Regulation yes, but how?

Regulation yes, but how?

This year’s key event of the German blockchain community, the Crypto Assets Conference, took place under somewhat difficult circumstances on 9 and 10 March 2020. Professor Philipp Sandner, Director of the Frankfurt School Blockchain Center, and his team succeeded in organizing an attractive event, which involved a number of talks and discussion panels. The focus of the event was regulation of the crypto ecosystem.

Strict rules for the crypto-custody business
Ever since the introduction of partial regulation in Germany at the beginning of this year, the custody of digital assets has come firmly onto the radar of the banking industry. Whereas Switzerland and the Principality of Liechtenstein have already introduced regulation for this area of the new ecosystem, strict rules regarding custody did not enter into force in Germany until 1 January 2020. What do these look like?

The custody of digital assets of private individuals and companies in Germany requires authorization from the Federal Financial Supervisory Authority (BaFin) as well as a local branch presence. This requirement makes it difficult for foreign providers of custody solutions to access the German market, and looks to be quite restrictive in what is a heavily globalized industry. 

Unlike in other countries, Germany's regulatory approach does not revolve around technical possibilities and challenges. Instead, it seeks to achieve a form of regulation similar to the kind that exists in the traditional custody business. Specifically, this means that the focus of regulation is on a company's specialist capabilities and procedural adequacy in the custody area. By contrast, technical security aspects play a lesser role in German regulation. We believe that BaFin is keen to play a pioneering role within the European Union and push for EU-wide regulation in this area.

Legal basis in Switzerland
Together with its specialized partners, Maerki Baumann is also working on a custody offering for digital assets in Switzerland. During this process, we have remained in close contact with the Swiss Financial Market Supervisory Authority (FINMA). The main focus here lies on technical and procedural security measures, the segregated custody of assets, and precautions to cover emergency situations. Although a banking licence is not mandatory for the custody of cryptocurrencies, the providing institution must be affiliated to a self-regulatory organization in the financial sector.

Differences in the scope of regulation compared to money laundering checks in Europe
Differences in the scope of regulation compared to money laundering checks in Europe

Cryptocurrencies have not been immune to recent equity market panic
One intensively debated topic at the Crypto Assets Conference was the current dislocations in the equity and crypto markets. A surprising development for many participants was the strong correlation of cryptocurrencies with the falling stock market. 

An explanation given for this correlation was the limited market volumes and in some cases the reduced liquidity of these digital assets. Due to the low market capitalization levels, significant transactions can have a stronger impact on the price of a cryptocurrency than they would on the prices of assets in traditional markets. In addition, in the world of cryptocurrencies there is still not a sufficiently large number of investors with different price expectations, sufficient market depth and a large number of “algo traders” systematically exploiting market movements and thereby potentially contributing to a stabilization of prices.

“Due to limited market volumes and in some cases reduced liquidity, cryptocurrencies have not been able to escape the equity market panic.”

Milko Hensel, Head of Digital Partnerships, member of senior management, Maerki Baumann & Co. AG

Blockchain technology – not just for the financial sector
One aspect of blockchain technology that has not yet received much attention in Switzerland was explored in greater detail in Frankfurt: its application in the industrial environment. This is attracting an increasing amount of attention in Germany. Whether in the chemical industry or among automotive manufacturers and mid-cap mechanical engineering firms, numerous companies are testing potential applications with a view to improving services, streamlining payment channels, or achieving critical mass more rapidly through network effects. 

Germany appears to be a global leader when it comes to the linking of blockchain-based services to machinery and equipment. For example, German speciality chemicals manufacturer Evonik Industries AG is working on ways to measure the use of the raw materials by its clients on an ongoing basis so that the commodities consumed can be automatically invoiced. At other companies, measuring sensors attached to machinery and equipment report back to the manufacturer on the quality situation and maintenance requirements. The ongoing reporting and invoicing of expenses and costs is also being linked to a blockchain solution. 

Regulation remains the key challenge
For the crypto ecosystem as a whole, the fragmented and multifaceted nature of the regulatory environment in Europe remains a major challenge. Whether in relation to the custody, “tokenization”, or trading of digital assets, the legal basis remains incomplete in all countries. Thus, some companies have to establish convoluted legal workarounds. Representatives of numerous interesting companies attended the Crypto Assets Conference. Convinced of the potential and success of blockchain technology, these companies are responding to the current challenges with creativity and entrepreneurial spirit. We too hold this belief!