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Category: blog EN

Apr 29, 2019

Building a Crypto Exchange (Part III) – The Crypto Exchange Bureau

A crypto exchange platform does not always have to be designed comparable to professional stock exchanges for requiring the operator to obtain a BaFin permission. Platforms not automatically matching and executing the buy and sell orders of the users can also be required to acquire a BaFin permission prior to its launch if it is supposed to be accessible for German customers. The requirements of a successful license application in these cases are not necessarily lower than those for a multilateral crypto trading facility. An operator wanting to offer his customers the option to buy and sell cryptocurrencies from and to his own stockpile commercially or to an extent that requires professional structures can be, according to BaFin administrative practice, dealing in financial proprietary trading and is therefore offering financial services being subject to a prior BaFin permission. The key criteria for the classification of a crypto exchange platform as a crypto exchange bureau is that the operator of the platform enters into an agreement with his customers.

WHAT IS FINANCIAL PROPRIETARY TRADING AND WHEN IS AN ACTIVITY QUALIFIED AS SUCH?

Every time that financial instruments are traded for one’s own account it might be a case of financial proprietary trading. To trigger an obligation to obtain a license in accordance to the German Banking Act (KWG), certain further circumstances must accrue. One of these circumstances is e.g. a service character of the activity. If someone offers his customers to sell or buy cryptocurrencies from or to them out of or to his own stockpile as a service, he is operating a crypto exchange bureau. It does not make any difference if this service is offered via the internet or in a local shop. A service of this kind will generally be subject to a BaFin license requirement if financial instruments are traded to the account of the operator and that the offering is a service to the operator’s customers.

CAN PRIVATE TRADING OF CRYPTOCURRENCIES ALSO QUALIFY AS FINANCIAL PROPRIETARY TRADING?

The obligation to obtain a permission from BaFin in accordance to the German Banking Act is only triggered if banking services or financial services are actively offered to German customers and if those services are either offered commercially or to an extent which requires professional structures. Whether this commercial extent is given or not is a case to case decision which is made by BaFin as the competent authority. Generally, such extent can also be reached by private traders of cryptocurrencies. BaFin therefore developed a rule of thumb for financial proprietary trading according to which no approval is needed if the transactions made on average per month do not exceed 25 single transactions, even if the activity qualifies as financial proprietary trading and a license requirement would generally be given. So, whenever someone performs less than 25 trades on monthly average, he generally does not operate a business that would require BaFin’s permission. The final decision if a license is necessary or not always rests with BaFin because individual cases might deviate from the rule of thumb. A close coordination with BaFin is therefore always advisable.

WHAT ARE THE REQUIREMENTS A CRYPTO EXCHANGE BUREAU MUST FULFILL IN ORDER TO OBTAIN A BAFIN LICENSE?

As with other financial services BaFin issues the admission for financial proprietary trading only if the applicant is run by fit and proper managers that are professionally apt. Professional aptitude requires that the manager in question has sufficient theoretical knowledge and practical experience in the area of business in which the applicant wants to operate. If it comes to financial proprietary trading this means that the manager should be experienced in the trading of financial instruments e.g. from working in investment banking. Next to that he or she should have some management experience. A fundamentally solid business plan and budget figures for the first three years of business as well as all the sample contracts and internal manuals that are necessary to run the business are further requirements of the applicant by BaFin. On top of that a minimum starting capital of 730.000 euros has to be shown to BaFin and the applicant needs to be in free disposition of this amount at any time. The requirements for a BaFin license to operate a crypto exchange bureau are therefore relatively substantial. Small businesses only wanting to offer to their customers a limited or entry level access to cryptocurrencies should in most cases refrain from this design option. For companies willing to access the German crypto market with high trading volumes the requirements are manageable and a crypto exchange bureau might be a viable design option.

Attorney Lutz Auffenberg, LL.M. (London)

I.  https://fin-law.de

E. info@fin-law.de

Read more:

Building a Crypto Exchange (Part I) – What are the Regulatory Design Possibilities?

Building a Crypto Exchange (Part II) – The Multilateral Crypto Trading Facility

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    Apr 15, 2019

    STO Without Prospectus – What Are the Possibilities?


    Security tokens are blockchain tokens that are issued via smart contracts and that grant to their owner certain monetary rights like e.g. an interest rate or a participation right on the issuing companies’ profit. In this respect the security token differs from the utility token which grants its holder access to or benefits within the issuers’ business model and the currency token which in general is just an alternative means of payment and grants to the token holder no rights vis-à-vis the issuer at all. Within the German jurisdiction and therefore in all cases where German investors are targeted by the token issuing company as potential investors, BaFin will generally qualify the security token as a security if the token is tradable without restrictions and therefore is fungible and fits for capital markets. To those tokens the German Securities Prospectus Act and the EU Prospectus Directive are applicable. The public offering of these tokens in Germany can therefore only take place if the emitter has a securities prospectus created, approved by BaFin and published prior to the public offering.

    LEGAL EXEMPTIONS FOR BIG TICKETS AND SMALL OFFERINGS

    The obligation to publish a securities prospectus is generally in effect when offering a security token but there are exemptions. The German Securities Prospectus Act provides a couple of legal exemptions that lift the obligation to create a prospectus in certain cases from the emitter of security tokens. A security token offering that exclusively targets qualified and professional or institutional investors is subject to such an exemption. Likewise, emitters offering their security token either to not more than 150 non-qualified private investors within the European Economic Area or only allow minimum investments of 100.000 euros from each individual investor also do not need to create a prospectus for their security tokens. Banks and Emitters whose shares are already publicly traded are also exempted.

    PRIVATE PLACEMENT OF SECURITY TOKEN WITHOUT A SECURITY PROSPECTUS

    The obligation for emitters of securities respectively security tokens to create and publish an approved prospectus only applies when publicly offering the security or the security token. In case of offering those products exclusively to family and friends or to investors to whom a business relation had already been established before the offering, the creation and approval of a prospectus is unnecessary. When it comes to security token offerings this method may primarily be useful in the context of a presale to the actual token offering because through a private offering no new investors can be acquired. On the other hand, this possibility can be useful to finance and market the STO main sale if the issuer has a financially strong network that is willing to invest in his project

    STO WITH A VOLUME OF UP TO 8 MILLION EURO WITH AN INFORMATION SHEET INSTEAD OF A PROSPECTUS

    Another interesting exemption from the obligation to create a prospectus for a security token offering can be employed by emitters of STOs with a hard cap of 8 million Euro. For these types of STOs the emitter does not have to draft a full securities prospectus but rather an information sheet that includes information regarding the emitter, the security token to be offered and the risks associated with the investment. If the issuer wants to procure capital of in between one and up to 8 million euros, the token sale has to be performed by a BaFin licensed investment intermediary or a BaFin licensed investment advisor. The BaFin licensed sales company has to ensure that private investors with an average wealth profile do not invest more than 1,000 euros and that wealthy private investors do not invest more than 10.000 euros maximum if their financial situation allows it. The review of the financial situation of the individual investor and the determination of the maximum sum that he can invest is the responsibility of the BaFin licensed sales company. If the hard cap of the STO is less than one million euros, the STO can be conducted without a BaFin licensed distribution partner. This funding method can be a viable alternative to the classical sale of company shares for startups in the early business stages.

    Attorney Lutz Auffenberg, LL.M. (London)

    I.  https://fin-law.de

    E. info@fin-law.de

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      Building a Crypto Exchange (Part II) – The Multilateral Crypto Trading Facility

      Bitcoins and comparable cryptocurrencies are, according to BaFin, classified as financial instruments as defined in the German Banking Act (KWG). Therefore, a BaFin license is a mandatory prerequisite for operating a crypto exchange in Germany. What are the requirements to fulfil in order to obtain such license and what are the conceptual design options for companies to tailor a crypto exchange to their needs while matching the aforementioned requirements? The second part of FIN LAW´s blog series “Building a Crypto Exchange” tackles multilateral crypto trading facilities, shows essential features of this kind of crypto exchange as well as the most important requirements to legally operate such a facility in Germany.

      WHAT IS A MULTILATERAL CRYPTO TRADING FACILITY?

      According to the German Banking Act, the operation of a multilateral trading facility in Germany is a financial service that requires prior approval from BaFin. A multilateral trading facility is legally defined as a multilateral system that brings together its users buying and selling interests in financial instruments within the system and in accordance with preset, non-discretionary rules in a way that leads to a sales contract between the users. If the only tradable financial instruments in such a system are cryptocurrencies, it’s a multilateral crypto trading facility. The key difference between this type of crypto exchange and others is the anonymity of the paired users. The actual matchmaking and execution of the buy and sell orders between the users on these types of exchanges happens anonymously and automatically by the system itself. The users of a multilateral crypto trading facility do therefore not know with whom they are trading cryptocurrencies. The transfer of coins to the buyer and the transfer of the acquisition price to the seller are also automatically executed by the system, so the users need a sufficient balance of cryptocurrencies or fiat currency with the operator when placing a buy or sell order.

      WHAT ARE THE FINANCIAL MEANS NECESSARY TO ACQUIRE A BAFIN LICENSE?

      The granting of the license to operate a multilateral crypto trading facility depends on a multitude of requirements that have to be matched. The exact requirements depend on the details of the individual case. These details should therefore be diligently reviewed and defined prior to the license application. If the operator of the crypto exchange will not be entitled to hold customer funds or customer securities himself a starting capital of at least 50.000 euros has to be proven in the license application to BaFin. Otherwise a starting capital of 125.000 euros is the minimum. If the operator additionally wants to trade financial instruments on his own account and for own interests – in this case cryptocurrencies- the minimum starting capital is at least 730.000 euros. In order to keep the starting capital low a cooperation with a licensed bank for payment processing is often advisable.

      WHAT ARE THE REQUIREMENTS FOR THE EXECUTIVES OF THE CRYPTO EXCHANGE?

      The managers of a multilateral crypto trading facility need to be fit and proper. They should, if possible, have relevant and appropriate working experience in a managing position in a comparable project or company. They need to have the theoretical and practical abilities to lead a multilateral crypto trading facility. The needed reliability to manage such a project may be compromised if the manager has a previous criminal conviction or a negative entry into the commercial register. This kind of reliability is also required from every shareholder holding more than 10% of the company. Moreover, BaFin expects the managers to be sufficiently available so that they can manage the crypto exchange in a diligent and prudent way.

      WHAT OTHER DOCUMENTS ARE NECESSARY FOR A BAFIN LICENSE?

      A successful application requires the applicant to submit a viable business plan that not only shows the financial planning of the project for the next three years but also detailed information regarding internal control and monitoring procedures to fulfil regulatory obligations such as anti-money laundering prevention, IT-security and basic risk management. The owners and the managers need to submit CV´s, clearance certificates and a multitude of other documents to BaFin. Furthermore, the most important contracts as well as the terms and conditions and the cooperation contracts should be submitted if possible. Depending on the individual design of the multilateral crypto trading facility and the owners and designated managers, further documents and statements might be necessary to submit. A diligent planning of the whole project ahead of time is therefore absolutely necessary.

      DIFFERENCES IN CONTRAST TO CLASSICAL MULTILATERAL TRADING FACILITIES

      The stated requirements also have to be fulfilled by applicants wanting to operate a multilateral trading facility for other financial instruments than Bitcoin and other cryptocurrencies. Multilateral crypto trading facilities have the regulatory advantage that the strict provisions which are applicable to securities trading are inapplicable to units of account and therefore to Bitcoins and comparable cryptocurrencies. As long as the listed cryptocurrencies on the crypto exchange do not qualify as security tokens or other financial instruments according to the second EU Directive on Markets in Financial Instruments (MiFID II) but are rather qualified as units of account, the securities regulations as for example the German Securities Trading Act (WpHG) are not applicable to multilateral crypto trading facilities. Therefore, classical multilateral trading facilities are prohibited to allow private investors to trade on their platform whereas multilateral crypto trading facilities are not prohibited to do so.

      Attorney Lutz Auffenberg, LL.M. (London)

      I.  https://fin-law.de

      E. info@fin-law.de

      Read more:

      Building a Crypro Echange (Part I) – What are the regulatory Design Possibilities?

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        Apr 08, 2019

        Valid Transfer Mechanism for Security Tokens

        Besides of the regulatory qualification of security tokens as security, shares in investment funds or alternative investment assets quite a number of private law issues are raised when conducting securities token offerings. The most prominent pitfall when it comes to private law and security tokens is the fact that the German Civil Code BGB in its current form does not foresee electronic debt securities so far. Classical securities which must be freely tradable at the capital markets are therefore still issued in paper form in traditional manner so they are tangible assets that can be subject to property rights and be acquired on the secondary markets in good faith and free from encumbrances. Tangible assets however in German private law are only physical objects. For security tokens, being not more than virtual information in a smart contract on a blockchain, a different legal construction for transfer must be found. The only suitable alternative is probably a cession of the obligation represented by the security token by which the obligation against the emitter can be transferred to the acquirer of the security token. In this case however it must be made sure that the obligation will strictly be tied to the token because otherwise a separation of the token and the obligation and a confusion on the markets may happen.

        LEGAL CONSTRUCTION OF TRANSFER IS CRUCIAL FOR CAPITAL MARKETS ELIGIBILITY

        The necessity of a valid construction of the transfer of a security token is not at all only an academic problem. As the unlimited fungibility of a security token and therefore its’ eligibility for the capital markets can only be given, if the acquirer of the security token can be sure that he has not only acquired the token but also the obligation against the STO emitter. In case the token and the obligation can get separated, such security tokens being traded at the capital markets will not be standardized anymore. In such case the eligibility of the security token to the capital markets would have to be declined because the acquirer of such token could not be sure whether he has acquired only the bare token but also the obligation against the STO emitter. In addition to that, such token could not be qualified as a security from a regulatory law perspective. The token could at best be qualified as an investment asset according to the German Investment Asset Act (Vermögensanlagengesetz) as these instruments characterize by their limited fungibility in comparison to securities.

        SECURITY TOKEN TERMS SHOULD EXPLICITLY SET OUT RULES FOR THE TRANSFER MECHANISM

        With regard to the massive legal consequences that may occur in case of non-existent rules for the legal transfer of the security token, the security token terms should set out a clear legal mechanism for the initial acquisition of the security token during the STO as well as for the secondary acquisition after the STO. The security token terms should definitely regulate, how exactly the obligation of the STO emitter to repay the investment and/or the payment of interests will be transferred to the acquirer of the security token in case of a secondary acquisition. It is of utmost importance that these rules factor the technical peculiarities of the blockchain technology and of smart contracts to make sure that the security token and the associated obligation can never be separated. The legal conception of a security token therefore differs fundamentally from the legal conception of classical securities’ terms and requires a profound consideration of the peculiarities of blockchain technology and technical knowledge. FIN LAW combines the necessary technical understanding and the regulatory expertise and is therefore the right legal partner for security token offerings.

        Rechtsanwalt Lutz Auffenberg, LL.M. (London)

        I.  https://fin-law.de

        E. info@fin-law.de

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          Apr 01, 2019

          Building a Crypto Exchange (Part I) – What are the Regulatory Design Possibilities?

          Since BaFin qualifies Bitcoins and comparable cryptocurrencies as financial instruments, the operating of a crypto exchange requires the operator to be BaFin licensed. But what are the requirements to fulfill in order to acquire such license and what are the conceptual design options that businesses have for meeting these requirements while at the same time tailoring their exchange to the performance of their business? The first part of FIN LAW´s “Building a Crypto Exchange” blog series discusses the three major possibilities for regulatory designs of crypto exchanges in Germany. In the upcoming weeks the follow-up blogs will go into greater detail regarding the regulatory prerequisites for obtaining the above-mentioned licenses.

          ACTIVE ADVERTISING TO GERMAN CUSTOMERS REQUIRES BAFIN LICENSE

          A common misconception is that BaFin is only competent for exchanges that are registered in Germany. In reality, BaFin, as the German financial watchdog, is also the competent supervisory authority for all crypto exchanges that act from outside of Germany but actively target German markets and customers. The authority interprets its competence very broad and intervenes e.g. in case a service provider operates a German website, hosts roadshows in Germany or gives interviews in German magazines presenting the businesses’ services to the German public.

          1. VARIANT: THE MULTILATERAL CRYPTO TRADING FACILITY

          The most common way of running a crypto exchange outside of Germany is to operate trading platforms that work by an automated matchmaking system pairing the users’ buy and sell orders. Characteristic for these exchanges is that the matchmaking process does not reveal the parties’ identities which is why they do not know who they enter into an agreement with. The German Banking Act (KWG) defines a multilateral trading facility as a system that brings together two parties’ buying and selling interests in financial instruments within the system and in accordance with preset, non-discretionary rules in a way that leads to a sales contract between the two parties. The execution, meaning the transfer of coins or tokens to the buyer and the transfer of the acquisition price to the seller, is processed automatically by the operator of the facility. The users therefore must at all times dispose of a sufficient balance of cryptocurrency respectively fiat currency with the operator of the trading facility so that the trade can be settled.

          2. VARIANT: THE CRYPTO EXCHANGE BUREAU

          A comparatively easy way to design a crypto exchange is the sale of cryptocurrencies from the operators’ own stockpile. In this case the operator of the exchange becomes the contracting partner of the customer and owes him fulfillment of the contract meaning either the transfer of cryptocurrencies to the customer in exchange for fiat money or vice versa. From a regulatory point of view this constitutes either proprietary trading or a financial commission business. A financial commission business can be given if the operator only buys or sells the cryptocurrency in question from or to the international markets on basis of a customer’s order.

          3. VARIANT: THE CRYPTO BROKER

          A version of a crypto exchange already tested in Germany is the crypto broker design. Users of these exchanges can issue offers to buy or sell cryptocurrencies via the platform. The users then interact and enter into contracts with each other directly. The operators of these exchanges are not contractual partners of the customers but rather act as an intermediary to them bringing together the potential contractual partners. In contrast to the multilateral crypto trading facility the users know the identity of their contractual partner in this version of a crypto exchange.

          LISTED CRYPTOCURRENCIES INFLUENCE THE REGULATORY REQUIREMENTS AS WEL

          Additionally, the nature of the listed cryptocurrencies on the exchange influences the regulatory requirements that have to be met. Generally spoken, the requirements tend to be lower if the exchange lists “classic” cryptocurrencies such as Bitcoin or Litecoin and they get higher if the exchange lists e.g. security tokens.

          The regulatory conception of crypto exchanges is complex and any detail can potentially influence the requirements that have to be met. A competent legal advisory is therefore the basis of every successful project. In the upcoming weeks FIN LAW will publish further parts of the blog series “Building a Crypto Exchange” illustrating the supervisory details of the specific variants of crypto exchanges.

          Attorney Lutz Auffenberg, LL.M. (London)

          I.  https://fin-law.de

          E. info@fin-law.de

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            Mar 25, 2019

            What are the Regulatory Requirements for Operation in Germany?

            Probably one of the oldest Bitcoin based business models since Bitcoin became popular is the operating of Bitcoin ATMs. ATM is the abbreviation for Automated Teller Machine while a Bitcoin ATM is a machine that changes Bitcoin into bank money and vice versa. In other European countries like Austria, Switzerland or the Netherlands Bitcoin ATMs can be operated without the need to fulfil any specific regulatory requirements. In contrast to that in Germany a prior approval from BaFin (German Federal Financial Supervisory Authority) is necessary in order to operate such machines. But what exactly is the subject of approval and what are the requirements which must be fulfilled to obtain a BaFin permission for operation of a Bitcoin ATM?

            BITCOINS ARE CONSIDERED FINANCIAL INSTRUMENTS IN GERMANY

            To a great extent, the financial regulations are harmonized within the European Union. In regard to Bitcoin and comparable cryptocurrencies there are some points that differ from member state to member state and that have to be kept in mind. In the Federal Banking Act (KWG) the German legislator chose to not only qualify the instruments listed in the second Markets in Financial Instruments Directive (MiFID II) but additionally units of account as financial instruments. Examples for units of account are the euro’s predecessor European Currency Unit (ECU), the special drawing rights of the International Monetary Fund or Goldfranken which were formerly used in the international post and transportation industry. BaFin also qualifies Bitcoin and comparable cryptocurrencies as units of account and accordingly as financial instruments as defined in the Federal Banking Act (KWG). Even though the qualification for Bitcoin as a unit of account has been ruled unlawful by the Berlin Court of Appeal in a criminal judgement dated 25 September 2018, BaFin holds on to the qualification and argues that a criminal judgement has no binding effect for a supervisory authority like BaFin. As long as the administrative courts that are competent for BaFin’s administrative practices do not confirm the legal opinion of the Berlin Court of Appeal, Bitcoins must be considered units of account and therefore as financial instruments in the sense of the Federal Banking Act and therefore the license requirements set out in the Federal Banking Act are applicable to all Bitcoin related businesses as well.

            WHICH ACTIVITIES MUST BE PERMITTED BY BAFIN FOR THE OPERATION OF BITCOIN ATMS?

            Providing a Bitcoin ATM service means that on the customers’ demand Bitcoins get transferred from a wallet owned by the operator to a wallet that is owned by the customer in exchange for a payment in fiat currency or vice versa. Simply put, a Bitcoin ATM can be seen as an automated exchange office for Bitcoins. Acquiring or selling financial instruments as a service for customers from an own stockpile in a commercial extent is considered as proprietary trading. The service provider must therefore obtain a permission from BaFin in accordance to the German Banking Act (KWG). If those financial instruments are not delivered from the operators’ stockpile but are purchased by the operator on behalf and on account of the customer before delivery to the customer, the operator is required to be licensed for financial commission business by BaFin in advance.

            WHAT ARE THE REQUIREMENTS THAT NEED TO BE FULFILLED TO OBTAIN A BAFIN LICENSE?

            A successful BaFin application for proprietary trading and/or financial commission business requires the applicant (the Bitcoin ATM operator) to have a starting capital of at least 730.000 euros at his disposal. Furthermore, BaFin requires the directors of the company to be fit and proper and – if possible but that is not a necessity – to have experience in the fields of proprietary trading respectively financial commission business. For a successful application a sustainable business plan with key figure estimates for the first three business years, a comprehensive description of the planed compliance processes and internal monitoring and controlling procedures as well as detailed information on the key shareholders of the operating company must be shown to BaFin.

            FIN LAW supports its clients with the preparation of BaFin license applications and specializes in the legal specifics of business models that are related to cryptocurrencies.

            Attorney Lutz Auffenberg, LL.M. (London)

            I.  https://fin-law.de

            E. info@fin-law.de

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              Mar 18, 2019

              E-Money on a Blockchain: What Serives can a Cypto E-Money Institution Offer?

              Blockchain tokens that are issued by the emitter in exchange for money and that can be exchanged back to a legal tender and that are accepted as a means of payment by others than the issuer can be e-money from a regulatory perspective. But what are the advantages of blockchain based e-money and who would be legally allowed to provide it?

              Who would be Allowed to Offer Blockchain Based E-Money?

              Within the European Union the issuing of e-money requires the emitter to be licensed as an e-money institution. These licenses are issued by the banking regulator of the country in which the service is originally provided. Once the license is acquired in one of the EU-countries it can then be “exported” via the so called EU-Passporting process and be used in all the other EU member states without the need of another approval and licensing process. The EU-Passporting procedure is a relatively simple notification process that is initiated by the banking regulator of the originally licensing member state upon application of the e-money institution. Next to licensed e-money institutions banks with a full banking license and certain government institutions are also allowed to issue e-money.

              What are the Advantages of Crypto Based E-Money?

              The most exiting feature of blockchain based e-money would be that fully digitalized units of value could be transferred directly between the users. The physical handover of an electronic or magnetic data carrier from the buyer to the seller would be as obsolete as the involvement of the issuing e-money institution in the transaction. Documentation and confirmation of transactions would be processed on the blockchain itself. The double spending problem would not occur with blockchain based e-money because the ownership of a value unit would be forgery-proof documented within the blockchain itself and therefore blockchain based e-money could circulate fully automated and digitally.

              What Services would Crypto E-Money Institutions be Allowed to Offer?

              E-Money institutions are not limited to the issuing and re-exchange of e-money. The permission to issue e-money and conduct an exchange business with it additionally enables e-money institutions to provide other interesting activities which usually require a separate permission. Next to the e-money business a crypto e-money institute could additionally offer e.g. fiat payment accounts and money remittance. Furthermore, licensed crypto e-money institutions could, within strict regulations and boundaries, even grant credits to customers, as long as the credit is related to a payment process. Even foreign exchange transactions would be possible, as long as they are related to the e-money business of the company.

              What are the Requirements for an E-Money Institute to Get BaFin Approved?

              As shown above blockchain based e-money institutes could have access to numerus business models that can connect traditional payment activities with the crypto world. But there are also regulatory requirements that have to be fulfilled in order to acquire the necessary e-money license. To name a few, a sustainable business model, sufficient and adequate security precautions, two fit and proper directors and at least 350.000 euros as starting capital will have to be shown to BaFin. FIN LAW supports its clients from the project planning phase to the preparation and submission of the license application and represents them vis-a-vis BaFin in the permission process.

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

              I.  https://fin-law.de

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                Mar 10, 2019

                How Should a Security Token be Legally Designed?

                Since a few weeks the German crypto community celebrates the first BaFin approved securities prospectus, being fully compliant with German regulatory laws and statues. With this approval BaFin really displayed an innovative and progressive attitude towards blockchain based funding methods. At least three more STO prospectuses are currently awaiting BaFin’s approval and more will follow. The security token now being offered through the first approved STO prospectus is legally designed as a registered bond and therefore, according to German capital markets regulatory law as an asset investment. Nevertheless, BaFin categorizes the token as a security and not as an asset investment. This stems from the legal view of the BaFin that because the registered bond is embodied in the (transferable) token it is tradable just like a security. But what should be the legal design of a security token from the issuer’s perspective so that the Security Token Offering can be conducted without any problems?

                The Administrative Practice of BaFin Regarding Blockchain Tokens.

                On the 20st of February 2018 BaFin pointed out that tokens having been issued via an Initial Coin Offering, depending on the actual token design, may classify as either securities as defined in the German Securities Trading Act (WpHG) or an asset investment as defined in the German Asset Investment Act (VermAnlG) or even as shares of a investment fund as defined in the German Capital Investment Code (KAGB). According to BaFin, this regulatory qualification cannot be generalized but instead has to be considered on a case to case basis. For a token’s classification as security the following four criteria have to be fulfilled: (1) The token is not meant to be a mere means of payment, (2) it embodies corporate and/or participation rights, (3) it must be transferable and (4) it must be tradable on the financial or capital markets. BaFin actually considers crypto exchanges as financial markets in this sense. A token can be classified as a share of an investment fund as defined in the KAGB if it represents a share of an entity that makes collective investments for a number of investors. If a token neither qualifies as a security nor as a share of an investment fund while granting patrimonial rights to the investor it will most likely be classified as an asset investment. In 2012 the German legislator passed the Asset Investment Act with the intention to regulate those capital market products that where neither a security nor a share of an investment fund and therefore were at that time unregulated. All three of those regulatory regimes differ from each other and the creation and approval processes for creating prospectuses and further legal documents for their public offering have different prerequisites.

                Security Tokens have to be Designed Coherently in regards to Supervisory Law as well as Private Law

                A risk for emitters of security tokens lies in the fact that the approval of the prospectus is granted by BaFin, being an administrative authority while claims that arise from a missing or wrong prospectus in the form of prospectus liabilities are decided by civil courts. Due to the principal of separation of powers the civil courts are not legally bound to the classification decision of BaFin regarding the legal nature of a token. They will assess if a token is a security, an asset investment or a share of a capital fund themselves on basis of the law. It therefore is possible that a civil court might qualify a token as an asset investment while BaFin qualified the same token as a security. That might lead the deciding court to the conclusion that a required asset investment prospectus has not been published by the emitter. For the issuer of an STO this poses a major liability risk. The consequences of a missing prospectus are usually that the emitter has to refund the original investment to the investor plus any transaction fees. In return the emitter will get back the tokens . The legal conception of a security token therefore must be designed with the highest diligence and professional competence. FIN LAW specializes in the legal conception of Security Token Offerings and offers its clients the highest advisory quality in all relevant legal aspects.

                Attorney Lutz Auffenberg, LL.M. (London)

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                E. info@fin-law.de

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                  Mar 04, 2019

                  Security Token Offering vs. Initial Public Offering – Are STOs a Real Alternative to the Conventional Issuing of Securities?


                  After the end of the crypto-hype in February 2018, initial coin offerings (ICOs) in general do not accumulate as much capital anymore as before. The exchange prices of the tokens decreased in many cases and ICO investors more often than not had to come to the conclusion that the business ideas in which they had invested did not turn out the way they expected. In some cases, the regulators even investigated the ICO issuers because they lacked a prospectus which the regulators deemed necessary.

                  ICO as a New Way to Procure Funds from the Capital Markets

                  Initial Coin Offerings have been established in the last couple of years as a new, innovative and, most importantly, digital way of corporate financing. While this method was at first primarily used to finance and advance the development of new blockchain technologies like Ethereum or IOTA, soon other startup companies within the blockchain community realized the potential of this new funding instrument. In 2017 at the latest, even numerous non-blockchain related projects and companies started to gather funds this way. The tokens that where offered through these ICOs differed a lot from each other in terms of applicability and attached rights. Next to tokens that were simply designed to be an alternative means of payment (currency token) there were also tokens having a voucher function within the business model of the issuer (utility token) and tokens granting participation rights and a return on investment right (security token). This variety of tokens led to the involvement of the international regulatory authorities which since then have to find an answer to the question if and to what extend the existing capital markets laws and regulations are applicable to ICOs.

                  What Remains of the Hype – are ICOs a Failure?

                  If we take a closer look at the tokens offered during the ICO-hype, it quickly becomes clear that investors cannot have the sustainable and lasting economic interest that is essential for any capital markets asset class in neither currency tokens nor in utility tokens. These products can only trigger the interest of investors during a hype phase. Security tokens which are equipped with a profit-sharing mechanism, a return on investment and in some cases even with a repayment claim or the option of converting tokens to shares of the issuing company on the other hand differ from traditional securities primarily in technical aspects. The blockchain technology is only used in this case as a vehicle for already established capital markets products. This is also the approach of BaFin when it comes to the aforementioned question if capital markets law is applicable to STOs. BaFin answers this question with the principle “same business, same risk, same rules”. If emitters of security tokens abide these rules, STOs might be an interesting alternative to traditional issuing methods for securities.

                  What are the Advantages of STOs over Traditional Security Issuings?

                  The decision for a security token offering will only be made if it is sensible for the emitter from an economic point of view. The during the hype of 2018 spread argument that ICOs are unregulated and therefore cheaper than traditional security offerings is obviously false if the emitters of both products have to abide by the same rules and regulations. In both cases the issuer must create a prospectus and undergo a BaFin approval process.

                  The real advantages of STOs are not to be found within the regulatory regime which is applicable to them but in the underlying blockchain technology. Security tokens can be stored in the purchaser’s own wallet, potentially sparing out custodian banks that are necessary with traditional, paper-based securities. The rate of return or any other financial contribution can – if promised beforehand – be made directly and automated via smart contract to the token holder. This also applies to repayment claims. Furthermore, due to the documentation of all transactions within the blockchain itself, every transaction is potentially transparent to the issuer and, if need be, to the supervising authorities.

                  These advantages offer real value over traditional security emissions. STOs can therefore become a viable alternative to emit securities to the capital markets in a short to medium timeframe. Therefore, not only legal expertise in capital markets law but also a fundamental and sound knowledge of the functionality of the blockchain technology is an absolute must for a successful security token offering. FIN LAW offers both and supports its clients with the legal conception of the security token as well as with the coordination with BaFin and the creation of all necessary legal documents.

                  Attorney Lutz Auffenberg, LL.M. (London)

                  I.  https://fin-law.de

                  E. info@fin-law.de

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                    Feb 25, 2019

                    E-money on a Blockchain?

                    Most publications covering cryptocurrencies and e-money come to the conclusion that Bitcoins cannot be classified as e-money in the sense of the German Payment Services Act (ZAG) because of the fact that there is no emitter who issued the coins in the first place while such emitter is a prerequisite to the e-money definition according to sec. 1 para. 2 sentence 3 ZAG. Even though due to this argument Bitcoins cannot be qualified as e-money question remains if blockchain based e-money is a regulatory option for providers at all or if this technology is in fact not useable in connection with e-money solutions.

                    What Exactly is E-money?

                    E-money as defined in sec. 1 para. 2 sentence 3 of the ZAG is every electronically, including magnetically stored monetary value as represented by a claim against the issuer which is issued on receipt of funds for the purpose of making payment transactions, and which is accepted by a natural or legal person other than the electronic money issuer. This definition is talen from the Directive 2009/110/EC of the European Parliament and Council of 16 September 2009 and was incorporated by the German legislator word by word into the Payment Services Act (ZAG). Bitcoin and for example Ether are not issued by an issuer but instead “mined” at the expense of computing power and then distributed by the “miners” themselves. These cryptocurrencies also cannot be considered a claim on a certain issuer because, in contrast to a claim that can only be enforced on the obligor of that claim, these cryptocurrencies embody something of value for everyone willing to accept them. The aforementioned publications and their conclusion seem to be correct in general. There should be no doubt that Bitcoins, Litecoins and Ether are in fact no e-money.

                    Are Blockchain Token the E-Money of the Future?

                    Is the aforementioned qualification of certain cryptocurrencies as not being E-Money valid for all blockchain based payment systems? How about tokens that have been created via smart contract onto the Ethereum blockchain (e.g. ERC-20, ERC-223 tokens) and that cannot be mined because there is a predetermined quantity of them? In these cases, the argument that there is no emitter does not hold true. Instead, whoever programed the smart contract and therefore the tokens is the emitter of it. The same would be true in the case that a completely new blockchain were to be created if its units (coins) were transferable and associated with a claim to change the token into fiat at a preset price against the creator. This shows that the arguments that are made against certain cryptocurrencies as e-money are not transferable offhandedly to all blockchain based e-money solutions.

                    What are the Advantages of Blockchain Based E-money?

                    As shown above, from a regulatory point of view there are indeed ways to base an e-money system on a blockchain. The advantages of such a system for the issuing e-money institutions are obvious. The transactions of the e-money product would only take seconds, international transfers would not be limited by national boarders and the transactions would not need the original issuer to be included in the process to take place. At the same time the blockchain would provide an unforgeable and gapless transaction record which allows the issuing e-money institution to substantially lower its administrative efforts and thereby reduce costs. FIN LAW, due to its experience and expertise in blockchain related BaFin processes is the competent partner for issuers of legally sound blockchain based e-money.

                    Attorney Lutz Auffenberg, LL.M. (London)

                    I.  https://fin-law.de

                    E. info@fin-law.de

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                      Feb 13, 2019

                      Interview with Lutz Auffenberg on #STOinGermany


                      Geekforge Academy interviewed Atty. Lutz Auffenberg, LL.M. as german legal expert on the proper legal and regulatory drafting of #SecurityTokenOffering under German law. The full interview is available here:

                      https://medium.com/geekforge-academy/sto-registration-procedures-in-germany-e9b6954936ab
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