New Crypto Law in Germany: What Does this Mean for Bitcoin, Ethereum, DeFi, and the Euro as of January 2020?
The newly adopted German crypto law — which focuses on custody of crypto assets — is a step in the right direction. Importantly, the new crypto law is that the new rules provide clarity for companies. Also, it will raise awareness for crypto, blockchain and DLT in general. This will attract financial and human resources. Germany is currently front-running to not lose time. Decision-makers in Germany — both in companies and public administration — should support the following priorities: 1) education, 2) blockchain-based Euro to leverage use cases in Industry 4.0, mobility, logistics, 3) more budget for DLT projects, 4) dematerialization of all types of securities. — Authors: Philipp Sandner, Jonas Gross
Consequence of the new crypto legislation
With the new “crypto license”, the German regulator BaFin creates a new type of license that companies need to receive until Q4 2020 to be allowed to address German customers with crypto services. This licence applies to Fintechs, startups, larger banks, larger exchanges, and of course, all crypto exchanges, like Binance and Coinbase. Similar to Switzerland, a tech due diligence will probably be part of the license requirements such that BaFin demands some kind of “technological opinion” about the technology involved. This requirement might be a bottleneck if indeed dozens of applying companies will be tech-due diligenced. But once market participants have received the license, crypto assets become institutional-grade; and this is necessary for the adoption of crypto assets in the next step.
Weighted by volume, Bitcoin currently has a market share of 85%, Ether further 10%. So, by actual numbers, we can summarize that especially Bitcoin and Ether become institutional-grade as of Q2 2020. For illustrative purposes, one can therefore also talk about the “Bitcoin/Ethereum drivers’ license” all companies, such as startups, banks, crypto exchanges, have to obtain to provide services to German customers. Of course the new license will later in 2020 be also applied to other crypto assets and security tokens. But in early 2020, the license will be mainly used for Bitcoin and Ethereum trading and custody. That’s a fact.
Will Germany become a “blockchain role model”?
Yes and no. Concerning regulatory clarity, Germany is front-running and seeks to provide legal certainty for companies’ investments in crypto assets. However, Germany is not alone. Switzerland and Liechtenstein also drive this development. In Europe, these countries are leading — even compared to Asia and the Americas, these countries seem to be ahead. But the market is very dynamic and can reshape very quickly. In the short-term, Germany may become a powerhouse on blockchain, but there is no guarantee that this position also holds in the long-run. Therefore, Germany should not rest and further develop its institutional setup for blockchain technology.
Implications for open source projects and DeFi
The new German crypto law will provide the necessary foundation on which companies and startups will develop business models. It will also provide the foundation about which crypto assets can prosper. This foundation attracts investment, human resources, etc.; but what companies will exactly do with such crypto assets is subject to other regulatory frameworks.
Illustrating example: Due to the new law, “traditional” crypto assets such as Bitcoin and Ether are properly regulated. But security tokens underly security law, where traditional laws apply. Consequently, we might see promising developments in companies handling Bitcoin and Ether; but the same must not necessarily hold for other crypto assets (e.g., security tokens). The same logic applies to decentralized crypto exchanges (DEX). For these exchanges other regulatory frameworks might apply, e.g., regulation for trading assets, such that they might not develop similarly to “basic” Bitcoin trading.
Nevertheless, also a few traditional exchanges are well positioned in the crypto space. Börse Stuttgart, for example, launched a crypto trading app for retailers and gained more than 50 thousand new clients in half a year. But this was just the beginning: Börse Stuttgart will expand their app to entire Europe soon; they also launched a “crypto segment” for institutional investors. Additionally, we can expect them to launch a “security token segment” in Q3 2020. To summarize, we see a high level of progress on the business model of traditional centralized exchanges.
However, not all types of crypto assets are covered by the new German law. For example, it remains unclear how to classify MakerDAO and the respective DAI token. DAI is a stable coin, but not a tokenized USD. According to rumors, MakerDAO currently considers getting DAI under an E-Money license — which would then be legal according to E-Money regulation.
Short-term: the blockchain-based Euro
Besides regulatory clarity, a digital blockchain-based Euro is essential for the German blockchain ecosystem to evolve. A digital, blockchain-based Euro is currently a hot topic, and, indeed, the German Association of Banks (Bundesverband, BdB) also demanded such a “digital Euro”. We have analyzed a digital blockchain-based Euro in detail in a recent publication. With Commerzbank, CashOnLedger, and Monerium, there are three companies active in Germany that provide the Euro-on-blockchain with an E-Money license and already fall under current regulation. Their digital Euro is not just a stable coin — it is a tokenized Euro. But issued and traded on a blockchain system. A digital blockchain-based Euro will enable smart contracts with the Euro flowing through it. The possibilities are endless: machines start payment to each other; chemical silos start factoring invoices; sensors deliver data through an escrow smart contract against payment. The Euro-on-blockchain will be of crucial importance for the digital transformation of manufacturing (Industry 4.0), new mobility, logistics/supply chain and — with some delay — health care.
Long-term: central bank digital currency
From our perspective, a central bank-issued digital Euro (CBDC) is the next logical step. Central banks around the world analyze and explore this topic. However, the private sector will act more quickly and — as mentioned in the previous paragraph — projects tokenizing the Euro already exist. Therefore, these companies already provide market-ready solutions for industrial companies to use the euro-on-blockchain for their projects. Such a digital blockchain-based Euro has a tremendous potential if we e.g., think about the machine economy. However, we have to keep in mind that this e-money constitutes commercial bank money and not central bank money. Even if both kinds of money represent the Euro, one difference is highly relevant: In the case of bankruptcy of financial institutions, commercial bank money will potentially default, whereas central bank money is a claim to the central bank, which can, by definition, not become bankrupt. Even if this difference seems not essential in times of economic and financial stability, this difference gets highly relevant in times of crisis.
The ECB might also provide a digital euro — but only at a later stage. Furthermore, it is not guaranteed that this central bank-issued euro will be issued on a blockchain system. A quick response of the ECB is not urgently necessary because there are already market-ready solutions with digital commercial bank money.
How could Germany strengthen its role as a blockchain hub?
Besides supporting a digital blockchain-based Euro, there are a few steps Germany could additionally undertake to become a blockchain powerhouse. We propose the following priorities: First, there is the so-called “Urkundenpflicht” in Germany, a requirement that securities have to be printed and signed on paper; real physical, touchable paper. Due to the evolution of security tokens, securities have to become dematerialized. Therefore, we need to change the “Urkundenpflicht” and have to remove the paper-based requirement. Without this change, security tokens cannot thrive. Fortunately, the Ministry of Finance of Germany starts to address this topic in the next few months proposing new rules for a specific class of dematerialized debt instruments. However, this can only be the beginning; and this development has to increase in speed.
Secondly, it is necessary that financing for blockchain startups becomes easier. We have great blockchain startups in Berlin, Munich, Frankfurt, and Hamburg. Thanks to the new crypto law, we soon have legal certainty. From a company perspective, technology and regulation are then set up. But one issue remains unsolved: financing. Most startups suffer liquidity shortages since budgets are not provided by larger organizations, such as banks, industrial corporations or even the public administration (including public grants for research and universities). This has to be the next step: Decision-makers need to provide budget. The typical issue apparent in companies is that in companies’ boards there are experienced senior managers who are not digital natives, who are overloaded with regulatory burdens, and who do not have sufficient time to investigate with blockchain technology in detail. As blockchain technology is not easy to understand, this issue becomes a bottleneck. Recall that to understand blockchain, smart contracts, private/public key architecture in-depth, you need multiple weeks (or better months) of research, reflection and understanding. A short presentation in a seminar or some YouTube videos do not suffice. Decision-makers need to educate themselves in order to make decisions on budgets. To do this, the following article might help where we designed a 10-day program to help people onboard to the blockchain ecosystem:
Germany is now front-running with respect to crypto assets and blockchain technology. However, Germany is an EU Member State and needs to comply with EU regulation. Unfortunately, with blockchain, the EU is only moving slowly so that Germany “had to” move forward by introducing their own rules. But there is a risk of disintegration if any EU Member State introduces its own rules. From our perspective, it is desirable to move ahead. Somebody has to take the leadership, having the tremendous benefits of blockchain technology in mind — especially when the environment (i.e., the EU) is moving slowly. The chances of blockchain are there, and we have to act to realize them. We do not have time to lose.
Conclusion
The conclusion is short and precise: The most important point about the new crypto law is that the new rules will bring blockchain on top of the agenda. It will raise awareness for crypto, blockchain and DLT in general. This will attract financial and human resources and will provide an incentive for people to deal with blockchain technology. This “impulse” is will make 2020 an amazing year for crypto assets and blockchain.
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Authors
Prof. Dr. Philipp Sandner has founded the Frankfurt School Blockchain Center (FSBC). From 2018 to 2021, he was ranked among the “top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. He has been a member of the FinTech Council and the Digital Finance Forum of the Federal Ministry of Finance in Germany. He is also on the Board of Directors of FiveT Fintech Fund and Blockchain Founders Group — companies active in the field of blockchain startups. The expertise of Prof. Sandner includes crypto assets such as Bitcoin and Ethereum, decentralized finance (DeFi), the digital euro, tokenization of assets, and digital identity. You can contact him via mail (m@philippsandner.de) via LinkedIn or follow him on Twitter (@philippsandner).
Jonas Gross is a project manager and research assistant at the Frankfurt School Blockchain Center (FSBC). His fields of interest are primarily cryptocurrencies. Besides, in the context of his Ph.D., he analyzes the impact of blockchain technology on monetary policy of worldwide central banks. He mainly studies innovations as central bank digital currencies (CBDC) and other crypto currency projects as “Libra”. You can contact him via mail (jonas.gross@fs-blockchain.de), LinkedIn (https://www.linkedin.com/in/jonasgross94/), Xing (https://www.xing.com/profile/Jonas_Gross4) or follow him on (Twitter Jonas__Gross).
