Blockchain has been subject to much discussion recently because of the wide remit of potential applications of the technology and its potential to change the financial industry as we know it. Naturally, this hasn’t gone unnoticed and regulators around the globe are trying to catch up with the phenomena. This report looks at the current regulatory situation in Germany and gives an overview of the views of the German regulator on the topic.
Early in 2014, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, “BaFin”) published an assessment on Bitcoin and an overview of the risks to which users of this and other cybercurrencies may be exposed.
BaFin has classified Bitcoin with legally binding effect as financial instruments in accordance with the German Banking Act (Kreditwesengesetz – KWG). These are units similar to foreign currencies and not of legal tender. They include value units having the function of private means of payment in barter transactions, as well as any other substitute currency used by virtue of private-law agreements as a means of payment in multilateral settlement accounts. This makes a central issuer obsolete.
Bitcoin are however not e-money in accordance with the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz – ZAG) because there is no issuer establishing claims against himself by issuing Bitcoin. This is different for digital currencies, which are based on a central agent (e.g. Liberty Reserve, the former Costa Rica based centralized digital currency, which was shut down by the U.S. government). Bitcoin are not legal tender either, and therefore qualify neither as foreign currency nor as foreign banknotes and coins.
Commercial use without authorization of Bitcoin could constitute a criminal offence (section 54 KWG), which could result in a term of imprisonment not exceeding three years or by a fine. The mere use of Bitcoin though as a substitute currency for cash or scriptural money in currencies of legal tender to participate in the economy through exchange transactions is not an activity subject to authorisation. The provider may have his services paid with Bitcoin without thereby providing banking transactions or financial services. The same holds true for the customer. Likewise, mining Bitcoin per se does not constitute a transaction subject to authorisation since the miner does not issue or place the Bitcoin himself. Neither is the sale of mined or acquired Bitcoin or their purchase generally subject to authorisation.
However, an authorisation requirement may arise from additional circumstances. This applies where it is not only the case that Bitcoin are mined, purchased or sold to participate in an existing market but in addition a special contribution is paid to create or preserve such market. This then qualifies as proprietary trading subject to authorisation (section 1 (1a) no. 4 KWG) because of the additional service providing element. This is e.g. the case if persons advertise on the market that they regularly purchase and sell Bitcoin. Another example is mining pools commercially sharing profit from mined and sold Bitcoin in return for computing power provided by the user.
If Bitcoin themselves become the article of trade, several authorisation elements may be satisfied, notably principal broking services (section 1 (1) sentence 2 no. 4 KWG), the multilateral trading system, investment and contract broking, as well as proprietary trading already described above (section 1 (1a) sentence 2 nos. 1 to 4 KWG).
Commercial trading in Bitcoin so far has essentially been transacted through Bitcoin exchanges. Under these terms, the media have lumped together many different business models, but where the question of an authorisation requirement is concerned, a differentiation has to be made in terms of technical implementation and the respective terms of the contracts and transactions.
BaFin differenciates between Bitcoin platforms as conducting principal broking services and the operation of a multilateral trading system. With regard to the first, the elements of a principal broking service subject to an authorisation requirement are therefore satisfied if:
- the individual participants have power to issue instructions to the platforms up to the time of execution of the order by specifying the quantity and price of the transactions;
- the respective participants do not know their trading partners and the BTC platform acts not as representative of the participants but in its own name;
- the economic advantages and disadvantages of the transactions are carried by the participants who wire cash to platform accounts or transfer BTC to their accounts; and
- the BTC platform is required to render account to the participants on the execution of the transactions and to transfer purchased BTC.
Multilateral trading system bring together multiple third-party buying and selling interests in financial instruments within the system and in accordance with pre-defined provisions in a way that results in a contract in respect of the financial instruments. In the case of Bitcoin platforms it means that there is a framework on membership, on Bitcoin trading between the members and on reports of concluded transactions. A trading platform in the technical sense is not required and multilateral means that the operator brings together only the parties of a potential transaction for multilateral trading system.
Offering regionally structured commercial web lists consisting of persons who buy or sell multilateral trading system at their place of residence qualifies as investment and contract broking. Providers who act as “currency exchange offices”, exchanging currencies of legal tender directly into multilateral trading system, satisfy the elements of proprietary trading. In the past, it was often not described or not described clearly how exactly multilateral trading system platforms work, and there were frequently no general terms and conditions either.
The authorisation requirement is generally a legally complex question and BaFin advises potential providers to obtain an assessment from the regulator of their planned business activity well in advance to clarify whether it is subject to supervision.
Lastly, BaFIN pointed out in its assessment that Bitcoin hold risks for companies and consumers. Although these risks are not new on the financial market per se, they are being increasingly encountered there given the specific structure of Bitcoin, mainly the risk of loss and theft, rising costs for transactions and the fluctuations in their value
BaFin therefore advised that every potential user must carefully assess the network together with its opportunities and risks. Users have to assume responsibility themselves through their selection of clients and regular participation in the network. The network is not subject to any central supervision or regulation by government authorities. For such decentralised network this is not feasible.
One has to bear in mind that this reflects a regulatory view of the Blockchain and cybercurrencies that is two years old and may not have benefitted from having fully appreciated the potential and development of the technology that has happened since. BaFin acknowledged that to an extent by setting up an internal project group on the topic of FinTech in November last year and has published an update on blockchain and distributed ledger technology recently (see post). Unfortunately, the report merely describes the technology in more detail and doesn’t provide any news from a regulatory perspective. BaFin reported though that it is monitoring the latest developments in the FinTech industry very closely and is engaged in discussions related to distributed ledger technology with other supervisory authorities. The authority further stated it is also actively in contact with experts and market participants for the purposes of identifying any potential supervisory problems, so we can assume that regulation in some form is probably around the corner.
However, with Germany the second biggest market for FinTech VC investments, traditional financial institutions like Deutsche Bank or the German exchange Deutsche Börse show an increasing interest in the technology and how it could be used to change the landscape of financial services in Germany. No wonder BaFin is trying to keep a close eye…