The regulatory mess of German crypto regulation and what banks need to be mindful of now

New rules for Crypto risk assessments that will make German banks even more reluctant to work with cryptocurrencies, a court decision that puts the entire current legal framework into question and the wait for a European solution that will give the industry a framework in which it can fulfil its potential. The German crypto sector is in upheaval, as the future looks grim in Europe’s largest economy for the token industry. Planet Compliance looks in detail at the current events and explains the consequences.

Clear as mud

Yesterday, the German financial regulator BaFin (“Bundesanstalt für Finanzdienstleistungsaufsicht)“ published a draft circular in respect of proposed obligations for German financial institutions when dealing with virtual currencies aka cryptocurrencies. The reason of this publication is to gather feedback from the financial industry on how it should proceed regarding the appropriate and risk-based supervision of cryptocurrencies in particular in view of money laundering and terrorism financing.

AML 5, please

As a reminder, the European Union has published its 5th AML Directive in June. One of its key amendments to the existing rules is the extension of the AML regime to additional service providers such as electronic wallet providers, virtual currency exchange service providers, and a few other people. The Directive seems to have prompted BaFin to clarify a few things that the financial watchdog believes should be considered in the context of risk assessments of dealing with virtual currencies. The draft emphasises the definition of virtual currencies, which will also be relevant in another matter that we will discuss in a minute. The Directive defines virtual currencies as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically”.

Since this overlaps with some of the requirements that will be introduced by AML 5, it can be only be concluded that BaFin felt it needed to advise German financial institutions to be better get started already since the new EU rules will not become applicable until 10 January 2020. It’s also a sign of the current uncertainty among financial institutions regarding how or even if to deal with cryptocurrencies, which in turn has catastrophic consequences for the industry as we will see, but it is probably fair to say that ICOs have not really taken off in Germany.

Crypto risk assessments

In detail in its draft circular BaFin suggests that financial institutions that come across payments that indicate an exchange of virtual currencies should consider additional measures such as requesting further information from account holders regarding the origin of the funds and circumstances of the acquisition including a rise or loss of value. An increasing element that would make additional enquiries necessary would be the use of tumblers or mixers, i.e. services that help cloud the origin of funds and transactions. Other aspects that should be considered in a risk assessment are  he use of regulated trading platforms as opposed to unregulated ones or what payment forms had been used originally to acquire the virtual currencies, e.g. bank transfer versus anonymous prepaid cards.

Based on these considerations, market participants need to determine whether to file a suspicious activity report with the authorities, a general obligation applying to all forms of financial transaction including virtual currency transactions, which the BaFin document stresses explicitly.
The draft also highlights that authorisation is required by providers engaged in exchange services between virtual currencies and Euro, pointing out that the exact classification of services has to be determined on a case by case basis.

Financial Instruments

The classification of cryptocurrencies by BaFin is also subject of another, even further reaching event, namely a recent decision of the higher regional court of Berlin concerning the owner of a cryptocurrency platform and BaFin. Just to recall, BaFin had classified Bitcoin and other cryptocurrencies as financial instruments as early as 2013 and published several documents subsequently that look into the different aspects in more detail, for instance, in its advisory letter on the classification of tokens as financial instruments.

Getting back though to the recent decision by the Berlin judges, which goes back to a criminal case against the provider of a trading platform that operated without the required authorisation and was convicted in a criminal case by the court of first instance. In this final appeal against this judgement (the second appeal overturned the first ruling against which the authorities appealed), the court decided that BaFin overstepped its authority when categorising Bitcoin as a financial instrument (or more precisely as a subcategory of the same as a unit of account). In a nutshell, BaFin was not allowed to make the distinction to categorise Bitcoin as a financial instrument with consequences for criminal law as according to the German constitution this power rests entirely with the legislator as opposed to executing administrative bodies.

A clear track?

While BaFin’s decisions are only subject to administrative court rulings as opposed to criminal court rulings by which it is not bound, it might still force BaFin’s hand in the classification of cryptocurrencies. On the other hand, unlike in common law jurisdictions, the German system establishes a court decision as a single-case decision, which means another court could potentially rule differently. Neither is it a solid foundation upon which other market participants should assume that they can operate without BaFin authorisation – the safe road still leads to the regulator if you want to avoid any nasty surprises.

What next?

Talking about nasty surprises, the decision does not bring legal certainty or clarity and it adds to the overall issues of the German crypto sector. Compared to other jurisdictions, Germany has fallen behind and its regulatory handling of the matter has been one of the main reasons. The continuous lack of clarity will not improve the situation but rather make things worse. All the more remarkable is that while BaFin feels the need to try to clarify details and therefore clearly recognises the confusion in the industry, Germany does not seem reactive approach to crypto regulation. However, as pointed out by Frank Müller in its post for PayTechLaw, whether cryptocurrencies will be regulated in Germany is not a question of if but when.

Agreeing with BaFin that the arrival of the 5th AML Directive might still be too far away, it cannot be emphasised enough that the sooner a comprehensive framework can be established the better it will be for the industry. Only then will cryptocurrencies be able to step out of the shadow of Ponzi schemes and fraudulent ICOs to realise its full potential.

Lavanya Rathnam

Lavanya Rathnam is an experienced technology, finance, and compliance writer. She combines her keen understanding of regulatory frameworks and industry best practices with exemplary writing skills to communicate complex concepts of Governance, Risk, and Compliance (GRC) in clear and accessible language. Lavanya specializes in creating informative and engaging content that educates and empowers readers to make informed decisions. She also works with different companies in the Web 3.0, blockchain, fintech, and EV industries to assess their products’ compliance with evolving regulations and standards.

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