Many European countries, as well as national and international organisations have realised the new importance of the blockchain technology (also referred to as Distributed Ledger Technology or DLT) and related crypto assets, and have started to regulate this topic, albeit with very different approaches.
Typically, what is commonly referred to as a blockchain consists of a network of participating computers. Information in this network is stored decentralized and identically on each computer or node in the network. For example, an owner of a Bitcoin is registered on every independent server that forms part of the Bitcoin blockchain. Proponents of DLT say that this mitigates the risk of false or manipulated bookings, fraud and theft. If the data in one node gets edited without the approval of the other nodes, the DLT will not accept this change. The idea is that participating parties do not have to trust in the compliance with market regulation of service providers, like banks, brokers, stock exchanges or depositaries, but rather to make it technically impossible to alter the information of the network, and therefore not needing many of the regulations present in financial markets.
Crypto assets have been controversial since their beginning. While some countries worldwide are cautious about cryptocurrencies, many countries over the last couple of years (such as Germany, France, the UK, Liechtenstein, Luxembourg, Gibraltar or Cyprus) have started to pass regulation concerning the crypto space, despite the controversies surrounding this topic, perhaps due to acknowledging the potential and significance of the rise of crypto assets.
The European Union has also undertaken work on a new legislative proposal on crypto-assets, called Markets in Crypto-assets (MiCA), that was developed to help streamline Distributed Ledger Technology and virtual asset regulation in the European Union whilst protecting users and investors. Besides, it’s thought that regulating crypto assets by given them a legal status will prevent crypto assets from being used for illegal activities such as money laundering, tax evasion, or drug trafficking, thereby increasing their value in the long term. It’s estimated that about 0,05 per cent of northern and western Europe’s crypto assets activity is illicit.
With the VT Act (for “vertrauenswürdige Technologien” or trustworthy technologies), Liechtenstein is the only country analysed, that has passed a singular legal act regarding various issues related to crypto assets and the blockchain. The other countries chose the approach to regulate different questions regarding DLT and crypto assets in a more fragmented way, mostly by expanding already existing regulations onto certain aspects of crypto regulation. For example, Germany regulates crypto assets and investments into crypto assets in the German Capital Investment Act (“Kapitalanlagegesetzbuch” or “KAGB”) and financial institutions providing crypto services in the German Banking Act (“Kreditwesengesetz” or “KWG”). Luxembourg defines crypto assets in its Anti-Money Laundering Law.
Definition of Crypto Assets
One of the primary questions that every crypto regulation addresses is the legal qualification of crypto assets. There are multiple different types of crypto assets and there is no universal definition of this term (but there is often some overlap between the commonly used terms, such as “crypto assets”, “crypto token”, “crypto currency” and “virtual currency”). The cornerstone of every definition of crypto assets is the characteristic of being a digital representation of a right or value. Oftentimes, additional prerequisites may include that the crypto asset is not issued by an official source or does not meet the definition of other regulated instruments, such as financial instruments, e-money or legal tender.
This leads to a second common characteristic of crypto regulation: its design as a fall-back provision. In most cases, an asset will first be characterised as being part of other asset classes, whenever it meets their definitions. Only when an asset cannot be categorised under any other asset class will it be open for being a crypto asset. Most crypto-adoptive regulatory frameworks aim to capture under their definition of crypto assets all of these “remaining” assets, that did not meet definitions of shares, bonds, derivatives, etc., and that would commonly be referred to as “crypto”. The characteristic of being a fall-back provision also applies when it comes to the regulation of various types of crypto services and the providers of such services. Whenever a service provided meets the definition of a “classic” financial service, like operating a stock exchange, providing payment services or depositaries, these definitions apply. Only when none of the other cases apply, a service may be considered and regulated as a crypto service.
Private Law Questions
With regards to private law questions, some countries like France and Liechtenstein have passed regulation answering the most pressing issues, such as the prerequisites of legal transfers of crypto assets, acquisition via bona fide or the relationship between the crypto asset and any underlying right it represents. Other countries like Germany have not addressed these private law questions, yet. When no such clarifying regulation has been passed, legal literature tries to classify crypto assets under already existing legal concepts.
The Liechtenstein VT Act specifically addresses these private law questions in a dedicated chapter. A crypto asset has been transferred, when the acquirer has been registered as the new owner in the distributed ledger, all involved parties have agreed that the tokens should be transferred and the disposer needs to be entitled to dispose of the token. In case the disposer of the crypto asset was not entitled to do so, crypto assets can be acquired through bona fide. With the acquisition of the crypto asset also corresponds the acquisition of the right it represents. If the recipient needs to take further action to acquire the underlying right (e.g. filing of a change in ownership in the land registry), the disposer is responsible for these further steps and to prevent a conflicting transfer of the underlying right.
For comparison, in order to transfer crypto assets in France, the only provision is that the new owner has to be registered in the distributed ledger. In France, holders of crypto assets are considered to be their owner and therefore enjoy the same property rights that they would enjoy regarding tangible assets. Accordingly, in case of insolvency of intermediaries, like crypto exchanges and wallet providers, the crypto assets are not part of the insolvency estate, but remain in the ownership of the holder.
Crypto Service Providers
Another topic many regulatory frameworks touch upon is the creation and oversight of companies providing crypto-related services, often referred to as crypto service providers, or variations thereof. These services usually include the exchange between various crypto assets or between crypto assets and legal tender, access to and storage of crypto assets or access credentials. Again, usually these services can fall under pre-existing financial service categories, if their definitions are being met. Setting up a crypto service provider usually involves a registration with or approval of the home country’s financial market authority, including the fulfilment of requirements regarding the minimum capital, management team and compliance processes.
For example, on June 25th, 2021, the Cyprus Securities and Exchange Commission (CySEC) published the Directive for the Prevention and Suppression of Money Laundering and Terrorist Financing (Register of Crypto Asset Service Providers) which regulates three categories of crypto asset service providers, depending on whether they provide investment advice, brokerage activity with regards to crypto assets or administration and custody of such assets. Moreover, CySEC publishes on its website the register of crypto asset service providers, which is accessible by the public, the following information in relation to the registered crypto asset service providers.
Gibraltar has elected a very unique way of tackling the problem of balancing new regulation between being specific enough to provide additional regulatory value while at the same time being still open for new innovations in the field of crypto. Gibraltar has set out nine principles that every business that provides crypto services must follow. The interpretation of these nine principles is open to the Gibraltar Financial Services Commission (GFSC), which has published detailed guides regarding each principle. For example, some of these principles, set out in legislation, are that a crypto service provider must conduct its business with honesty and integrity, must maintain adequate financial and non-financial resources and must ensure that all systems and security access protocols are maintained to appropriate high standards. The GFSC informs through its guidelines how each of these principles has to be met and interpreted. In case a new DLT technology or business model enters the market, the GFSC could adopt its interpretation of these principles as suited, without the need to change the law.
Apart from above, wherever crypto service providers (including e.g. investment funds) are regulated, they must also comply with the requirements of money laundering and terrorist financing acts.
Crypto funds are a relative new form of investment funds, which emerged from the growing awareness of interest in crypto currencies. Investors interested in enjoying some of the volatile, yet often large returns of crypto currencies but not interested in the high risk and the process of trading on crypto exchange can invest in these funds. Crypto funds are funds that either exclusively contain cryptocurrencies, or funds that manages a mix between cryptocurrencies and other assets. This rather new segment of the investment industry is growing, with new fund launched and new inflows to already existing funds.
Most of the crypto funds worldwide, over 95 percent, are either venture capital funds or hedge funds, with a slightly higher number of venture capital funds than hedge funds. Except for these two, crypto funds can also be private equity or ETF, but these comprise a rather small share of total crypto funds, according to Crypto Fund Research analyses. As stated above, crypto funds are quite new in the investment fund industry and around two thirds of the crypto hedge funds were launched between 2018 and 2019, mostly in the US and various offshore jurisdictions, and average assets under management of crypto hedge funds more than doubled during these years.
An interesting topic that out of EU countries only Germany has specifically addressed so far is the ability of investment funds to invest a part of their AUM into crypto assets. Since July of 2021, so called Special AIF with fixed investment terms are allowed to invest up to 20 % of their assets into crypto assets. This addition has been made by simply adding crypto assets to the list of assets these funds can invest in and prescribing a percentage cap for crypto assets. Germany seems to be one of the first countries, if not the first among major European nations, to specifically allow institutional investments into crypto assets.
When it comes to setting up a German “crypto fund” and its governance, the already established rules for Special AIF with fixed investment terms apply. A Special AIF with fixed investment terms is a fund whose units or shares may be acquired only by professional investors, usually restricted on the basis of agreements concluded in text form with the management company or on the basis of the constituent documents of the AIF. They are to be distinguished from Public AIFs, which represent all other types of AIFs which are not Special AIFs. In order to set up an AIF management company, a petition has to be filed with BaFin, which has to subsequently grant the management company permission to manage Special AIFs. The fund itself has to be incorporated either as a separate fund, investment stock corporation, or investment limited partnership.
Switzerland is another country that allows investment funds to invest into crypto assets. As of 29 September, the Swiss market authority FINMA has approved the countries first crypto fund, issued by Crypto Finance AG, with SEBA Bank acting as its depositary. The fund is set up in the form of an “other fund for alternative investments" with special risk, under Swiss law. Distribution of this fund is restricted to qualified investors. FINMA categorized the funds as “other funds for alternative investments” that have particular risks. According to the financial watchdog, the approval of any crypto asset fund is tied to specific requirements due to the industry’s risk. For example, the fund may only invest in assets that are established with a large trading volume, and investors can only transact through established counterparties. The counter platforms must also be located in a member country of the Financial Action Task Force and must be compliant with anti-money laundering regulations.
More than half of the worldwide number of crypto funds were based in North America as of the third quarter 2020, and around one fifth in both Asia and Europe, respectively. The leading countries for crypto hedge funds were the United States and the United Kingdom, where 80 percent of crypto hedge fund managers were located. This, however, only refers to the physical location of the managers and not the jurisdiction of the fund.
Assessment of the regulatory situation in Europe
As the analysis of the above mentioned jurisdictions has shown, countries that are home to major financial hubs start to accept crypto assets as being its own investment class and start do adapt financial market regulations accordingly.
Liechtenstein’s approach to codify all regulation regarding the crypto space, be it questions concerning private law or the oversight of crypto service providers, into one singular legal act is very convenient for companies and legal advisors that have to apply these rules. Depending on the specific contend of each of the rules in Liechtenstein’s VT Act, it seems like rules are either a fall-back provision (likely the ones concerning the establishment of crypto service providers) or a lex specialis to already existing regulation (likely in relation to other private law rules). Having all crypto regulation in one legal act allows people interested in crypto to easily find all relevant provisions and sends the signal that crypto has been taken serious enough to deserve its own legal act. However, the approach chosen by other countries, to regulate crypto-related questions in already existing legal frameworks might provide for a more flawless integration into these areas and also more legal certainty, as it merely expands an already established field of the law.
Gibraltar, with its nine principles, has chosen a very innovation-friendly and flexible solution that will likely allow the country more flexibility in the future to react to new developments in the crypto space, that would otherwise cause new regulatory challenges. The nine principles and related crypto regulation did not make it into a new crypto act, like in Liechtenstein, but have rather been issued based on the already existing Financial Services Act. However, since most of the practically relevant information can be found in the GFSC guidelines regarding the nine principles, most of the relevant information can still be found comprised in one place. This allows Gibraltar’s crypto rules to be embedded into the already established financial services regime, while also appearing concise, well-structured and easily findable. Maybe the way Gibraltar executed the nine principles and adjacent guidelines could be considered to be the current “gold standard” regarding the balance between 1) the integration into already existing frameworks, 2) the establishment of a concise, clear and well-structured new legal act and 3) openness to innovation.
A negative example, on the other hand, is the way Germany implemented its crypto regulation. German crypto regulation is scattered between two different legal acts and countless of paragraphs, that only experts familiar with financial market law are able to make sense of. For someone without prior knowledge of the German capital market law system, it seems impossible to comprehend the German regulation of crypto assets.
Through enabling certain AIFs to invest into crypto assets, Germany has made a big leap in the direction of institutional crypto investment products. Nevertheless, while the possibility to invest 20 % of AUM into crypto is better than nothing, it can merely be seen as providing an additional way of diversification for funds between different asset classes. An exposure to crypto of only 20 % is too small to really enable the emergence of crypto investment products. In addition, the restriction to Special AIFs with fixed investment terms, which only institutional investors have access to, seems very conservative and might even cater to the wrong audience. Professional investors are themselves heavily regulated with regards to how much they can invest in different asset classes and might therefore be neither interested nor allowed to invest 20 % of their assets into crypto, if at all. On the other hand, many retail investors are involved in crypto investments, as many examples from the past months have shown (like Dogecoin and Bitcoin), and might be interested in crypto investment products and in need to have the option of a professional fund manager investing their funds into crypto assets. It seems unclear why retail investors should be denied access to professionally managed crypto funds, while they are at the same time allowed to “yolo” all of their retirement savings into hyped-up, pump-and-dump “shit coins”. This leads to a situation where access to crypto investment products is limited to institutional investors, many of which won’t be able or interested to invest in crypto, while retail investors, that might be interested and in need for professional crypto fund management, don’t have access to such products.
A final problem that every country faces when it comes to crypto regulation is the danger of overregulation. For proponents of the blockchain technology, one of the biggest arguments in favour of its widespread adoption of is the fact that crypto currencies and assets can technically operate outside of the reach of official institutions, as the technology of the blockchain promises to make trust in other involved parties and regulation to support this trust redundant. Even though the need for regulation in the crypto space is understandable, countries could risk their “first mover advantage” by overregulating crypto assets and therefore turning away crypto proponents and ruining the potential positive impact that a well-regulated crypto market could have. What is more, national and international authorities face challenging questions about the number the nature of crypto assets and their regulation, as certain aspects of the rapidly ecosystem and its related risks are still largely unknown.
In this respect it’s to be noted that regulators in other European jurisdictions have issued guidance on their approach to crypto assets. Some European jurisdictions have introduced specific regimes to encourage FinTech firms to set up in their countries and are promoting a “FinTech friendly” approach, which in and of itself does not face the crypto asset question, but rather allows firms which develop infrastructure and services related to the crypto-world to set up and develop in such jurisdictions.
On the other hand, on the long term, better, more comprehensive regulation of crypto assets may myriad advantages for investors and financial services in general. It could aid the development of new technologies, restrict the potential uses if crypto assets in fraudulent or illicit transactions, and reduce the risk of cyber-attacks.
What would a country need to offer in order to be considered the new “gold standard” (or “bitcoin standard” if you will) regarding crypto legal frameworks? From all of the findings from above, it can be said that the “ideal” crypto regulation could likely be achieved by embedding a flexible framework of principles or goals into an already existing regulation and specifying them via concise and well-structured guidelines by the market authority. This legal framework would solve some basic private law aspects unique to crypto assets. Furthermore, it should also allow crypto investment products to be available to retail investors and therefore really open the market for a brand new niche of investment products. Finally, the regulation would embrace the fact that the decentralised blockchain technology has a self-regulatory effect in some areas and, therefore, legal regulation should only be applied where the blockchain by its nature does not lead to regulatory benefits itself.
Going forward, the right approach will likely depend on how crypto assets themselves evolve. Projecting this evolution, and drawing conclusions on appropriate regulation requires analysis of the users and the crypto-economy in which they operate.
 Jones Day, 2019, White Paper: Setting Up Crypto Funds in the European Union, p 1 and 2.
 Terrorist financing just 0.05%of all illicit crypto transactions: report, 2021, https://www.livemint.com/market/cryptocurrency/terrorist-financing-just-0-05-of-all-illicit-crypto-transactions-report-11632295198513.html.
 Art 6 Liechtenstein VT Act (VTG); Lehmann, 2021, National Blockchain Laws as a Threat to Capital Markets Integration, p 8.
 Art 9 VTG.
 Art 7 VTG.
 Lehmann 2021, p 8.
 Lehmann 2021, p 9.
 Schedule: The Regulatory Principles, Financial Services (Distributed Ledger Technology Providers) Regulations 2020.
 Art 284 (2) 1 j and (3) 2 German Capital Investment Code (“Kapitalanlagegesetzbuch” KAGB).
 Art 2 (6) KAGB.
 Art 22 (1) KAGB.
 Art 20 (1) KAGB.
 Art 91 (1) and (2) KAGB; Art 273 KAGB.
 Cash.ch, 2021, Erster Schweizer Kryptofonds erhält Finma-Zulassung, https://www.cash.ch/news/top-news/bitcoin-co-erster-schweizer-kryptofonds-erhaelt-finma-zulassung-1831098, accessed on 29 September 2021.
 Before Part I, Financial Services (Distributed Ledger Technology Providers) Regulations 2020.