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.
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.
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.
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.
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.