Crypto Industry Report #9
Balzers (LI), 19 November 2019
This week, our blockchain experts assessed the following headlines:
Our weekly Crypto Industry Report news ticker provides you with the latest information on the global crypto industry – picked and analysed by our blockchain experts.
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Germany amends bill for the transposition of the 5th EU Anti-Money Laundering Directive (AMLD 5) impacting crypto custodians
The Finance Committee of the German Federal Parliament has introduced some adjustments regarding a government bill for the transposition of the 5th EU Anti-Money Laundering Directive (AMLD 5). The bill is introducing amendments to the German Banking Act (KWG) to establish crypto assets as financial instruments and to define crypto asset custody as a new financial service, which will require authorization from the Federal Financial Supervisory Authority (BaFin).
The changes involve allowing crypto asset custody providers to offer other financial services in the same entity, the introduction of reduced capital requirements for crypto custodians that are not providing any other services and also the extension of the period to notify the intention to obtain a licence and to fully obtain a licence.
Assessment
The announced adjustments have significant implications for crypto custody providers in particular compared to the previously proposed draft bill. Firstly, banks and other financial institutions will now be allowed to provide crypto custody services without the need to create a separate subsidiary and legal entity as introduced in Section 32 (1g) KWG-E. This could reduce costs and may incentivize more financial institutions to offer crypto custody. However, these institutions will still need to comply with the traditional Capital Requirements Regulation (CRR) if they decide to provide crypto custody in parallel with other financial services.
Another adjustment of the bill is that institutions providing only crypto asset custody services will be exempted from most of the CRR regulations and also part of the KWG regulations that are applicable to financial services institutions, according to section 2 (7b) KWG-E. By not having demanding capital requirements, crypto custodians that are not providing any other financial service could increase the assets under custody significantly without needing a large amount of capital.
Although in theory financial institutions in Germany could now offer crypto custody without the need to establish a subsidiary, since the exemption from capital requirements in 2 (7b) KWG-E may not apply in this case, it could still be better to keep crypto custody as a separate entity. This would avoid the CRR regulations and requirements, which could be useful especially for those crypto custody service providers that are not able to comply with the traditional capital requirements for financial institutions.
The third key update announced for the bill is that for entities that are already providing crypto services before January 1, 2020, a licence would be provisionally granted. However, they will need to notify BaFin by March 31, 2020 of the intention to submit an application and they must obtain a full licence by November 30, 2020, according to section 32 KWG.
Crypto Storage, which is part of the Crypto Finance group and based in Switzerland, has already announced that they are expanding to Frankfurt following the new regulations. This indicates that Germany may attract an important number of blockchain companies and crypto custodians and therefore it may become a leading country for the crypto industry.
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Ledger Vault obtains a $150 million custom crime insurance policy at no additional costs for their customers
Ledger announced last week that, in collaboration with the leading broker and risk advisor Marsh and the Lloyd’s of London syndicate Arch Insurance, it will provide Ledger Vault clients with an insurance up to $150 million at no additional cost.
The insurance will cover several risks including the theft of the private keys or the master seed by a third party following a physical breach in a hardware security module in a Ledger data center, the transmission of the master seed fragments during the client onboarding process and also the risk of insider Ledger employee theft. Ledger has claimed that all supported tokens and coins are covered by the insurance, and that there is also a mechanism to add new coins or tokens to the insurance policy.
In addition, Ledger Vault clients have the option to obtain their own additional insurance on top of the provided $150 million policy. Ledger Vault is now the first crypto asset security platform providing such insurance policy and, unlike custodians like Bakkt, they are not obliged to provide this insurance since their clients manage the custody of their own crypto assets.
Assessment
While the Bakkt Warehouse provides clients with a similar $125 million insurance cover, Ledger does not offer custodian services but instead it provides the Ledger Vault to institutional clients to custody their own crypto assets by themselves. This is a significant difference because Ledger is not required to obtain crypto asset insurance like custodians, banks or exchanges. The fact that Ledger is providing this insurance of $150 million to Ledger Vault clients at no additional cost is likely to be welcomed by existing clients and it may also attract new clients. In addition, customers will be able to go through a simple process facilitated by Marsh and Arch if they want to obtain additional insurance coverage.
This insurance has been the result of a long cooperation of over six months between Ledger, Marsh and Arch to develop the details and specific insurance for Ledger Vault clients.
It is likely that due to the complexity for clients to get this type of insurance by themselves, Ledger decided to obtain the insurance directly at no additional costs for clients. This may benefit customers by saving them both the time and costs required for the insurance security evaluation process, while also allowing them to add additional insurance easily in addition of the $150 million policy provided by Ledger.
With this $150 million insurance and the $125 million offered by the Bakkt Warehouse, which is now accepting any institutional client in their warehouse and not only those trading their bitcoin future contracts, it seems that leading insurance companies are gradually entering the crypto industry and accepting to provide large insurance for crypto assets.
This is important because institutional custody solutions require both a high security infrastructure and also an insurance policy. Therefore, with the high security and the significant insurance cover provided by Ledger Vault and the Bakkt Warehouse, more institutional investors may decide to enter the asset class and allocate a part of their portfolios to bitcoin or other crypto assets.
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Bakkt Warehouse now available to all institutions following authorization from the New York Department of Financial Services (NYDFS)
According to an official announcement, the Bakkt Warehouse will offer bitcoin custody to all institutional clients globally while until now only those clients trading the Bitcoin Futures contracts were able to use the custody solution.
This expansion of the Bakkt Warehouse was possible due to the approval from the New York Department of Financial Services (NYDFS). The NYDFS had previously authorized Bakkt to become a trust company, which allowed the launch of the first physically settled bitcoin futures contracts that, in addition, do not rely on unregulated spot markets for settlement prices.
Bakkt was founded by the parent company of the New York Stock Exchange, the Intercontinental Exchange (ICE), therefore this provides an important source of trust and credibility for institutional investors.
The custody solution is covered by a $125 million insurance policy and it provides bank-grade security. Bakkt also announced recently the upcoming launch in 2020 of a consumer app to purchase goods with bitcoin, which will start with Starbucks, and also options on top of their bitcoin futures contracts.
Assessment
Since bitcoins are controlled and owned by private keys and transactions are not reversible, an institutional-grade custody solution for private keys for bitcoin and other crypto assets has been a key barrier for institutional investors to enter the asset class, since the risks involved were considered to be too high.
While there were certain custody solutions targeted at institutional investors, they were provided by startups, which generally do not meet the necessary requirements or accepted risks of large institutions.
In contrast, with the Bakkt Warehouse, now an established and major corporation in the financial markets, the Intercontinental Exchange (ICE), is providing a custody solution that is likely to fulfil the compliance and requirements of institutional investors.
There are several factors that may attract large institutions to Bakkt’s custody solution and thus they may decide to diversify part of their portfolios into bitcoin, which could be positive for the overall crypto industry. In particular, the Bakkt Warehouse offers a $125 million insurance policy provided by a global syndicate of insurers, it is collaborating with BNY Mellon which is one of the leading custody banks worldwide, it is regulated by the New York Department of Financial Services (NYDFS) and it has third party audits. In addition, in terms of security, it provides bank-grade vaults and hardware security modules (HSMs), armed guards and disaster recovery plans as well as controls against insider threats.
If several large institutional investors decide to diversify into bitcoin using the Bakkt custody solution, this could create an increased demand for bitcoin and it may affect positively its price, especially since the current market capitalization of bitcoin is small compared to the asset under management of the largest asset managers. For example, Blackrock’s assets under management are close to $7 trillion, while the total market capitalization of bitcoin is below $200 billion. Therefore, if Blackrock or other major asset managers decide to diversify into bitcoin, even in a small percentage, the implications could be important and other asset managers could follow.
However, despite the institutional-grade custody solution and the $125 million insurance provided, bitcoin’s price volatility may still be an important risk factor for institutional investors, although the upcoming options of CME and Bakkt could contribute to better hedge and manage this risk.
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Crypto Storage AG expands to Germany as regulation for crypto assets evolves
Crypto Storage, which is a subsidiary of the Crypto Finance group based in Switzerland, informed in an official email that it will expand to Germany to offer storage of digital assets to institutional and professional investors.
Crypto Storage also mentioned that it will open a new office in Frankfurt and that the expansion to Germany was motivated by the new regulations regarding the 5th EU Anti-Money Laundering Directive (AMLD 5) that Germany will include into its banking law, in particular the Banking Act (KWG).
The new regulations affect crypto asset custodians and are expected to help Crypto Storage and other crypto custodians to continue their expansion in Germany through more regulatory clarity regarding their services and compliance requirements.
In order to offer crypto custody services, an independent legal entity is recommended to be exempted from the traditional capital requirements for financial institutions. Following a recent update of the bill, it will be possible to provide other financial services in the same entity apart from crypto custody, although in this case it will be required to comply with the necessary capital requirements.
Assessment
The Crypto Storage expansion to Germany is likely to have been motivated by the amendments introduced to the German Banking Act (KWG) based on the 5th Anti-Money Laundering Directive from the EU (AMLD 5), which will be implemented by EU member states from January 2020.
This new regulation provides trust and indicates that Germany is legitimising crypto assets. Since Germany is one of the major economies globally, it could become also a significant country for the blockchain industry and the token economy.
Crypto Storage is already establishing its presence in Germany through the participation in the Euro Finance Week in Frankfurt, in a program called ‘Blockchain Nation Switzerland meets FinTech Hub Frankfurt’. Given the proximity of Germany to Switzerland, it seems likely that Germany could also become a leading blockchain country globally.
From the beginning of 2020, crypto asset custody will require a licence with the German regulator BaFin, therefore compliance with the same standards as in traditional capital markets will be needed. In addition, other regulated banking or financial services are allowed to be provided by crypto asset custodians as long as they comply with the established BaFin capital requirements.
This implies that independent entities may be recommended to provide crypto custody services in order to avoid most of the capital requirements. Banks with existing licences for example could provide crypto custody either in the same entity or through a subsidiary to reduce or avoid most of the capital requirements.
Furthermore, security tokens may be classified as securities instead of crypto assets and therefore it may not be possible to store crypto currencies and security tokens in the same legal entity. Regarding the passporting rights framework in the EU, since custody of crypto assets is not defined in European regulation, the passporting rights are not applicable.
This implies that institutions based in Germany or in the EU that want to provide crypto asset custody to German clients will need to obtain the required licences and authorization.
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Regulated Swiss crypto bank SEBA opens doors
SEBA Bank, which is based in Zug, announced last week that its services for professional investors, enterprises and asset managers have been launched officially and that Swiss clients can now open an account, following a one month phase of testing.
SEBA recently obtained a banking and securities dealer licence from the Swiss Financial Market Supervisory Authority (FINMA) in August, thus becoming a fully regulated institution. SEBA also mentioned that from December this year it will begin to target clients from certain foreign jurisdictions.
Clients who open an account with SEBA will receive a SEBAwallet app, e-banking services and also a SEBA card with support for five cryptocurrencies including BTC and ETH. The SEBA cards can be used at 42 million sale points worldwide and through the online services provided, crypto to crypto or crypto to fiat conversion will be supported.
In addition, SEBA is introducing specific services for Swiss blockchain companies by providing them access to corporate bank accounts.
Assessment
The demand for crypto banking services seems to be gradually increasing. Some private and traditional banks based in Switzerland and Liechtenstein that started to provide crypto services have confirmed a significant demand for services such as custody or fiat gateways, with a large amount of requests received from interested clients.
New crypto focused banks like SEBA or Sygnum have received banking licences in Switzerland and Sygnum also in Singapore now. In addition, the US based crypto friendly bank Silvergate recently did an IPO in the New York Stock Exchange (NYSE).
Given the complexity and the speed of blockchain innovation, it seems that smaller banks are able to develop crypto products and services faster than large banks. While some services like custody are possible to be done independently through products such as Ledger, crypto banks provide a comprehensive offering which is preferred by institutional investors, corporations and some private individuals due to the efficiency, security and reduced complexity among other advantages.
In particular, spending crypto assets for purchasing different products and services is complex and crypto banks facilitate this with specialized cards for example. In addition, self-custody of crypto assets involve a lot of risks and therefore many crypto asset owners prefer to use the custody services provided by a crypto bank, especially for large amounts of crypto assets.
SEBA Bank was founded in April 2018, it has raised CHF 100 million and now in less than two years it is regulated and operational. Crypto banks provide additional credibility and trust to the crypto industry, and they may attract more institutional investors by providing a bridge between crypto and traditional banking.
While SEBA has now launched for Swiss clients, additional clients from other jurisdictions are expected to begin the onboarding process from next month in December.
It seems possible that in the same way that traditional banks were successful offering a comprehensive range of products and services focused on fiat currencies, crypto banks may also succeed by linking crypto assets with fiat money and traditional investment products.
In particular, the following services are expected to be in high demand by crypto banks’ clients: fiat gateways, custody with insurance and staking, cards to seamlessly spend crypto assets, the ability to use crypto assets as collateral for credit, the tokenization of traditional assets and online banking and apps integrating both crypto and traditional banking.
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Our weekly Crypto Industry Report news ticker provides you with the latest information on the global crypto industry – picked and analysed by our blockchain experts.
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