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Legal Framework Market

Switzerland and Germany favour securities on blockchain

Introduction

The emergence of Bitcoin and other cryptocurrencies has had a much wider impact on the financial world than it might at first seem.

Indeed, the underlying technological infrastructure, Distributed Ledger Technology (DLT) and the Blockchain, have since served as the basis on which many other financial services were built in a decentralised mode, giving rise to Decentralised Finance (DeFi).

The paradigm shift that these innovations underlie has on the one hand caused resistance in the existing financial system, but has also confronted the authorities with the need to regulate a sector with new characteristics. On this front, not all countries have moved in the same way and at the same speed, resulting in a situation with heterogeneous and sometimes deficient regulations. The countries of reference, such as the world’s financial centers, are the ones that have done the most in-depth work on this issue and have the most consistent regulatory framework to date.

Having a regulatory framework in place demonstrates acceptance of the phenomenon as part of the system, and both Switzerland and Germany have taken important steps on this front in recent months.

Germany

In December 2020, the German government passed a new law authorising the storage of security transactions on electronic registers, no longer requiring, as before, additional paper documentation, i.e. certificates to document transactions. Paper documentation is still possible but, in the vision of the German finance minister, the future will be electronic only. The law talks about electronic registration leaving the way open for various technological solutions that could be available in the future, however, it was made clear that the measure is part of the federal government’s blockchain strategy.

BaFin

The issuance of electronic securities and the management of digital ledgers will be monitored by the Federal Financial Supervisory Authority (BaFin). The German approach is clear, but at the same time also cautious: the law passed applies to bonds, but not yet to shares.

The approval of the legislation is part of a path started in 2019 in which the Ministry of Finance recommended to proceed to recognise and regulate blockchain-based securities. It was clear to the authorities that an investment- and growth-oriented regulatory framework had to be created. In the financial sector, where blockchain technology has long since moved well beyond Bitcoin’s prominent use case, blockchains, Bitcoins and tokens were placed under BaFin’s supervision with a first regulatory measure in early 2020, coinciding with the transposition of the EU’s 5th Money Laundering Directive.

Crypto custody

However, the German legislator took the opportunity to take a special route within the EU and introduce the so-called crypto custody business as a financial service also under the supervision of BaFin. Crypto custody companies are companies that hold, protect or manage crypto assets.

Cryptographic assets, according to the German Banking Act are “digital representations of a value that has not been issued or guaranteed by a central bank or public entity and does not have the legal status of a currency […] but […] is accepted as a medium of exchange or payment or serves investment purposes on the basis of an agreement or actual practice and can be transmitted, stored and exchanged electronically”.

A safety-oriented regulamentation

Regulation of the entire environment of DLT, tokens and cryptocurrencies is important to gain the trust of service providers and investors by enabling them to operate in an environment with legal certainty. For this reason, the German government’s blockchain strategy has been welcomed. Investors will be able to rely on a high standard of protection and invest more securely in encrypted assets in the future. However, the German special position is rather controversial: while in many EU member states crypto activities do not yet require a permit, financial service providers in Germany now face an obstacle they do not find in other countries. This can also lead to complications; for example, if a foreign provider wanted to operate in Germany, it would necessarily need a permit from BaFin. The path taken by the German government is being observed by other EU countries and may serve as a model once its successful operation has been verified.

Switzerland

As a leading financial country, Switzerland has been paying close attention to developments in the fintech sector, particularly in the crypto industry, from the outset and has sought to be at the forefront of this emerging sector.

In recent years, over 900 new blockchain and DLT companies have emerged in Switzerland, and many traditional financial organizations have started to offer crypto services and experiment with new technology-based initiatives, including UBS and Credit Suisse. The numerous private initiatives have raised the political attention that has seen the authorities at various stages to propose legislation to further improve the framework conditions for Switzerland to exploit the opportunities offered by these technologies. At the same time, the government gave great importance to continuing to ensure the integrity and reputation of the Swiss financial and economic center in this area as well.

The need for a legislative intervention

In December 2018, the Federal Council published a report on the legal framework for the use of blockchain and DLT in the financial sector. The report indicated in particular where the Federal Council considered legislative action to be necessary. In March 2019, the Federal Council then put forward a proposal for legislation, which received favourable feedbacks. The Swiss approach was to avoid specific laws relating to blockchain, as the sector is constantly evolving, but rather to proceed with interventions in individual areas of law where targeted adjustments were necessary to increase legal certainty, remove obstacles for DLT- or blockchain-based applications and limit new risks. In September 2020, the Swiss Parliament therefore adopted the law on the adaptation of federal laws to the evolution of Distributed Ledger Technology.

The federal legislation

This general law required the adaptation of several federal laws in order to propose a consistent and solid regulatory framework to ensure that Switzerland can continue to develop as a leading and innovative country in the field of blockchain technology and DLT, but also to protect investors and service providers.

In the law, a distinction is made between payment tokens or cryptocurrencies and security tokens, which have the same legal status as traditional securities. With regard to the securities law, the main change was to allow the existence of tamper-proof electronic records. But bankruptcy laws were also changed to make room for crypto assets, as were insolvency laws, particularly for custodians of digital assets who go out of business. At the financial market level, the regulations will be adapted to create a new licence category for DLT trading systems, providing a more flexible authorization scheme. Subsequently, on 11 December 2020, the Federal Council approved the regulation making it possible to introduce electronic security based on a ledger. The consultation process with cantons, political parties and other interested parties will last until February 2, 2021. The changes to the laws and regulations are expected to come into effect on August 1, 2021.

New Exchange license on Security Tokens (DLT Trading Facilities)

This new type of license has been defined as a professionally managed venue for multilateral and non-discretionary trading of digital securities. The aim is to offer trading, clearing, settlement and custody services with DLT-based assets, not only to regulated financial companies, but also to private clients.

The Exchange focuses on trading in DLT securities. DLT securities include blockchain-based securities (Security Tokens) introduced by the DLT Act and their foreign equivalents. In addition to DLT securities, other digital assets, such as payment tokens and utility tokens, can also be used in DLT trading exchanges.

Contact us for more information on this new type of license.

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Market

What is Bitcoin? A simple explanation

Introduction

In order to understand what Bitcoin is, it is necessary to go back to its origins and the reasons that led the inventor to conceive this system. On 31 october 2008, Satoshi Nakamoto, the pseudonym of Bitcoin’s inventor, whose identity is unknown (it is not even known whether he is a single person or a group of people), published the Bitcoin protocol on a Cryptography mailing list. In 2009, the article ‘Bitcoin: A Peer-to-Peer electronic cash system’ and the software that implements what is described in the article were published.
It is important to place the birth of Bitcoin in time: 2008 is the year of the economic crisis triggered by subprime mortgages, a crisis which also made its effects felt in the following years and which not only caused the failure of several banks, but also eroded trust in organisations in the financial sector.

Bitcoin was thus created as a system designed to disintermediate and, in its own way, democratise financial services, in particular the system of currencies and payments. According to the Bitcoin philosophy, there is no need for an intermediary (the bank) and transactions take place directly between the parties, in a peer-to-peer system that is designed to provide trust in the counterparty, through the use of mathematics. Bitcoin doesn’t need central banks, normally issuers and guarantors of traditional, so-called fiat currencies.
Bitcoin is thus designed, if not to replace, at least to offer an alternative economic network that should have the potential to create a better financial system for society.
Despite these positive intentions, Bitcoin has encountered many acceptance difficulties. Difficulties partly induced by the reaction of the traditional financial system and partly due to the prejudices of use for illicit purposes, with which it has long been cloaked. This is because Bitcoin has often been seen as a potential tool for money laundering and anonymity for illicit purposes. A few years later,

the situation has radically changed. 2020 in particular has seen the consecration of Bitcoin by institutional investors who have started to include it in their investment portfolios, as digital gold and an asset now cleared of previous skepticism. In the consumer sphere, the most important case among many has been that of Paypal, the well-known online payment system, which has announced that it will integrate Bitcoin from 2020 for US customers and from 2021 for other countries.

How does Bitcoin work?

Bitcoin is a network-based system consisting of a large number of computers (nodes) scattered around the world and connected to the Internet. A specific software operates on each node. This software keeps a copy of the transaction records of the entire network in a file on each node. The file in question is the so-called Blockchain. The Bitcoin computer network is public, i.e. anyone can add their own computer to the network and thus participate in the operation of the cryptocurrency. On the other hand, any node can be turned off or removed from the network without impacting its functioning. This is possible because within the network there is no central computer that governs the system, all nodes are of equal level and perform the same functions, therefore it is a decentralised system.
The way of recording transactions is based on cryptography and algorithms such that a certain block of transactions, once validated and stored in the blockchain, can’t be modified: anyone wishing to make changes would have to violate most of the nodes of the network itself, since there is a copy of the transactions on each node.

Who prints bitcoins?

As there is no central authority, the system itself has to produce new money. This is regulated by a specific algorithm that leads to the production of a progressively smaller amount of new bitcoins: the amount that is produced halves approximately every 4 years until 2140, when production will end. The production of new Bitcoins is done through a mining process involving a large number of network nodes in a competition to solve a mathematical problem within the transaction validation mechanism. The winner receives new bitcoins as a reward.

Who wants to buy bitcoins and then use them for payments, how should proceed?

On the Internet, there are various sites, known as “Exchanges”, which allow you to exchange fiat currency into Bitcoin. Payments made on the Bitcoin network give rise to transactions that spend the bitcoins and update the balance of the two parties involved. In reality, no transfer actually takes place, only the balances of the coins in storage in the accounts involved are updated in the ledger (blockchain).

To allow secure access to the account there is a cryptographic system based on the use of public keys and private keys, which are always alphanumeric codes.
Whoever owns the private key of an account is in fact the owner, being able to access it and make transactions.

On the Bitcoin network there is therefore no information on either the payer or the receiver.

Security

Since the credentials for accessing one’s account consist of the private key, forgetting it or disclosing it to third parties or having it fraudulently stolen would be fatal. According to recent statistics, the amount of bitcoins in accounts that are now inaccessible due to the loss of the private key is about 4 million, which, at the current exchange rate of about 20,000 dollars, is about 80 billion dollars.

Wallets, both software and hardware, make it easy to store such private keys and always suggest good backup practices to keep your coins safe.

Conclusions

Bitcoin brings with it new opportunities. Bitcoin was the first of the cryptocurrencies and has since been followed by many others, even if none has been able to match its value and strength.This process is now underway and can be observed in the growing number of initiatives undertaken in both public and private institutional settings, and by the gradual increase in Bitcoin investments. We are witnessing a historical moment of transition, where Bitcoin is becoming a key asset of reserve and value accretion.

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Market

What is blockchain? A simple explanation

Introduction

The blockchain appeared on the scene at the beginning of the last decade following the advent of cryptocurrencies. Since then, the blockchain has been frequently discussed in the media and has come to be described as a technology capable of having an impact similar to that of the internet. The blockchain was first used with Bitcoin in 2009, the cryptocurrency invented by Satoshi Nakamoto in 2008.

The term blockchain is often used in conjunction with another term: Distributed Ledger Technology (DLT). Blockchain is a subcategory of the broader DLT family. These are trustless systems for value transfer, organized in a decentralized way.They are often spoken of in reference to their application in the field of cryptocurrencies, or more generally in the fintech sector, but in recent years also in other areas of use such as fashion and luxury industry, food, art, etc.
But what do this technology consist of and what role does it play in the systems it helps to create?

Blockchain features

The blockchain is similar to a spreadsheet, in which the transactions that take place in the system are stored sequentially and chronologically. In essence, it is the equivalent of a ledger in which every operation that takes place is recorded.
The transactions we are talking about represent the transfer of an asset, a currency in the case of cryptocurrencies, from one account to another. By looking in the ledger you can see all the movements and deduce the current situation.
The blockchain has a number of particularities that make it different from a normal database used in other traditional applications. One of these is that the file is organized in interlinked blocks, hence the name ‘blockchain’. Each block contains a set of transactions and is linked to the previous one by a number that the system calculates using an algorithm applied to the content of the block that precedes it in the sequence.

Blockchain: a chain of data blocks

If we were to modify a block, the algorithm would give a different result and the chain would break, so if we wanted to check the integrity of the blockchain starting from the oldest block, we would find that when we arrived at the block following the modified one, the number stored in that block would be different from the one produced by the algorithm applied to the previous block and it would emerge that the data had been modified.
One might mistakenly think that to make the structure consistent again, after having modified a piece of data, it would be sufficient to rewrite the new number produced by the algorithm in the next block, but by doing so, the content of the next block would be changed as well, thus also modifying the result of the algorithm for it and breaking the link with the block following it. In practice, one would end up having to update the entire chain starting from the block that has been modified to the most recent one, an extremely costly operation both in terms of calculations to be carried out and in terms of time. Another property of the blockchain derives from this fact: the immutability of the stored data. This immutability applies to the most important blockchains, such as Bitcoin and Ethereum, while for other minor ones there is a cost, which under certain conditions can be economically advantageous, to attack them and succeed in falsifying their blockchain.

Blockchain and the Distributed Ledger Technology

Blockchain is only one of the components of the system. The other fundamental component is the consensus that determine whether a transaction has taken place or not. It is able to operate in a decentralized environment that can make use of a large number of devices (nodes) on the network, each of which is responsible for managing its own copy of the blockchain. Anyone wishing to attempt to modify data already stored on the blockchain would therefore have to do so simultaneously on the majority of all nodes, which is technically almost impossible. If, hypothetically, he managed to do so on one device, this system would no longer be aligned with the other ones and would therefore be excluded from the network.

The blockchain system in a world without computing

To make the system easier to understand, we can try to imagine how a similar solution could be implemented in a world where the information technology does not exist.

First of all, one would need a network of notaries scattered throughout the world, each with its own ledger. Then, each notary would have to send by mail to the other notaries in the network all the transactions requested by their clients. In this way, everyone would know the transactions carried out by the clients of all the notaries in the network, would be able to record them in their own ledgers and thus their respective ledgers would contain the same data. However, not all ledgers would be the same, because in the ledger of one notary the transactions would be recorded in an order probably different from that of other notaries due to the timing of the post service.

Consensus

So how can we maintain the same sequence of transactions in all ledgers and ensure that they are for all intents and purposes identical? Without computer science it would be very complicated, perhaps impossible, but in technological solutions a new group of transactions, before being added to the blockchain, must be validated. In blockchains using proof of work (PoW), each node validates the transactions that are next to be stored, but one will always finish before the others. The one that “wins” this challenge will have produced the next official block of the chain. This block will be sent to all the other nodes, which will add it to their own chain, i.e. their own file. In this way the chain will continue the same on every node in the network. Transactions not included in the winning block will fall into one of the following blocks. There is therefore no specific node in charge of validating transactions, but it is a group activity whose result will be produced each time with high probability by a different node.

Disintermediation

This way of operating makes the system decentralised and provides the capacity for disintermediation that is another feature of the blockchain: there is no central computer that governs the system, indeed, none of the nodes in the network is indispensable for its operation. Any computer can be stopped at any time, just as any computer can be added to the network, provided it is equipped with the appropriate software, without altering its operation.

Conclusion

It is very hard to describe in a simple way what is a blockchain and what is its functioning. Because there are different types, even with very different features. Fundamental elements are the technical protocol, the consensus system used, the governance, the openness and decentralization of the system, its real autonomy from any form of control.

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Market Services

Blockchain in the fashion and luxury industry

The blockchain, initially used in cryptocurrencies, has then spread to the Fintech solutions sector, but is gradually taking on an important role in other sectors, including the fashion and luxury industry. Many companies are beginning to experiment with this type of technology whose potential is capable of making their brand evolve considerably: from tracing the origin of the materials used to make the products to guaranteeing their authenticity, to guaranteeing the ownership of the goods by the customer, the blockchain applied to the fashion and luxury industry is therefore a challenge that is only just beginning.

The main uses of blockchain in the fashion and luxury industry:

– Traceability of the origin of materials

Blockchain technology makes it possible to trace the transactions that take place along the company’s supply chain in a certain and unchangeable way and therefore guarantees a high level of traceability and security of online transactions and of the product along the supply chain, production and distribution. International organizations also push for supply chain tracking, such as the UN and the EU. For companies, the use of the blockchain guarantees a series of advantages among which the traceability of the different buying and selling transactions up to the different steps of processing, distribution and even in some cases geolocation of the product. In this way, also the consumer is protected: monitoring products step by step in their path from the raw material to the factory up to purchase, is a strong guarantee factor for customers who are increasingly interested in the origin of the materials of which the garments or luxury goods purchased are made, for both ethical and environmental sustainability reasons.

– Proof of authenticity of the products

The track-and-trace capability, guaranteed by the blockchain, becomes an important weapon in the fight against product counterfeiting. The blockchain in the fashion and luxury sector guarantees incontrovertible certification of the authenticity of the origin of the products, thus promoting the fight against counterfeiting and stolen goods trafficking. In addition, it allows total transparency of information up to the moment of sale: the customer receives a personalized certificate of authenticity with an integrated cryptographic system and the buyer has the possibility to make payment by cryptocurrency. The blockchain technology applied in this area also opens the door to the development of direct communication with customers and a more effective marketing strategy that also involves improving brand storytelling: in addition to increasing public awareness of the harmful effects of buying counterfeit products, brands today must think creatively about identity building, giving due importance to environmental and social sustainability aspects and maintaining constant proximity to the consumer.

Notarization: proof of ownership

Through the blockchain it is possible to associate the customer with the purchased product in an immutable and permanent way, thus guaranteeing its legitimate ownership and being able to trace any subsequent changes in ownership. This possibility is particularly interesting for luxury goods that have a significant value and for which it is important for the owner to be able to prove both their authenticity and ownership.

Examples of blockchain implementations in fashion and luxury industry

Blockchain technology is also beginning to be explored by the major fashion and luxury industries as an effective means of ensuring safety and quality and thus increasing confidence in the product within the business and also by the customer. Louis Vuitton and Dior were the first brands to enter the platform and to be able to verify the traceability and authenticity of the products. The platform, open to all luxury brands, offers them the opportunity to exploit the great potential of the technology, allowing customers to have access to the origins and history of the product they have purchased, a decisive factor against counterfeiting that is now increasingly amplified by the growth of e-commerce. The luxury fashion brand Alyx by designer Matthew William also started using the blockchain in May 2019 to monitor the production of clothes from the raw material to the final product, to allow the customer through the QR code to understand in detail the origins of their purchases and their genuine quality, thus gaining confidence in the brand.

Conclusions

Blockchain technology offers great opportunities for the fashion and luxury industry through systems that can be integrated relatively easily, in order to allow luxury companies to quickly take their first steps and become familiar with the benefits mentioned above.

Fashion companies will be able to find a significant way of innovation using the blockchain: dialogue with consumers who are increasingly attentive to values such as those of traceability and authenticity, which must be told in a transparent manner, providing detailed and simple information.

BrightNode and Alpenite are working on technological solutions specifically designed for fashion and luxury brands, for more information please contact us.

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Funding Services Startups

The available funding sources for startups

Nowadays the possible funding sources for startups have expanded and diversified: new opportunities have arisen largely made possible by the internet and the fact that we operate in a globalized world.
In the startup growth process, there is a tendency to use a phase-based approach in which new financing is progressively sought. In the initial period (seed) the founders mainly draw on their entourage, apply for grants and try to enter incubators and accelerators.
In this regard, it is useful to check the Crunchbase website which lists the 100 best accelerators in the world.

But for the next steps, what are the possible funding sources for startups? With regard to the search for capital, venture capitalists are undoubtedly still an important source, corporate venture capitalists and crowdfunding are another effective option to consider, as well as royalty-based financing and new ways of financing based on blockchain and cryptocurrencies.
In any case, whichever way you decide to follow, it should be considered that after the financing has taken place, a part of the company and/or its future profits or its future products or services, have in fact been transferred.

Venture Capital financing

Venture capitalists (VCs) finance companies that show high growth potential and the main sectors in which they invest are biotech, semiconductors and “tech” and “digital media” in general. VCs first ask for equity and places in the Board of Directors of the companies they have selected and financed and, once they have granted the capital, they expect the startup to be able to use it efficiently.
It should also be kept in mind that receiving funding from a VC involves the establishment of a very close bond whose term and conditions will be decided by the VC, moreover, the liquidation of his investment will take place only at the time of the sale of the company or its IPO, therefore, this type of investment usually lasts between 5 and 10 years.

Over the years, even non-financial companies have started to invest (Corporate Venture Capital) directly in startups, financing companies in their sector used to experiment with technologies and business models to be eventually bought and integrated into their own company. For the financing company this is a further way of doing research and development, and also serves to have control of technologies avoiding that they end up in the hands of competitors. Examples of some large companies that practice corporate venture capital and have internal units dedicated to this function are Google, Intel, Salesforce, etc.

The website Foundersuite has a database of over 120,000 investors and provides a range of tools to get in touch with those who are interested and to manage the relationship.

Venture financing via royalties

Royalty-Based Financing (RFB), on the other hand, consists of acquiring financing in exchange for sharing the revenue with the lender. The costs of financing are lower than those of equity financing, but higher than those of a bank loan. This method has been widely used in life science and energy companies. First, you agree with the lender the percentage of monthly turnover to be returned to him, how long and in what range will be the total amount that will be returned. Typical figures are 2-20 % of the turnover for 3-5 years, with a total figure in the range between 1.5 and 2 times the capital granted.

Crowdfunding

For some years now crowdfunding has become another important tool to finance startups and projects. It is a method to collect small amounts from a large number of people using one of the hundreds of dedicated internet platforms that act as intermediaries and retain a percentage of the funding. In a crowdfunding campaign you must first define a deadline and the amount you want to reach by that date. As far as the lenders are concerned, they contribute small amounts and receive incentives in return: discounts, early availability of products and equity.

A further effect of a crowdfunding campaign, however, is that you also get feedback from users and significant visibility. In fact, this tool can also be considered a marketing tool as it tends to turn lenders into customers and the financing becomes a sort of pre-order for the product that will be realized. Before considering crowdfunding as a source of financing it is important to be well aware that if you don’t already have a significant follow up on the internet and at least one prototype of the product, you will hardly be able to be accepted by a platform.
There are 5 fund-raising models: donation, reward, debt, royalty, equity.

The reward model provides that the investor receives a non-financial reward (early access to the product, discount, merchandise, etc.).
The main platforms that are based on this model are Kickstarter and Indiegogo: the first one requires to have a working prototype and if the campaign does not reach the objectives it is cancelled and the money returned. The average contribution of an investor is 70 dollars.
In the debt crowdfunding, the company receives a loan that will be returned with some interest, between 3 and 8%.
In the royalty crowdfunding you will give the investors rewards based on turnover as soon as you start selling.
In the case of equity crowdfunding, on the other hand, you give equity to the investors. This model is particularly suitable for startups at an advanced stage and for this type of financing some platforms only give access to accredited investors. In fact, accredited investors are venture capitalists who use the platforms and are also those who usually have access to the best opportunities.

Blockchain-based crowdfunding

Blockchain-based crowdfunding is a decentralized and international crowdfunding system that, if successful, can very quickly raise large amounts of money. The mechanism used by this system is the Token Sale. A Token Sale can only be proposed by startups that have their roots in blockchain technology and through it startups can sell to the public their tokens that are not a currency intended as a means of payment, but a kind of coupon that can be converted into company products or services (utility tokens). Initially, startups publish a white paper in which they describe both the company and what they intend to make and on this basis the public can adhere to the proposal made by deciding to buy tokens. To take advantage of this financing method it is necessary to have a business based on blockchain and the support from experienced lawyers to avoid the violation of regulations that are different from country to country and are often unclear. Switzerland is currently the most advanced country in this respect.

Conclusions

It is clear that it is impossible for a startup to grow without adequate capital. In this regard, a certainly positive factor to consider is that today you can find capital at a global level, although then obviously also the competition will be global.
Moreover, incubators, accelerators, Capitalist, Corporate Venture Capitalist, crowdfunding and all the options described so far, can certainly help in a concrete way to progressively grow a startup. After having deepened all the possibilities of choice, the startup can follow the path most appropriate to its characteristics, also considering its willingness to give up participation within the company.

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Europe & Market Legal Framework

Digital finance package: the innovations introduced by EU

The European Commission presented a new Digital Finance package on 24 September 2020. It is a package that is positioned at both a strategic and regulatory level and which overall aims to standardize financial services regulations and support their digital development in order to produce concrete benefits for both citizens and businesses. All this by seeking to ensure financial stability, respect for privacy and the fight against money laundering.

The corpus of the digital finance package is developed along four main lines: the Digital Finance Strategy, the Retail Payments Strategy, legislative proposals for a common regulatory framework at EU level on crypto-assets and a proposal for a regulatory framework on operational resilience.

The Digital Finance Strategy

The Digital Finance Strategy aims to stimulate the digitalisation of financial services, stimulating innovation and competition between the various competitors in the European Union, whether they are traditional operators or from the digital world, i.e. the Fintech sector. The strategy is based on the “same activity, same risk, same rules” principle, creating a level playing field between all financial services providers. A further objective is to ensure that the new financial environment supports the new industrial strategy for Europe and encourages the development and growth of highly innovative digital startups.

The strategy considers digital innovation a pillar in the world of finance. In fact, it is now clear that innovations based on Distributed Ledger Technology, artificial intelligence, but more generally those based on Information and communication technology (ICT), are able to improve services for consumers and businesses that therefore benefit from easier access to financial services and greater control over their assets. The push towards a European financial area that promotes Open Finance also implies the proposal of a European digital finance platform: by 2024 the European Commission envisages the introduction of new licences with an EU passport that will allow the birth of a European digital platform.

The Retail Payments Strategy

The second theme of the digital finance package presented by the European Commission is the Retail Payments Strategy: the strategy for innovative retail payment services and solutions.

The objective of the European Commission is to achieve a homogeneous retail payment system across the European Union that includes solutions for instant cross-border payments. This strategy should therefore ensure digital, immediate and efficient payment systems, operating at pan-European level, creating innovative and potentially more competitive retail markets.

Markets in Crypto-Assets (MiCA)

The European Commission presented on september 24th, 2020 a new legislative package to support Digital Finance, the so-called Markets in Crypto-Assets (MiCA) regulation which aims to achieve a regulation of crypto-assets (digital identity, open Finance, stablecoin, blockchain-based assets), applicable at European level in all member States, which should come into force by the end of 2022. This is the most extensive regulation of digital assets ever made to date and seems to promise great opportunities in terms of development and growth for the entire financial ecosystem.

The European Commission aims to reduce the legal fragmentation of the digital market that still exists among many EU member States. Before the MiCA agreement, companies operating at national level often had to adapt their international business to the financial policy of each Country and this entailed high costs. This regulation, which is directly applicable throughout Europe, can concretely reduce the difficulties faced by Fintech service providers. In addition, the greater uniformity of the European financial regulatory framework will promote a level playing field between financial operators, which is lacking when heterogeneous regulations coexist.

The regulation introduces the possibility to define a pilot regime for crypto-assets, tokens, and Distributed Ledger Technology solutions for the capital market like tokenized securities, trading and post-trading and the reclassification of token, stablecoin and CBDC definitions. In these experimental environments both the technological infrastructure and the adequacy of regulations can be put to the test.

Digital resilience framework

The regulatory framework on the digital resilience of technological solutions in the financial sector is designed to contribute to the increase in operational security safeguards. In essence, every company operating in the financial sector will need to ensure that it is able to cope with or limit the damage caused by any type of cyber- attacks or disasters related to its technological infrastructure.

New challenges and risks

The regulatory framework of the digital finance package highlights new challenges related to digital finance that are necessarily associated with potential risks to be faced: first and foremost that of financial stability, which is more complicated to safeguard when the digital component comes into play, as well as the protection of privacy, consumer safety and the integrity of the financial market. The European Commission will therefore propose by mid 2022 the necessary adjustments to the existing legislative framework for financial services with regard to consumer protection and appropriate rules to protect end users from the risks of digital finance, safeguard financial stability, protect the integrity of the EU financial sector and ensure a level playing field.

Although the digital finance package has just been presented, it shows great opportunities and a regulatory principle for crypto-assets that could soon put them on the same level as existing traditional financial products.

Categories
Europe & Market Legal Framework

What is the Central Bank Digital Currency

From cryptocurrency to CBDC

The traditional monetary and financial context was faced, just over 10 years ago, with the advent of Bitcoin, a peer-to-peer digital currency system in which the latter can be transferred without the intervention of an intermediary relying on a shared protocol between the network participants based on Distributed Ledger Technology (DLT) and Blockchain. Bitcoin has thus introduced an innovative ecosystem based on completely new logics, initiating the world of cryptocurrency and disintermediation by solving the problem of trust in the counterpart. The revolutionary features of the DLT allowed the birth of the token economy, based on the “tokenization” of physical or monetary assets, thus shifting part of the physical economy of the digital world through the Blockchain itself.

The idea behind cryptocurrencies, the creation of a private digital currency, has inevitably led the monetary context and financial institutions to perceive a potential threat to their business model: banks feel defrauded of their institutional role and total digitalization through cryptocurrencies is also perceived by institutions as a risk for clients.

For example, the advent of stablecoins, the cryptocurrencies that ontologically have the characteristic of price stability, has aroused great interest from the public, but many doubts on the governments and central banks side, this was clearly observed in particular when Facebook announced the project for a private stablecoin, the Libra Coin.

Central banks have therefore felt the need to explore innovative solutions to limit the loss of control of the system: their response to the rapid spread of these new innovative models lies in the introduction of the Central Bank Digital Currency (CBDC) concept, a new form of digital currency released by central banks as a complement or substitute for fiat currency. Many central banks are studying, and in many cases experimenting with, this kind of solution, the adoption of which may take place in the coming years with different timeframes and implementation models.

The CBDC is therefore a concrete response to the crypto wave. The interest of central banks in digital currency has therefore progressively increased in recent years, driven by the desire to secure control over the money supply, while offering a modern payment system that is part of the digitalization process that is spreading at all levels.

CBDC features

The CBDC is a new form of currency that allows anyone to make electronic payments using digital currency and can be classified into two categories depending on who has access to it: the wholesale CBDC, whose use is limited to financial institutions and the interbank market, or the retail CBDC, designed for universal use involving direct public access to central bank liabilities.

A CBDC thus combines the characteristics of a legal currency issued by a state or central bank with certain characteristics of cryptocurrencies.

Advantages and disadvantages

CBDC offer some positive aspects: efficiency, for the convenience and ease of payments similar to cash payments, accessibility, for ease of access by anyone who wants to use it, resilience, due to the redundancy of the technological infrastructure, especially in the case of decentralized architecture, and interoperability necessary for conversions to other CBDCs and international payments.

The CBDC also guarantees financial inclusion and some consumer protection: unlike banking liquidity and reserves, the retail CBDC gives central banks the role of trusted lender for households and small businesses. This means that in a potential financial crisis, central banks will be able to provide support directly to clients, ensuring greater financial stability. The latter is undoubtedly an indispensable dimension that the CBDC would ensure: a government-supported digital currency that is widespread in the domestic market limits the possibility of adopting private digital currencies as stablecoins that pose a risk in the financial and monetary domain.

While recognizing many advantages, one of the CBDC’s weaknesses is its lack of anonymity, which can never be equivalent to cash or cryptocurrency anonymity.

CBDC and retail banks

The CBDC and its features are highly dependent on the real interests of consumers, so they must ensure an efficient and accessible system that can be a valid response to market demands. For this reason, the currency promoted by central banks must be a modern payment system that must be based on DLT and blockchain: the ease of money transfer without intermediaries and the low costs that they guarantee make its use indispensable. The issuance of digital currencies by central banks can have many advantages for users, but its impact on the banking system could be negative for retail banks: if consumers can hold money directly from the central bank, the function of retail banks would be at risk and this could cause the crisis of the traditional financial environment. The possible massive adoption of CBDCs would lead to a reduction of assets managed by retail banks, endangering the private credit system with potential consequences on business credit and therefore on employment.

For this reason, ongoing studies and experiments are mainly aimed at understanding the best way to implement CBDC to avoid the system destabilization but giving concrete benefits for consumers.

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Market Research & Development

What is Decentralized Finance (DeFi) and why it is innovative

Introduction

In the last few months DeFi (Decentralized Finance) has found more and more space in the economic and market context. This trend is now in steady growth and is generating a real revolution in the field of finance with such a development potential for that a future mass adoption, currently still in its embryonic stage, is expected.

What is DeFi?

DeFi is an innovative financial ecosystem that refers to financial applications based on the Distributed Ledger Technology and Blockchain. More precisely, the concept of Decentralized Finance refers to an approach that aims to create open source financial services through public and decentralized, permissionless and transparent platforms that are publicly available and operate without any central authority and without the intermediation of financial institutions. In this scenario, users would therefore retain full control of their financial activities by interacting with this ecosystem through decentralized applications, the so-called Distributed Applications – DApps (P2P) that operate exclusively through blockchain.

The Ethereum platform and the smart contract

DeFi builds on Bitcoin’s and in general cryptocurrency pioneering concepts, but offers additional types of services. The DeFi system is not based on the Bitcoin network, but mainly on the Ethereum decentralized platform, that supports smart contracts, the software that are automatically executed by the network and that make up for the absence of the traditional intermediary making the financial transactions completely autonomous and free from administration overhead. The real paradigm shift is that the financial management takes place through an automatic mode implemented by open software verifiable by anyone, whose behavior is therefore predictable, based on pseudonym and the basic market logic. In short, the DeFi ecosystem completely eliminates the discretion of classic intermediaries, delegating the entire management of the system exclusively to smart contracts. This is only a first step towards the creation of a parallel financial system that is supposed to overcome those limits now evident and intrinsic in the classic financial modus operandi.

DeFi applications

DeFi’s applications are numerous, a major one is certainly open and decentralized lending and borrowing, which has clear advantages: by using public blockchain platforms the counterparty risk is minimized and lending and borrowing become consequently cheaper, faster and more accessible. Banking monetary services are also a common use case and include granting of mortgages and taking out insurances, once again eliminating the significant costs that in the traditional process are mostly caused by the involvement of the involved intermediaries: thanks to the use of smart contracts, underwriting and legal costs are significantly reduced. Blockchain technology through DeFi can also be used to issue and enable ownership of a wide range of conventional financial products, favouring projects that could, for example, enable the creation of decentralised forecasting markets. As outlined above, the greatest innovation and the resulting advantage of DeFi is the easy access to financial services. By avoiding the obligatory intervention of institutions as mediators, DeFi applications are much more efficient and faster, allowing users to maintain constant and direct control over their assets. In addition, another significant advantage is that the DeFi low cost and open system allow a particular ease of access to those people who remain for various reasons out of the current financial system whose services usually exclude low incomes citizens. In the DeFi approach, however, costs are significantly reduced. One of its main claims is in fact “bank the unbanked” which implies the involvement of low income potential customers.

Between innovation and risk

DeFi goes beyond the concept of open banking which, while guaranteeing access to data from banking and financial institutions and making new types of products and services possible, stand inside the traditional financial context. The world of Decentralized Finance offers users a completely innovative perspective to look at the financial world dynamics: the open finance, independent from the current infrastructure, is placed in the foreground and promotes new ways of interacting with financial instruments. The DeFi ecosystem, with its promise of decentralization, is certainly an attractive idea, but before we will see a real mass adoption of its new approach, there are some aspects to tackle: alternative investment systems create interesting diversified scenarios and are accessible to a very wide range of users, but the DeFi field, being extremely dynamic and autonomous, is necessarily potentially more subject to changes, exposing customers to a higher risk potential than the traditional model. A solid organization of DeFi with a clear information process to safeguard savings on decentralized financial platforms is the basis for the spread of a system that is already today evidently more performing than the traditional one due to its intrinsic characteristics.

Conclusion

Anyway, the DeFi is currently in continuous growth: traditional financial services and DeFi applications are moving on converging paths, separated by an ever decreasing distance. Whatever the future scenario that awaits us, we are undoubtedly already facing a progressive change in financial services, within which DeFi proposes a radical rethinking of the financial system: shifting the power of action from centralized organizations directly into the hands of the community and the individual himself, an autonomous and independent entity with the prospect of an increasingly less centralized and more automated future.