg, LL.M. (London)

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    Nov 18, 2019

    Let´s Build a Crypto Custody (Part I) – What Qualification is Required by the Management?

    After a lengthy back and forth, the German legislator last week finally decided on how to conduct the transposition of the provisions of the 5th European AML Directive into national law. The German Parliament accepted the recommended resolution of the 7th financial committee after the original draft of the federal government was heavily criticized by experts and market participants alike. Especially the so-called ring-fencing, which would have led to the situation that crypto custody service providers could not provide any other banking or financial services to their customers, was subject to heavy criticism. To the relief of the whole industry, the ring-fencing idea was abandoned. This hard to justify separation would not have been a suitable instrument to achieve the declared intention of the German federal government to develop Germany into a global blockchain hotspot. Moreover, the period in which crypto custody service providers that commercially store crypto assets for their clients and which have not been authorized by BaFin yet can continue to provide their services until the 30th of November 2020 if they apply for authorization until this date and inform BaFin until the 31st of March 2020 about the intended application. But what are the requirements that crypto custody service providers have to fulfil in 2020 to successfully apply for BaFin authorization?

    WHAT ARE THE REQUIREMENTS REGARDING THE PROFESSIONAL COMPETENCE OF THE MANAGING DIRECTOR?

    Crypto custody service providers, just as any other financial services institution, have to fulfil specific legal requirements to successfully apply for BaFin authorization. That of course means that the company has to be managed by fit and proper directors, that have enough time at their disposal to sufficiently take care of the business. The professional competence (the fit part of fit and proper) of a person is, according to the German Banking Act (KWG), legally assumed if the person has worked for at least three years in a managing position of a supervised financial services institution and if he or she was responsible for the kind of financial services that the applying company wants to offer. Otherwise, the professional competence of a managing director has to be proven explicitly to BaFin in the application. This is done by meticulously proving his or her theoretical and practical abilities by e.g. submitting a monthly-detailed curriculum vitae, training and working certificates or other suitable documents like specialist publications or lecturing activities. Since the crypto custody service is about to be newly introduced as a financial service nobody will fulfil the legal assumption because nobody has three years of working experience in that field of work. Applications for the authorization of crypto custody services will therefore always rely on the individual verification of the managing directors. At the same time, BaFin will have to take into consideration that crypto custody services are a new form of financial service providers and therefore, that the not only -temporal management of a bank or other financial service provider and a proven understanding of the technical basics of crypto assets will most likely qualify a person to be the managing director of a crypto custody service provider.

    WHEN IS THE DIRECTOR OF A CRYPTO CUSTODIAN CONSIDERED TO BE RELIABLE AND SUFFICIENTLY AVAILABLE FOR THE COMPANY?

    With regards to the reliability and temporal availability of managing directors of crypto custody service providers there are no specific peculiarities compared with the managing directors of any other institution being subject to BaFin authorization in accordance to the German Banking Act (KWG). The reliability of a managing director has to be proven in the application. The criminal record of the candidate and e.g. an excerpt of the central trade registry next to details of the candidate’s economic situation and bankruptcy procedures (if any) are used to prove a candidate’s reliability. The temporal availability depends on how much time the proper conduction of the business probably takes. It is possible that the managing director of a crypto custody service provider holds other managing, supervisory or administrative positions next to the managing position. It is necessary to display and globally justify the required and available time of the proposed managing director vis-à-vis BaFin.

    HOW MANY MANAGING DIRECTORS DO CRYPTO CUSTODY SERVICE PROVIDERS NEED?

    In general, financial service providers only need one professionally competent and reliable managing director who has sufficient time at his disposal to manage the service provider. Two managing directors are necessary if the service provider is authorized to acquire ownership or possession of customer’s monies or securities. The obvious reason for this regulation is to ensure the dual control principal for fiduciary and custody service providers. The crypto custody service providers will only store crypto assets. If these crypto assets are merely cryptocurrencies such as Bitcoin, Litecoin, Ripple or IOTA the still applicable administrative practice of Bafin defines them as units of account. They are therefore financial instruments but neither money nor securities in a legal sense. Therefore, one managing director would in this case be sufficient to propose in the BaFin application. The legal handling of the custody of security tokens on the other hand is not yet entirely clarified at this point. It would make sense to subsume the custody of security token under the deposit business and not under the crypto custody service, but the passed legislation does not mandate this explicitly. If it would be handled as stated above, security tokens could not be stored with crypto custody service providers but only with depository banks which regularly must have two managing directors.

    Attorney Lutz Auffenberg, LL.M. (London)

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      Nov 11, 2019

      Lending Cryptocurrencies – Is that a Lending Business and Therefore Subject to Authorization?

      Companies that commercially grant customers loans generally need, if they are subject to German banking supervisory law, a BaFin authorization for the lending business. According to the applicable legal provisions, this banking activity is reserved for companies with a full banking license. According to the legal definition of the German Banking Act (KWG), acceptance credits and money loans are considered lending business. BaFin generally places low demands on the definition. According to its administrative practice concerning the temporary granting of money it is irrelevant if interest or collaterals are contractually agreed upon or if the lender finances the business via burrowed funds. Relevant however is that the loan is a money loan which is given by the provider at the start and returned to him at the end of the duration in money. A provider that e.g. grants his customers money for a duration of five years and receives, as contractually agreed upon, a certain amount of preset securities at the end does not conduct a lending business in the sense of the German Banking Act (KWG). The loan has to be repayable in a way that the nominal value and the repayment claim are both denominated in money.

      PROVIDERS OF CRYPTO LOANS STILL NEED A BAFIN LICENSE
      According to BaFin’s administrative practice the temporary granting of cryptocurrencies is not a lending business that would be subject to authorization. With this reason for authorization being inapplicable, the providers of crypto loans are still subject to authorization by BaFin according to the German Banking Act (KWG) if the cryptocurrencies in question are deemed units of account and therefore financial instruments and the providers operate in or from Germany. The loaning of e.g. Bitcoins, Litecoins, Ether or Monero, which are all financial instruments according to BaFin, can be, under certain circumstances, considered proprietary trading if the provider conducts the business commercially or not merely occasionally. The decisive point is that the borrower of a crypto loan obtains the full power of disposition over the received units with the transfer of the units onto his own blockchain wallet to which he holds the private key. At the end of the crypto loans duration the borrower has to transfer the received number of crypto units back to the lender. He therefore bears the full market price risk during the duration of the loan. Overall this might amount to a classic derivative forward transaction. The crypto loan might be a derivative forward transaction and therefore a financial instrument according to the German Banking act (KWG).

      ARE CRYPTO LOAN PROVIDERS REGULATED BY THE GERMAN BANKING ACT (KWG) AS PROPRIETARY TRADERS?
      Proprietary trading that is subject to authorization in accordance to the German Banking Act (KWG) can occur in four different variations. It is conducted in particular if the provider continuously offers to buy and sell financial instruments, which he has acquired on his own account with his own means at his own prices. In all four variations it is necessary that the proprietary trader trades financial instruments on his own account.

      Attorney Lutz Auffenberg, LL.M. (London)

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        Nov 04, 2019

        Passporting an STO Prospectus – How Can an STO Prospectus be Used for EEA-wide Offerings?

        Numerous capital markets authorities throughout Europe approved security token offerings by now and thereby allowed the public offering of blockchain-based securities. Even in Germany, where the securities law still heavily relies on documents in paper form, a number of securities prospectuses regarding blockchain-based securities have been approved by BaFin. At the same time, the German legislator announced the introduction of digital debenture bonds as part of its blockchain strategy and promised to publish a draft legislation by the end of the year. Blockchain technology is gaining ground in the area of public offerings of securities and has yet developed into a serious alternative to traditional, paper document-based securities emissions. STOs offer emitters numerous ways to reduce the costs of the emitting process e.g. by making security depositories for collective certificates unnecessary or by enabling automation for countless processes during the emission which can make the services of paying agents expendable. Is a security token offering suited for emitters that want to offer their product to investors in more than one EEA member state?

        FULL-FLEDGED SECURITY PROSPECTUS FOR TOKENS QUALIFYING AS SECURITIES

        If a security token meets all the requirements for a security in the sense of the EU Prospectus Directive according to the supervisory authority that would be responsible for the approval of the prospectus, the emitter, in order to publicly offer the token, must have approved a security prospectus for that token by the competent authority, get it published and deposited with the approving authority. Before that, the security tokens may not be offered publicly. Just as with traditional, paper-based securities, STO emitters must create and compile a comprehensive security prospectus for their product. This security prospectus, if approved by the competent authority, is a full-fledged security prospectus in the sense of the EU Prospectus Directive that triggers the same rights and obligations as a prospectus for traditional securities would do. STO prospectuses can therefore be passported within the EEA because they are subject to the same passporting regulations as traditional security prospectuses are. As a consequence, STO emitters can use an approved STO prospectus for a public offering in other EEA member states, too, as long as they apply for notification for the target member states with the competent authority.

        HOW EXACTLY DOES THE NOTIFICATION PROCEDURE FOR STO PROSPECTUSES WORK?

        An STO emitter wanting to use his approved security prospectus in other EEA member states for the public offering of his security token can simply apply for notification with the competent authority that approved the prospectus. The competent approval authority will then inform the competent authority in the target member state and ESMA within a working day that the STO emitter created an EU Prospectus Directive compliant securities prospectus that has been approved. Furthermore, a copy of the prospectus will be sent to the competent authority in the target member state. The competent authority of the target member state is bound by the assessment of the competent approval authority. If e.g. BaFin approves a security prospectus for a security token offering and the emitter also wants to offer his token to Austrian investors, the Austrian FMA has no way to prohibit the public offering of the tokens in Austria if the emitter prior to the offering notified BaFin of offering the security tokens in Austria as well. Of course, the FMA could also not request from the emitter to draw up and have approved another security prospectus for the offering of the tokens to Austrian investors with the FMA. As to the prospectus language, all European capital markets authorities must accept prospectuses in a language that is commonly used in the sphere of international finance. Therefore, English is the sensible choice for prospectuses for European STOs.

        Attorney Lutz Auffenberg, LL.M. (London)

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          Oct 28, 2019

          Crypto Information Services – Is That Subject to Authorization in Germany?

          The trading of cryptocurrencies grew more and more complex over the past ten years. Nowadays, investors do not only have the option to directly sell and acquire Bitcoins but instead they can also hold long or short positions of Bitcoin. These derivative transactions allow them to bet on rising or falling prices without ever acquiring cryptocurrencies directly. Margin trading with cryptocurrencies has also been possible for years now. The offered cryptocurrencies range from blockchain-based currency tokens such as Bitcoin, Litecoin or dash to countless utility tokens that can only be used as vouchers in a specific eco-system. In this more and more maturing market, information concerning exchange rates and trade volumes of crypto assets is of vital importance. Since there is no official listing for cryptocurrency exchange rates, numerus private service providers now offer this information in real-time in a consolidated, compiled and useable form to their customers. Precise and up-to-date information regarding the development of exchange rates are of crucial importance to traders of cryptocurrencies. The information service providers do therefore play an essential role on the global crypto market.

          WHY COULD A REGULATION OF CRYPTO INFORMATION SERVICE PROVIDERS MAKE SENSE?

          Erroneous information regarding exchange rates and trade volumes can potentially cause massive damages to investors and is suitable to disrupt and compromise the crypto market in its core functions. Adding the fact that cryptocurrencies, in contrast to securities that are traded at the traditional security markets which are regulated by MiFID 2 and MiFIR, usually lack of emitters that would be obligated to inform market participants continuously via ad-hoc-notifications, prospectus and amendment obligations about incidents that have the potential to influence exchange rates. In light of the aforementioned circumstances an approval of crypto information service providers prior to the start of their operations by a supervision authority regarding the collection and evaluation as well as the publication of their data would not be entirely absurd. Nevertheless, such an official regulation is currently not in place. Providers of crypto information services are neither subject to an initial authorization requirement nor to an ongoing supervision of their services.

          CAN CRYPTO INFORMATION SERVICE PROVIDERS BE DATA REPORTING SERVICE PROVIDERS ACCORDING TO MIFIR?

          The European Markets in Financial Instruments repealing Directive (MiFID 2) as well as the European Regulation on Markets in Financial Instruments (MiFIR) call for the supervision of Data Reporting Service Providers. These service providers support emitters of securities with the fulfilment of their publication and reporting obligations. Certain Data Reporting Service Providers – the so-called Consolidated Tape Providers (CTP) – provide their collected data in a consolidated form to the public. In Germany, these Data Reporting Service Providers are subject to BaFin authorization according to sec. 32 subsection 1f of the German Banking Act (KWG). However, crypto information service providers cannot qualify as Data Reporting Service Providers in that sense, because cryptocurrencies generally do not qualify as financial instruments in the sense of MiFID 2 and MiFIR. Therefore, the activities of crypto information service providers are not covered by the European financial markets regulations MiFID2 and MiFIR. In contrast to that, publications of information that concern security tokens, which are designed as blockchain-based securities and therefore constitute financial instruments in the sense of the aforementioned regulation can be data reporting services, given that the service provider is involved in the fulfillment of the emitters publication and reporting obligations and publishes the so collected data in a consolidated form. On the other hand, crypto information service providers that merely provide and publish information about exchange rates and trading volumes are not subject to any financial regulation in Europe and Germany.

          Attorney Lutz Auffenberg, LL.M. (London)

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            Oct 21, 2019

            Multisig Wallets and Crypto Custody – What is Regulated Under the New Law?

            After the highly anticipated debate in the German Bundestag regarding the transposition of the provisions of the fifth European AML Directive only marginally included a discussion of the introduction of crypto custody services as a new financial service, it is still not foreseeable if the proposed draft, prior to the final vote will be revised following the criticism of the German Bundesrat or not. It has to be assumed that on 1st January 2020 crypto custody services will be included into the catalogue of sec. 32 of the German Banking Act (KWG) as proposed by the Federal Government. If so, it will not be possible for companies to commercially store, manage or secure crypto assets or corresponding private keys for customers as a crypto custody service without prior BaFin authorization. The legal design of crypto custody services in the German law will at that point in time substantially exceed the requirements of the fifth European AML Directive, which merely requires the operators of electronic wallets to actively enforce AML measurements and does not call for an authorization obligation. But who will be subject to this German solo effort and what is exactly will be considered as a crypto custody service by this regulation?

            CRYPTO CUSTODY APPLIES TO THE CUSTODY OF PRIVATE KEYS FOR CRYPTO ASSETS
            The term “custody” is, from a technical point of view somewhat misleading. It stems from the physical taking of objects, as e.g. security certificates. Things are different with crypto assets: They are only digitally existing information of the allocation of tokens to a certain address of the underlying blockchain. This information can only be changed if someone uses the corresponding private key of the blockchain address in order to transfer the tokens to a different blockchain address. The information which token is allocated to which address is stored decentralized on the blockchain itself and therefore on numerous so called “full nodes” that are operated all over the globe. Crypto custody therefore cannot refer to the storage of tokens on local storage media, but only to the case in which virtual tokens are received on a blockchain address to which the custodian holds the private key.

            IS THE SAFEKEEPING OF PRIVATE KEYS TO MULTISIG WALLETS A CRYPTO CUSTODY SERVICE?
            Multisignature wallets require private keys of two or more users in order to transfer tokens. This ensures that wallet holders can only collectively dispose of the tokens allocated to that wallet. Multisig wallets are e.g. used if crypto assets are temporarily kept in fiduciary capacity to settle transactions. The fiduciary cannot dispose over the wallet balance without the client and vice versa. This ensures a safe transaction settlement for all participants. According to the wording of the draft, this would constitute a crypto custody service by the fiduciary because he would hold private keys that are intended to transfer or manage crypto assets for his client. The definition draft of crypto custody services does in no way require the sole power of disposition over the crypto assets or private keys by the service provider.

            CAN IT BE INTENDED TO REGULATE FIDUCIARIES USING MULTISIG WALLETS AS CRYPTO CUSTODY SERVICE PROVIDERS?
            According to the explanatory memorandum to the draft proposal of the German Government, it is intended that especially service providers storing their client’s crypto assets in a collective holding without the client’s knowledge of the cryptographic key are subject to this regulation. In contrast to that, the mere providing of hard- or software to secure customer private keys without the provider having access to the stored data to use them shall not be subject to the regulation as long as the customer is solely responsible for the storage. Multisig fiduciaries, which are not explicitly addressed by the explanatory memorandum are in between the two alternatives. It is therefore unclear if the German Government wants to subject them to the regulation or not. According to the explanatory memorandum the overall reason for the regulation of crypto custody services are AML considerations. The business model of Multisig fiduciaries, the settling of transactions, is rather prone for money laundering which is a good argument for their subjection to the regulation. On the other hand, fiduciaries are already subject to the Money Laundering Act which only in certain cases subjects them to AML obligations. It seems as if at first BaFin as the competent authority and maybe later the administrative courts will have to define the details of this regulation via administrative practice or rather via judgement.

            Attorney Lutz Auffenberg, LL.M. (London)

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              Oct 14, 2019

              Let´s Sell a Security Token – Who is Actually Allowed to Sell Tokenized Financial Instruments?

              In 2019 BaFin allowed the first security token offerings in Germany and approved the corresponding and necessary security prospectuses. Blockchain-based capital markets issuances are therefore possible in Germany and a viable alternative for issuers seeking to acquire capital. However, the approval of the necessary prospectus is just the first step to a successful emission. The economic success of a capital markets emission depends heavily on the placement of the product with financially strong investors. The planed volume of STO emitters usually ranges between 50 and 500 Million euros. Amounts that are hard to reach with investors hailing from the IT and blockchain communities that are still shaken from the 2017 and 2018 ICO-hype. For blockchain-based capital markets emissions to reach these numbers, professional and reputable sales partners with access to wealthy individuals and institutional investors are needed.

              IS A TOKEN SALE UNDER THE ISSUERS OWN DIRECTION POSSIBLE?

              It is of course still possible for STO emitters to sell and market their security tokens to interested investors. Emitters do not need a BaFin license to distribute their own security tokens as long as they do not also offer other banking, financial or payment services. Emitters wanting to take the sale of their tokens into their own hands can still employ the services of external agencies to help them with the organization of the sales distribution. These external agencies are however not allowed to directly sell or establish any contact to investors. Their services are restricted to marketing advice during the token sale.

              WHICH FINANCIAL SERVICE PROVIDERS ARE ALLOWED TO HELP WITH THE DISTRIBUTION OF SECURITY TOKENS?

              In order to legally offer security tokens to investors in Germany, the service provider must be BaFin authorized as an investment intermediary or investment broker. If the service provider also advises the investors and provides customized investment recommendations that are tailored to the financial capabilities of the respective investor a BaFin authorization for the provision of investment advisory is additionally required. Besides these authorized service providers, numerous tied agents operate in Germany, offering their services under the liability umbrella of authorized financial institutions. They are allowed to distribute financial instruments of all kinds including security tokens. Therefore in Germany, there is a sufficient number of service providers that can legally offer the distribution of security tokens. Nevertheless, still only very few financial service providers dare the inclusion of security tokens in their distribution portfolio, may it be due to fear of rookie mistakes, blockchain related IT risks or simply because their customers do not yet demand tokenized securities as an investment option. If security token offerings establish themselves as a more commonly accepted alternative to traditional capital markets emissions, the distribution providers will most probably follow suit and expand their services accordingly.

              CAN A DISTRIBUTION OF SECURITY TOKENS ALSO BE OFFERED BY FINANCIAL INVESTMENT AGENTS IN THE SENSE OF THE TRADE AND INDUSTRIAL CODE?

              The distribution of financial instruments as defined by the German Banking Act (KWG) generally requires a BaFin authorization. Certain financial instruments, precisely investment assets as defined in the German Investment Asset Act (Vermögensanlagengesetz) and open-end and closed-end investment funds as defined by the German Capital Investment Code (KAGB), can be distributed without a BaFin authorization as long as the distributer is licensed as a financial investment agent in accordance to sec. 34f of the German Trade and Industrial Code (GewO). Of course, the distribution of tokenized versions of the aforementioned financial instruments is also possible. Tokenized securities as e.g. bonds and shares are not included in this exemption and can therefore only be distributed by a BaFin authorized distributer. A token that can also be distributed by financial investment agents being licensed in accordance with the German Trade and Industrial Code must therefore be designed as an investment asset or as a share of an investment fund.

              Attorney Lutz Auffenberg, LL.M. (London)

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                Oct 07, 2019

                Let’s Create a Stablecoin – Can Politics Prohibit Libra?

                In the last couple of weeks, the pressure on Facebooks stablecoin project Libra intensified. Government representatives like the German minister of finance Olaf Scholz and his French counterpart Bruno LeMaire see numerous problems and fear systemic risks if private companies offer their own means of payment as an alternative to national currencies. They therefore threaten Facebook with prohibiting Libra in Europe even prior to the project’s implementation. According to the current plan, Libra is supposed to be covered by a government bonds and currency basket in order to ensure value stability of the coin. According to the current plan Libra is going to be administered by a swiss-based association with members like Paypal, Visa and Mastercard that are linked to the payment industry but also companies like Ebay, Uber and Spotify. The basket-mechanism is supposed to ensure value stability. A direct connection to a specific national currency as e.g. the Euro is not planned. But how exactly could politics prohibit Libra and comparable stablecoins?

                HOW COULD THE PROHIBITION OF LIBRA BE JUSTIFIED?

                The prohibition of Libra or other Stablecoins within the constitutionally organized European Union would require a statutory basis. According to the Treaty of the Functioning of the European Union, only the European Central Bank has the power to authorize the issuing of euro banknotes which are the sole legal tender in the union. Libra would neither claim to be a legal tender nor would it be denominated in euro. The German Bundesbank Act penalizes on a national level the unauthorized issuing of monetary units even if they are not denominated in euro. If the term “monetary units” refers to blockchain units or only to the explicitly stated value tokens, cash money coins, bank notes or other certificates is questionable. Regardless of this a prohibition can only be stipulated in the cases where the issuing of alternative means of payment is not explicitly allowed by law.

                COULD LIBRA BE E-MONEY IN THE SENSE OF THE SECOND EUROPEAN E-MONEY DIRECTIVE?

                The prohibition of Libra in Europe could therefore be ruled out, if the stablecoin would meet the requirements for a qualification as e-money according to the second European E-money Directive, the Libra Association as the Libra issuer met the authorization requirements to conduct e-money-business and would additionally apply for such authorization in a EU member state. E-money is defined by the second E-money Directive as an electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions and which is accepted by others than the issuer. A cryptocurrency that is designed as a means of payment and that is issued by a central emitter it can be purchased from and re-exchanged with can therefore in many cases be defined as e-money. As stated, e-money is a recognized manifestation of money under EU law. If Libra and the Libra Association would therefore fulfill the aforementioned requirements, a prohibition of Libra would at least legally be hard to justify. That scenario would however require that Libra would be designed as a claim against the Libra association and could be purchased and re-exchanged at any time.

                Attorney Lutz Auffenberg, LL.M. (London)

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                  Sep 28, 2019

                  Credit Cards and Crypto Business – Crypto Companies as High-Risk Merchants

                  The vast majority of goods and services that are purchased online is still paid for via credit card. This also applies companies from the blockchain industry since cryptocurrencies as a means of payment, even in this field of business, have not yet reached mass adoption. It is therefore crucial for e.g. crypto exchanges, token emitters and crypto custody service providers to offer the most common credit card schemes as a payment option for their customers. It is precisely these big, global credit card providers that classify crypto related businesses as High Risk Merchants already since 2018. If a crypto company therefore wants to be become a part of the Mastercard network, it must undergo a special due diligence process in order to comply with the current Mastercard Statutes since the inclusion of Cryptocurrency Merchants in the Mastercard Business Risk Assessment and Mitigation Program (BRAM) as of 16th April 2018.

                  WHICH BUSINESSES ARE CRYPTO MERCHANTS ACCORDING TO MASTERCARD?

                  Mastercard defines businesses that are related to crypto transactions as Crypto Merchants. According to Mastercard´s Security Rules and Procedures – Merchant Edition from 14th February 2019 (SPME) a crypto transaction in this sense is basically every incident in which a credit card holder uses an account to buy or sell cryptocurrencies. Therefore, all crypto related business that offer their customers the option to buy or sell cryptocurrencies are generally affected. These are first and foremost crypto exchanges but also e.g. token issuers wanting to sell their issued tokens to investors.

                  WHAT REQUIREMENTS DOES MASTERCARD IMPOSE ON CRYPTO MERCHANTS?

                  Strictly speaking Mastercard´s SPME do not obligate the crypto businesses directly but rather their merchant acquirers to account for a certain due diligence in relation to the crypto business. According to number 9.4.9 of the SPME, merchant acquirers of crypto businesses have to be supplied with copies of authorizations according to which the activities of the crypto business are authorized in the countries in which business is supposed to be conducted with card holders. If the activity is not subject to authorization in countries in which business is supposed to be conducted with card holders but e.g. subject to an entry in an official register, a copy of the register is sufficient. Most crypto services in Germany are subject to BaFin authorization. Crypto businesses therefore must supply their merchant acquirer with a copy of their authorization notification or e.g. an officially approved excerpt from the tied agents register if they act as tied agents. Companies that merely conduct passive business with German card holders, meaning that these companies do not actively target the German market, are not subject to BaFin authorization and in consequence do not have to provide the merchant acquirer with documents of the aforementioned kind. In any case, Crypto Merchants must provide their merchant acquirer with a reasoned legal opinion of a qualified law firm explaining the regulatory obligations of the crypto business as well as the card holders for every country in which Mastercard payments shall be accepted, no matter if the business is conducted actively or passively. The SPME states that these legal opinions have to be “acceptable to Mastercard” which means that a certain level of quality should be observed when creating the legal opinion. For the German market, FIN LAW offers the creation of such legal opinions. For legal opinions concerning other jurisdictions FIN LAW disposes of a broad international network of qualified partner law firms.

                  Attorney Lutz Auffenberg, LL.M. (London)

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                    Sep 23, 2019

                    Introducing Digital Securities – What are the Implications for Security Token Offerings?

                    The German Federal Government resolved its blockchain-strategy on 18th September 2019. The resolved version includes 44 specific measures not only concerning initiatives that are related to capital and financial markets but also the promotion of blockchain projects that have an impact on the real economy, as well as research, cooperation initiatives and the implementation of the technology in the Government’s own administrative structures. The first project is due to be realized later this year: The digital security is supposed to be introduced into German law and should render the paper document obsolete, that is currently still needed to certify securities according to German securities law. But what are the specific measures that the German capital markets can expect? Are there legal consequences for security token offerings and will the novelization make blockchain-based public offers on the capital markets easier in Germany?

                    DIGITAL DEBENTURE BONDS AS A KICKSTARTER

                    In a first step, the German Federal Government will introduce digital debenture bonds. The introduction of digital stocks and digital investment fund shares is planned for the next couple of years, after experience is gained from the introduction of digital debenture bonds. And indeed, bonds are well suited for the first phase of digitalization of the securities law, because in contrast to shares, bonds are mere contractual relationships between the emitter of the bond and the investor. Bond investors obtain contractual claims vis-à-vis the issuer such as a return claim (fixed or variable) and a repayment claim. Shares on the other hand could grant dividend claims and shareholder participation rights. Moreover, Germany already has experience when it comes to tokenized bonds that are issued to the capital markets via a BaFin-approved security token offering.

                    WHY IS THERE A NEED FOR DIGITALIZED DEBENTURE BONDS IF STOS ARE ALREADY POSSIBLE UNDER CURRENT LAW?

                    Bonds are traditionally certified in a paper document in order to make them tradable freely at the capital markets. In order to enable a rapid and efficient trade it is essential that the claims arising from the bonds are unencumbered. That means that the security in question must be free from rights and claims of former owners as e.g. a right of retention, the objection to set-off or a pledge. Acquirers must furthermore be able to rely on the fact that the purchase of a security is effective even if the seller was not the owner of the security, for example to enable short selling. According to German law an unencumbered, bona fide purchase is only possible in regard to objects. Claims are not objects in the required sense and therefore cannot be purchased bona fide. This is the reason why debenture bonds currently are embodied in paper documents. The paper document itself is an object and so subject to property law. It can therefore be purchased bona fide and unencumbered while the owner of the paper document can assert the embodied claim. Blockchain tokens on the other hand are digital assets and so not objects in the required sense. They can therefore not replace the paper document as an object. The Security Tokens which were subject to the BaFin-approved offerings earlier this year were designed to be transferred by a mere contractual assignment of the represented claims to the purchaser instead of a property transfer. A bona fide purchase of these tokens is therefore currently not possible. For a professional exchange trading, where securities sometimes change hands in a matter of milliseconds e.g. through high frequent electronic trading,, the legal possibility of an unencumbered, bona fide purchase is essentially required. Therefore, the next level of digitalization of the capital markets must be the introduction of a reliable legal framework of an unencumbered, bona fide purchase of tokenized bonds. The German Federal Government wants to do that by introducing the digitalized debenture bond.

                    WHAT DOES THE INTRODUCTION OF DIGITALIZED DEBENTURE BONDS MEAN FOR EMITTERS AND SECURITY TOKEN OFFERINGS?

                    The announced introduction of digital debenture bonds might be the breakthrough security tokens need in order to be potentially available for trade on the secondary markets. If the unencumbered bona fide acquisition of security tokens becomes legally possible, the transfer of security tokens would no longer only work on basis of the contractual assignment of the represented claims but could instead be performed by a simple transfer of the tokens from the seller to the purchaser. Emitters of security tokens would face considerably less legal uncertainty with regards to the legal fate of their tokenized bonds and could offer their investors the prospect of exchange trading after the initial token sale. All of this under the condition that the German legislator properly implements digital debenture bonds into German securities law.

                    Attorney Lutz Auffenberg, LL.M. (London)

                    I.  https://fin-law.de

                    E. info@fin-law.de

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                      Sep 16, 2019

                      Spot on Crypto Payment Providers – How is that Regulated?

                      Next to crypto exchanges and Bitcoin ATMs, crypto payment service providers were one of the business models of the Blockchain community from the very get-go. The user of these services can transfer Bitcoin to the service provider which will in return transfer the equivalent in e.g. Dollar or Euro to a bank account of the customer’s choice after deducting a service fee. These services therefore enable the payment of debts with Bitcoin that are owed in fiat currency. Some crypto payment providers offer the reverse service. In these cases, the customer transfers fiat currency to the service provider which will then (after the deduction of a service fee) transfer the equivalent amount of crypto currency to a wallet address of the customer’s choice. Another existing variation is a service where a payment is made in one cryptocurrency and the service provider transfers the equivalent amount in another (most of the times in Bitcoin) to a crypto wallet determined by the customer. The most frequent form of crypto payment service however is crypto to fiat payment which will therefore be the subject of this blog. How are these services regulated under German law and what do the operators of these services have to consider when offering their services in Germany?

                      CRYPTO PAYMENT SERVICES ARE SUBJECT TO TWO DIFFERENT REGULATORY REGIMES

                      In fact, crypto payment services constitute a hybrid under German financial regulation. The basic idea of these services is the execution of customer payments to the respective recipient. If this service would not involve crypto currencies but only fiat currencies, it would be considered a mere money remittance servicein the sense of the second payment services directive and therefore be treated as a classical payment service. The operation of such a business requires a BaFin authorization in accordance to the German Payment Services Act (ZAG) if the business operates commercially or at least requires a professional business set-up in Germany and no legal exemption from this obligation is applicable. Crypto payment service providers on the other hand not only offer the aforementioned service but also an exchange service. As shown, the customer transfers e.g. Bitcoin to the crypto payment service provider who then forwards the payment to the recipient’s bank account in fiat currency and thereby effectively exchanges crypto currency into fiat currency. This exchange is, depending on the individual circumstances, either qualifies as a financial commission business or proprietary trading. Both alternatives require the service provider to be BaFin authorized in accordance with section 32 of the German Banking Act (KWG).

                      DO CRYPTO PAYMENT SERVICE PROVIDERS REALLY NEED TWO BAFIN LICENSES?

                      Naturally, also crypto payment service providers have the possibility to outsource the parts of their business that require authorization to a partner that is already authorized for these activities. If the service provider wants to be independent from these kinds of partners, the question arises if the different activities requiring individual authorization can be authorized by one single license with regards to either the German Payment Services Supervision Act (ZAG) or the German Banking Act (KWG). In the context of a single authorization, section 10 para. 1 2nd sentence of the German Payment Services Act (ZAG) might be interesting. This provision allows authorized payment institutions to also provide closely associated ancillary services such as foreign exchange transactions without a generally mandatory KWG license. Licensed payment institutions are therefore authorized to perform foreign exchange transactions in order to execute payment processes in the currency which their client requested even though these transactions are considered proprietary trading and would therefore normally require a separate BaFin authorization. BaFin considers Bitcoin and comparable crypto currencies as units of account. According to section 1 para. 11 no. 7 German Banking Act (KWG), units of account and foreign exchange are both financial instruments. The explanatory memorandum of the German legislator that accompanied the introduction of units of account into the KWG emphasizes that units of account must be comparable to foreign exchange. It could be argued that because of the comparability of foreign exchange and units of account the payment institutions should also be allowed to trade units of account in the same manner as foreign exchange as long as the trading is an ancillary service to a payment service. BaFin has proven to be rather conservative when it comes to these kinds of privileges, even more so when cryptocurrencies are involved. It therefore seems unlikely that BaFin would simply accept the aforementioned argument. It might however be an interesting option for crypto payment providers and should therefore be further discussed.

                      Attorney Lutz Auffenberg, LL.M. (London)

                      I.  https://fin-law.de

                      E. info@fin-law.de

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                        Sep 09, 2019

                        European Market Abuse Regulation – What do STO Issuers Have to Consider?

                        With the introduction of the European Market Abuse Regulation (MAR), which is directly applicable in the member states without transposition, in July of 2016 the regulations for securities trading with regards to insider trading, market manipulation and the publication of insider information are harmonized within the EU. The national capital markets regulations of the member states now only define the competent authority and the specific sanctions for violations of the MAR. Even though there had been a couple of economically successful ICOs prior to the summer of 2016 almost no one thought of the possibility to publicly offer a regulated, blockchain based security, in other words a security token. The goal of almost all ICO issuers until the end of the ICO-hype in spring 2018 was to issue a basically unregulated so-called utility token to avoid all forms of regulation in the form of prospectus and authorization obligations. Nowadays this trend has shifted in favor of regulated STOs. and issuers are exposed to the question to what extend the MAR regulations are applicable to security tokens.

                        WHAT EXACTLY DOES THE MAR REGULATE?

                        The MAR provides standardized regulations within the EU capital markets for financial instruments in order to prevent market manipulations. The strict rules and regulations are supposed to ensure that market price of securities will not be manipulated by e.g. the publication of important but delayed, misleading or even false information about the issuer and his business. The MAR obligates the issuer of securities to publish all information that have the potential to influence the market price of the issued financial product. This kind of information has to be published immediately, the so-called ad-hoc publication. Furthermore, the MAR regulates if and how employees, advisors and other associates that possess intimate or sensitive information about the issuer or the business are allowed to take part in the trading of the issued financial products. Insider trading by one of the aforementioned is obviously also suited to affect the trade rates of the financial product in question. In addition, issuers of MAR regulated financial products as well as operators of authorized trading facilities have to inform the competent authorities of any request regarding the listing or delisting of the financial product with the trading facility in question. The provisions of the MAR are very complex and to a great extent subject to interpretation, which is why the European and national supervising authorities provide extensive interpretive notes regarding the MAR.

                        IS THE MAR APPLICABLE TO SECURITY TOKENS?

                        The application of the MAR to security tokens is generally possible. However only financial instruments that are actually traded at the secondary markets are subject to the MAR regulations. Therefore, only financial instruments that are already traded or that are in the process of being listed at authorized exchanges, multilateral trading facilities or other organized trading systems are subject to the MAR. Security tokens that are solely and directly sold by the emitter to the investor and which are not afterwards traded at exchanges or other public trading places are not subject to the MAR regulations with its extensive publication obligations, restrictions and prohibitions. If an STO emitter wants his tokens to be listed at a public trading venue such as e.g. a crypto exchange, the MAR with its strict obligations can potentially be applicable.

                        Attorney Lutz Auffenberg, LL.M. (London)

                        I.  https://fin-law.de

                        E. info@fin-law.de

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