We’re witnessing a real cryptocurrency revolution taking place in Germany. Crypto law is actually a cross of number of different legal fields such as IT law, financial regulations, financial investment regulations, contract law, data protection, anti-money laundering regulations or tax law. It’s estimated that over 2.1 million people, 2.62% of Germany’s total population, currently own cryptocurrency. What is more, there’s a growing interest of Germans in purchasing this type of currency so it may be said that Germans are open to crypto. The same source states that a majority of German cryptocurrency owners are in the 18-34 age group – 33 %. Only 5% of them are 55 and above. Cryptocurrencies are largely owned by young, tech-savvy and affluent Germans.
Germany recognizes this challenge and therefore strives to prepare an appropriate legal environment for various types of investments. That’s why Germany is one of the first European countries to strive to create a comprehensive and unique legal regulation of crypto assets, and thus a high level of investor protection. Not without reason Germany is also one of the top crypto friendly countries in the world and is considered to be an attractive country for individuals to invest in cryptocurrencies. The German legislator has already taken steps to integrate blockchain technology into the national legal system a few years ago. And this is just the beginning.
Germany has no specific regulatory framework for virtual currencies and other virtual assets in place yet, the general financial regulatory regime applies instead, and brings various types of DLT (“distributed ledger technology”) tokens within the ambit of capital markets, banking, financial services, anti-money laundering (AML) and other laws. In some aspects, the application of these legal regimes for virtual currencies has recently been clarified by the legislature (e.g., use of digital registers for dematerialised securities).
Despite the above, the German government is supporting blockchain-based innovation across a variety of industry sectors with its blockchain strategy, published on 18 September 2019. Since then, legal and regulatory certainty for blockchain innovation has been enhanced through a number of regulations - the German legislator is successively creating a regulatory network and the German Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht or BaFin) publishes guidelines.
Germany, as a member state of the European Union is also obliged to comply with EU cryptocurrency regulations. Therefore, the European Commission’s proposal of regulation on Markets in crypto assets (MiCA) published in September 2020, if adopted, will also be binding in Germany. At present, however, it seems that Germany is ahead of the EU with its regulatory innovation, creating its own far-reaching standards.
According to the definition contained in Section 1 para. 11 sentences 4,5 of the German Banking Act (KWG), crypto assets are digital representations of a value that have not been issued or guaranteed by any central bank or public authority and that does not have the legal status of a currency or money, but that is accepted by natural or legal persons as a means of exchange or payment on the basis of an agreement or actual conduct or that serves investment purposes and that can be transferred, stored and traded electronically. The law does not go into detail which specific assets can be considered crypto assets under this definition. All assets that meet these requirements are crypto assets.
Crypto assets do not constitute e-money as defined in Section 1 para. 2 sentence 3 of German Payment Services Supervision Act (ZAG) or a monetary value which fulfils the requirements of Section 2 para. 1 no. 10 ZAG or which is only used for payment transactions pursuant to Section 2 para. 1 no. 11 ZAG. The term crypto asset is intended to be a fall-back provision. An asset will only be considered a crypto asset, if it cannot be characterised as being part of another asset class. In other words, on a case-by-case basis it must be determined whether or not a crypto asset is comparable to a share, bond or fund unit, a so-called asset investment or other sub-category of “financial instrument” such as a crypto-asset (Kryptowert) or even e-money.
Asset-backed crypto assets could be considered to represent claims for the performance of the underlying asset and be protected under the same rules as other claims. Crypto assets do not fulfil the requirements to be considered tangible assets, but a case could be made to expand the protection of tangible assets to crypto assets as well, even though there is neither legislative nor judicial consensus about this characterization.
Since the entry into force of the German law implementing changes to the 4th AMR, on January 1, 2020, each entity using cryptocurrencies in its business must obtain an appropriate BaFin permit for such activities. In addition, the concept of a cryptocurrency financial transaction was introduced to the German banking law, which requires the authorization of an appropriate authority - the indicated level of protection goes beyond the legal framework provided for at the EU level, creating an innovative solution. The use of cryptocurrencies as a substitute for traded cash is not a licensed activity as the service provider can pay for its services with crypto assets without the need to provide banking or financial services. Likewise, mining cryptocurrency and then selling it is not an activity that requires a license. It is worth remembering, however, that the legal qualification of the activity should be assessed each time, because the occurrence of additional circumstances in cases not subject to authorization may result in the necessity to apply for a license.
BaFin plays an important role in shaping the legal cryptocurrency environment. This authority in its official statements refers to various types of crypto assets – BaFin for example saw the need to clarify security tokens, which are not considered to be transferable securities in the sense of a security deposit. BaFin fail to mention, whether security tokens are therefore automatically crypto assets, although they are considered securities with respect to the regulation of the prospectus. Security tokens are now also regulated under banking laws, and they will often be considered securities, which means various capital market and investment laws (with prospectus requirements) may apply.
BaFin has issued a guideline detailing their legal understanding regarding the nature of crypto assets. The key take away is, that the characterisation of a crypto asset as being part of a pre-existing asset class can only be made on a case-by-case basis. A crypto asset is a transferable security within the meaning of the German Securities Trading Act (“Wertpapierhandelsgesez” or “WpHG”) and MiFID II directive, when it can be transferred, traded at a marketplace (including crypto trading websites) and give certain rights to the holder, such as shareholder rights or claims. The name of the token (such as “utility token”) is not relevant for characterising a token. If a token is characterised as a transferable security, relevant laws, such as the German Securities Trading Act and the MAR directive, may apply.
BaFin also, in line with its many years of practice, classifies Bitcoins as units of account, and thus as financial instruments. They are compared to foreign currencies, but they are neither legal tender (so they are also not currencies) nor e-money. This legal classification is generally applicable to all virtual currencies.
It is worth mentioning the general regulatory requirements for institutions providing financial services using blockchain technology that require obtaining an appropriate license, e.g., offering cryptocurrency trust services. BaFin imposes strict requirements on managers of such institutions, such as the need to undergo appropriate vocational training or obtain a university degree in specific fields of study or have practical experience in management in the banking sector.
The German legislation differentiates between funds investing in crypto assets and companies providing crypto custody services. Crypto custody means the safe keeping, administration or storage of crypto values or private crypto keys used to hold, store or transmit crypto values for others.
As of 1 January 2020, Germany introduced a licence requirement for the provision of crypto custody services. Similar to the licence requirement for the safekeeping and administration of traditional securities, this requirement now also applies to the safekeeping, administration and protection of so-called crypto-assets (Kryptowerte) or private keys to crypto-assets.
In "Guidelines concerning the statutory definition of crypto custody business" of March 2020, BaFin provides guidance on the scope of the licence requirement and has stated explicitly that any security or investment token that represents or is comparable to any traditional financial asset is subject to the crypto custody licence.
Companies, which aren’t located in Germany fall under the regulation if they actively approach the German market with crypto custodian services. There is no final definition of what is an active approach but the BaFin uses specific criteria in order to assess whether the German market is actively approached. Crypto custody license requirement for crypto custody is not based in EU law and the system of passporting is an EU law-based system. Other EU countries don’t have a license requirement for crypto custodians but only registration requirements and a license granted in Germany cannot replace the local registration in another EU country.
Additionally, the custody of crypto assets is included as a new class of investment service. The crypto-custody business is the counterpart to the classic custody business, which only refers to securities.
German Federal Central Tax Office considers cryptocurrencies as private money for tax purposes. In this sense, cryptocurrencies are not considered as a legal tender, foreign currency nor as property. At a personal level, profits regarding cryptocurrencies are tax-free if the total profit generated from private dales transactions in the calendar year was less than 600 EURO and sales of cryptocurrencies held over a year are tax exempt in Germany.
The German Capital Investment Code (KAGB) provides a comprehensive regulatory framework for the distribution, management and safekeeping of investment funds, and sets out organisational and transparency requirements for their managers and depositaries. It implements undertakings for collective investment in transferable securities (UCITS) and the Alternative Investment Fund Managers Directive (AIFMD). Prospective investors must be provided with detailed information in the form of a prospectus or offering memorandum. Failure to comply with the pertinent requirements will expose managers to liability claims. Definition of investment undertaking from the KAGB may apply in particular to investment funds investing into cryptocurrency tokens, security tokens or utility tokens.
The scope of requirements under the KAGB further depends on the type of fund. In this respect, the KAGB distinguishes between alternative investment funds (AIFs) that are available to professional and semi-professional investors only (special AIFs), and public investment funds, such as public AIF, which are available to retail investors. The investment funds are supervised by the Federal Financial Supervisory Authority (BaFin).
Germany has approved new legislation allowing to invest in crypto assets. On 22 April 2021, the new regulation - Fondsstandortgesetz (FSG), which was aimed at making Germany a more attractive market for investment funds was passed by the Bundestag.
The new law applies only to domestic Spezialfonds, also known as special funds, which are only accessible to institutional investors (not to the general public) such as pension funds, banks, corporate funds and insurance companies and therefore allows institutional and potentially direct access to funds investing up to 20 % of AUM in crypto. Special funds are aimed solely at institutional investors and are not available to the general public. Special funds have greater freedom in defining their investment strategy and even have the power to agree with investors in certain circumstances assumptions that deviate from the applicable regulations. This allows for more risky investments. This limitation results from the remaining legal uncertainties, particularly with regard to the custody of the funds’ assets by the custodian. The changes bring cryptocurrencies into the traditional, and more regulated, financial system and could result in increased, albeit intermediated, exposure to crypto assets for retail investors whose assets, retirement benefits or insurance policies are managed by such institutions. In all, around 4000 existing investment funds will be eligible to invest in crypto assets.
The new regulation allows special funds to allocate up to 20% of their capital in Bitcoin and other cryptocurrencies. In the opinion of experts, most funds will initially stay below the 20% mark. On the one hand, institutional investors such as insurers have strict regulatory requirements for their investment strategies and on the other hand they must also want to invest in crypto. Open-ended Spezialfonds had assets under management (AUM) of 2 trillion EUR at end-March 2021, or around 1.8 trillion EUR net of property funds, funds of funds and feeder funds. This could imply maximum crypto-asset investments of up to 360 billion EUR –compared to bitcoin’s current market capitalisation of around 860 billion USD. Theoretically, up to 350 billion EUR could enter the crypto market from those special funds alone.
Spezialfonds are compared to Special Investment Funds (SIFs) in Luxembourg and Qualifying Investor Funds (QIFs) in Ireland. These types of investment are attractive to investors because they allow for flexibility and are much less restrictive in requirements for liquidity, diversification, restrictions on borrowing, and leverage. Simultaneously, a robust regulatory framework provides assurance for investors.
The Federal Association for Alternative Investments (BAI) is positive about the new crypto rules. However, there are voices that the regulation should also cover public funds, and not only special funds. So far to the best of our knowledge, there is no information available as to Spezialfonds that already invest in crypto assets.
The asset investments that don’t qualify as investment funds under KAGB or as securities under the German Securities Prospectus Act distributed in a public offering sets out the German Asset Investment Act. This regulation may apply to tokens of any type, in particular where a securities token embeds certain characteristics of an investment but doesn’t meet all criteria required for the qualification of a transferable security under UE regulation.
Now, the funds are set to become the latest addition to the tools, which institutions have at their disposal enabling them to buy into digital assets without purchasing actual cryptocurrency—thus circumventing the need to deal with crypto exchanges or digital wallets. The addition of crypto assets in special funds is an important next step towards legitimising crypto assets as an asset class. The regulation has been hailed as a big boost to Germany’s position as a financial investment hub, and experts believe it will nurture the crypto industry as a whole by further legitimizing the asset class. 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. Thanks to this move Germany is taking a lead, underlining a major positive shift in global market perception. The change of law is a great opportunity for cryptocurrency and blockchain supporters in Europe and around the world. The new regulation could lead to an eventual boom in the market. The decision by German has opened a new avenue for other countries to allow investment in crypto projects by major institutional players.
 BaFin, 2020, Merkblatt: Hinweise zum Tatbestand des Kryptoverwahrgeschäfts, p 2.
 Wegener 2021, p 46.
 Wegener 2021, p 46, 48-50.