A guest contribution by Hartmut Giesen

At the end of November, in the course of the implementation law of the 4th Money Laundering Directive, the amendments to the German Banking Act (KWG) on the regulation of crypto transactions, which had been the subject of much discussion in recent months, were adopted. The KWG now defines the new financial instrument crypto value (hereinafter often referred to as crypto or cryptos), and at the same time crypto value custody was included in the law as a new financial service. Crypto depositors need a Bafin license and must identify their customers according to the Money Laundering Act in the same way as banks do.

Not included in the law was the passage discussed in the meantime that crypto custodians may not offer any other financial services. If this passage, which was still in the government draft of the law, had been passed, this would have meant for banks that they would not have been allowed to offer crypo-deposit. And conversely, crypto custodians should not have had other financial services in their portfolio.

New crypto-regulation: legal certainty for banks and cryptotechs - but no change in the status quo for banks.

In the reporting on the legislative resolution, the impression was created that the amendment to the law only now allows banks to offer crypto custody and trading. This is simply wrong. Banks were already allowed to offer their customers cryptos and to store them. The law has now only clarified that they may continue to operate the custody business after 2020.

There are other reasons why banks have not yet entered the crypto business, apart from a few exceptions – which actually do exist.

Why banks have not yet offered crypto trading and custody

There are a number of reasons why banks have so far crypto business in general and before crypto trade or storage in the special have shrunk back.

The general reasons are as follows:

  • Lack of regulation: In addition to the Bafin ruling that crypto currencies should be treated as financial instruments with the corresponding consequences for licensing obligations, there has been and still is a great deal of uncertainty on many (regulatory) issues such as accounting, money laundering regulations, safekeeping, etc.
  • The reputation of crypto currencies in general: They are not wrongly assumed to be close to criminal activities. Banks do not want to enter this environment;
  • Lack of know-how even among established consultants
  • The typical innovator dilemma: The volume of crypto businesses was and is comparatively small, but at the same time carries high risks and a high degree of uncertainty as to how it will develop. In addition, it potentially endangers the existing business of the banks.

Challenges of the crypto trade

Crypto trading, which is already carried out by at least two banks and the Stuttgart Stock Exchange, causes difficulties for banks for the following reasons:

New crypto-regulation: legal certainty for banks and cryptotechs - but no change in the status quo for banks.

– The money laundering effort is relatively high and the necessary analyses of the business – from the crypto origin analysis to the risk analysis of the wallet addresses involved – must first be learned and checked. The pseudonymous character of the crypto processes represents a fundamental challenge for money laundering monitoring.

One knows which wallet addresses are involved in transcriptions, but not with absolute certainty which persons are behind them. Nevertheless, in its money laundering risk analysis, the Ministry of Finance stated that the money laundering risk of cryptos such as Bitcoin is rather low, especially in comparison with cash  

-There were no regulated crypto trading partners for banks – now there is the Stuttgart Stock Exchange.

-There are no uniform rules yet for the balancing of cryptos. Accounting as intangible assets has emerged as a practice under the IFRS accounting standard. This is very unfavourable for banks because it leads to a high equity burden when crypto items are included in the balance sheet. These items are deducted in full from equity.

-Civil uncertainties in selling cryptos to retail investors: There is at least a risk that courts may declare cryptos unsuitable for retail investors and may imply that banks sell unsuitable financial instruments to their customers.

Challenges of crypto-custody

Many reasons why banks have not yet offered crypto trading are also striking for the custody business. But there will be more to come;

The technology for crypto-custody is new and must first be to be understood completely. The numerous hacks, which also include renowned crypto companies have taken, argue that this technology is also was not yet completely mature.

This is associated with the high risks that can arise from the loss of cryptos. Currently, there are hardly any possibilities to insure oneself against the loss of digital assets.  

How market conditions are changing

For banks, the law does not initially change anything, except that the prevailing practice is now legally underpinned and there is legal certainty for the future. However, many of the reasons that have kept banks away from crypto businesses have not disappeared due to legislation. It is therefore unlikely that banks will now start selling massive cryptos to their customers. Rather the opposite is to be feared. Regulation makes banks an indispensable part of the crypto business infrastructure. If they do not dare to enter the business field, the development of infrastructure and innovations will be slowed down.

“It is not to be expected that banks will now begin to sell massive cryptos to their customers. The opposite is to be feared.”

The law will have an effect to the extent that, for banks it is now clear that in the future they will be responsible for the entire crypto value chain can offer –  what at the same time means that you must at least check these options, because the Competitors will certainly do the same.

Apart from the fact that short- and medium-term potential must also be exploited in the crypto business, it is now clear at the latest – especially when one sees the legislative changes in connection with the federal government’s blockchain strategy – that the financial industry as a whole is moving towards a “tokenised future”. The technology with which cryptos in the sense of crypto currencies are processed today is the technology with which electronic securities will be traded in the future. Banks must prepare for this future when they are on the move in the securities business.

This is no longer just about crypto tokens, their trading and safekeeping, but also about processes in securities settlement, for example, where the block chain as a technology offers enormous optimization potential that progressive houses will soon use and thus exert pressure on the less innovative houses.

To the author:

Realized since 2012 Hartmut Giesen digital business models for Sutor Bank. His tasks include business development Fintech, digital partners and Crypto/Blockchain, the development and expansion of the Sutor Banking platform and the support of internal digitization projects. Previously, he was active in high-tech marketing as an agency board member and founder of his own agency.