Implementation of the fifth Anti-Money Laundering Directive: Rise or Demise of the German Crypto Market?

The draft, published on 24 May 2019 (last updated on 20 May 2019), the BMF by far exceeds the European requirements regarding the crypto sector, thus proposing (another) German special path (Sonderweg).

Requirements for the Crypto Market by AMLD5

The new standards set by AMLD5 that affect the crypto market were subject of an earlier article (available here). The European legislator wishes to include platforms which offer to exchange virtual currencies into fiat money (crypto exchanges) as well as providers of electronic wallets to store virtual currencies into the scope of national anti-money laundering legislation. Virtual currencies or crypto currencies are commonly known by their brand names like Bitcoin, Ether, Ripple and others. The directive suggests registering every crypto exchange and every wallet provider with the national financial supervisory authority. The directive’s wording does not include crypto exchanges that only offer the exchange of one virtual currency against another.

The German Draft Proposal

The BMF proposes with regard to virtual currencies to implement the directive not directly through the Anti-Money Laundering Act (Geldwäschegesetz – GwG). Instead, the BMF takes an ultimately more comprehensive approach to regulate the crypto market. The directive’s term “virtual currencies” is expanded to cover “crypto assets” (Kryptowerte) which are to be included in the German Banking Act (Kreditwesengesetz – KWG) as a new sub-category of financial instruments.

This terminological expansion sets the entire crypto market as a part of the financial sector which is supervised and regulated by the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). This is due to the legal definition of “crypto assets” offered by the proposal. Crypto assets are digital representations of a value which is not issued or guaranteed by central bank or any other public authority and does not carry the legal status of currency or fiat money, but is accepted by individuals or legal entities by contract or practice as a means of exchange or means of payment or means of investment which can be electronically transferred, stored and traded.

Regulation of Service Providers

“Crypto depository services” (Kryptoverwahrgeschäft) are introduced as financial services in the KWG. These encompass service providers which offer to store, retain or manage for others crypto assets or cryptographic private keys that are enabled to hold, safe or transfer these crypto assets.

In practice this means for all electronic wallet providers to become obliged entities under the GwG. They offer a financial service in the form of the new crypto depository service and thus require a license issued by BaFin.

Service providers that offer to exchange virtual currencies and fiat money will also soon be obliged entities according to the GwG and will need to obtain a BaFin license as a financial services institution to trade with financial instruments.

Regulation of Crypto Assets

Next to virtual currencies as defined in AMLD5, the German proposal additionally covers the possible investment character of token. Whether the definition only covers currency token and security token or also utility token is not entirely clear. The explanatory memorandum to the proposal however, suggests a wide interpretation of the term. The exchange character of a utility token, which is practically a digital voucher, can hardly be denied. The necessity to regulate such a voucher through the requirement of a permit for its issuance, solely based on the voucher being tokenized, may be considered bold. The effective protection for investors and consumers would have been possible as many token take a hybrid form, comprising characteristics of several types of token. This would make the overburdening of providers of true utility token obsolete.

To classify crypto assets as financial instruments making the exchange between token (not simply token and fiat money) a regulated financial service may be an additional potential overkill. The implementation proposal is far more intrusive and covers many more services, not addressed by the European legislator which thus all need a BaFin permit to keep operating.

Rise or Demise?

BMF’s draft proposal seeks to regulate the entire crypto market. What may seem plausible in the light of attempts to defraud investors and customers and the accompanying insecurities of early tokenization, bears the potential of overkill.  The regulatory hurdles of a licensing process are high and barely manageable without considerable funding. There could be another substantive impact: The definition of crypto assets is so broad that any electronically stored rewards program points might fall within the scope of regulation requiring a banking license going forward. Cooperation with established players will be the only option remaining. Yet, banks have been rather reluctant to explore or even invest in the crypto sector.

A similar implementation has been adopted in the Netherlands.

On the other hand, the proposal offers anticipated clarifications regarding the legislative and regulatory frame of the crypto market. Insecurities after the Bitcoin decision of the Higher Regional Court of Berlin (Kammergericht Berlin) which BaFin said would still not change its regulatory practice are remedied. The classification of Bitcoin as a financial instrument would be sealed. The ramifications of this classification would be the same for units of account (standing BaFin interpretation and rejected by the court) and the new crypto assets. The regulation of the market and its supervision through BaFin could reestablish trust which has formerly been lost.

The new regulations shall become effective as of 1 January 2020. This means that the industry has hardly time to address these changes (even in case they would be able to).

The authors thank Sascha Lucas for his support.