Definition of Crypto Custody Business – Changes After Only One Year?

(For German version click here)

 

The crypto custody business is currently the youngest financial service regulated in the German Banking Act (KWG). As of January 1st, 2020, the custody, management and safeguarding of crypto assets or private keys that serve for storing, holding or transferring crypto assets for others is regulated as a financial service that is subject to authorization. Now, not even a year later the German legislator plans to change the wording and thereby the legal definition of this just introduced activity again. In the course of the introduction of the electronic security and thus also while introducing the sub-category of crypto securities, the German legislator plans to expand the crypto custody business to also be applicable to the safeguarding of private keys that serve for storing, holding or securing crypto securities.

Only Safeguarding of Private Keys for Crypto Securities shall be regulated

The current draft intends for the financial service of crypto custody service to be worded in a way that there will be two variants. While the first variant will continue to relate to the custody, management and safeguarding of crypto assets respectively of private keys corresponding to those, the legislator intends the second variant to regulate the safeguarding of private keys corresponding to crypto securities. The custody and management of crypto securities themselves is not intended to be a case of crypto custody business. According to the draft´s explanatory memorandum published by the federal German government, these two activities will in the future continue to be subject to the regulation dealing with security depository business and will therefore be regulated as banking activities. This approach is consistent, because crypto securities are intended to be a sub-category of electronic securities and these are intended to be securities in the sense of the Securities Deposit Act. According to BaFin’s established administrative practice, the custody of securities in the sense of the Securities Deposit Act is subject to the security depository business.

How Does the Safeguarding of Private Keys Differ from the Custody of Crypto Securities?

A custody service in the sense of the crypto custody service is defined by BaFin as the custody of third-party crypto assets. Subject to this are therefore inter alia providers that transfer crypto assets in wallets to which the provider and not the customer holds the private keys. The safeguarding of private keys in the sense of the definition of the crypto custody service on the other hand relates to the storage of private keys for third parties, e.g. by digitally saving the keys or by taking custody of data storing devices such as USB-sticks, hard drives or a simple sheet of paper on which the private keys are saved.

Regulatory Differences Between Crypto Assets and Crypto Securities

The proposed changes explicitly show, that the legislator makes a clear regulatory differentiation between crypto assets and crypto securities. Crypto securities will not simultaneously be crypto assets, should the proposed introduction of the electronic security come into effect as planned. Otherwise, the differentiation between crypto securities and crypto assets in the definition of the crypto custody business would not make any sense. Crypto securities will be a sub-category of securities in the sense of the Securities Deposit Act, while most other blockchain tokens will continue to be qualified as crypto assets. Interestingly, the possibility to issue security tokens that will not have to be registered with a crypto security registry and which will therefore be qualified as crypto assets will remain an option should the draft bill come into effect. Such security tokens will continue to be qualified as securities in the sense of the European securities regulation, but not as securities pursuant to the Securities Deposit Act.

 

Attorney Lutz Auffenberg, LL.M. (London)

 

I.  https://fin-law.de

E. info@fin-law.de

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