Luxembourg can be described as a country that stands out from the European and world FinTech market. Therefore, it seems that the process of opening to the crypto market will take place quite smoothly, thanks to which Luxembourg has real chance to become one of the market leaders.
Despite the fact that there’re no specific cryptocurrency regulations in Luxembourg, the government’s open to development in this matter. The best proof of this is that Luxembourg was the first country in Europe to license virtual currency exchange platforms named Bitstamp as payment institutions. What is more, a considerable number of FinTech companies, including leading industry players in e-commerce and e-payments, such as PayPal, Amazon and Rakuten have chosen Luxembourg as their European hub. There are over 240 fintech’ firms now operating out of Luxembourg, generating over 500 EURO million in annual revenue. It is also not without reason that it is mentioned as the top crypto hedge fund domiciles. A fintech-friendly jurisdiction, widely promoted and supported by national authorities, assuming an innovative approach to the use of modern solutions in the multiplication of capital undoubtedly attracts the biggest players on the market.
Luxembourg chose a similar way to Germany with regards to the regulation if the crypto space, as it mostly uses the already existing regulatory frameworks and applies them to crypto assets as well. Virtual assets are defined in point of Article 1 of the Law of 12 November 2004 on the fight against money laundering and terrorist financing, as amended, (AML/CFT Law) as a digital representation of value, including a virtual currency, that can be digitally traded or transferred and can be used for payment or investment purposes, with the exception of the virtual assets which qualify as electronic money as per point of Article 1 of the Law of 10 November 2009 on payment services, as amended, and the virtual assets which qualify as financial instruments as per point of Article 1 of the Law of 5 April 1993 of the financial sector, as amended. The development of new technologies like distributed ledgers and cryptography have resulted in the creation of various types of virtual assets that may be referred to as “virtual currencies”, “cryptocurrencies” or “tokens” (e.g. so-called “payment tokens”, “investment tokens” or “utility tokens”). Assets that meet the definitions of either e-money or financial instruments fall under the corresponding regulatory regimes. In general, wherever a particular service or token meets the definition of another regulatory regime, the said regime is applicable. For example, crypto exchanges need to obtain a licence as a payment institution.
What is important, on 21 January 2021, the Luxembourg Parliament adopted the Law of 22 January 2021 modifying the Law of 5 April 1993 on the financial sector and the Law of 6 April 2013 on dematerialised securities (the Bill). The Bill introduces important modifications to the legal framework applicable to dematerialised securities by explicitly allowing for the issuance of dematerialised securities directly using distributed ledger technology, such as blockchain.
First of all, the new regulation establishes a new definition of the issuance account, which means an account held with a settlement institution or central account keeper in which the dematerialised securities of an issuer must be registered exclusively. Account will be primarily held using DLT and no other record of the existence of such securities is required. This means that issuance accounts may be held within or through secured electronic registration devices, including distributed electronic ledgers or databases. The definition remains technology-neutral, what allows for the use of both traditional registers and databases and distributed ledger technology and databases. The Luxembourg legislator introduced a number of related items, including confirmation that successive registrations of securities using distributed ledger technology have the same effect as transfers between securities account. Luxembourg based actors will be able to expand their services with regard to dematerialised securities, this contributing to the attractiveness of the local financial sector.
Secondly, the Bill allows credit institutions and investment firms to operate as Central Account Keepers for the purpose of holding Issuer Accounts using DLT, without needing to obtain any additional authorisations from the Financial Sector Supervisory Commission.
The Bill is an important innovation to the Luxembourg legal framework affecting the operations of many market participants which are now vested with additional capabilities and may offer their clients a wider range of services in the rapidly evolving Fintech market. This regulatory also positioning shows that the Luxembourgish government wishes to promote as many blockchain-friendly projects as possible in the financial and others sectors. Previously the law of 1 August 2001 on the circulation of securities, as modified most recently on 1 March 2019, in a first step by the Luxembourg authorities towards establishing a legal framework for DLT, allowed accounts to be held and securities to be registered on such accounts pursuant to technologies such as DLT.
The following legal acts should be also mentioned among the important acts that may have a potential impact on cryptocurrency projects: the law of 5 April 1993 on the financial sector, the Luxembourg law of 30 May 2018 on markets in financial instruments, the Luxembourg law of 17 December 2010 relating to undertakings for collective investment, the Luxembourg law of 12 July 2013 on alternative investment fund managers, the Luxembourg law of 10 November 2009 on payment services and the Luxembourg law of 16 July 2019 on prospectuses for securities.
It is very important to emphasize that the Luxembourg cryptocurrency market is waiting for the completion of work on the draft regulation of the European Commission on Markets in Crypto-Assets Regulation. The indicated legal act is considered to be an important legislative direction for future domestic regulatory actions.
VIRTUAL ASSET SERVICE PROVIDERS (VASP)
The AML/CTF Law defines the term Virtual Asset Service Provider (VASP) as anyone who exchanges crypto assets for other crypto assets or fiat currency, transfers crypto assets between parties, safekeeps crypto assets or keys to crypto assets, or offers other services related to the offer or sale of virtual assets. VASP need to be registered with the Financial Sector Supervisory Commission (CSSF).
What is important, no provider of virtual asset services may be established in Luxembourg without being registered with the CSSF as provided for in Article 7-1 (1) of the AML/CFT Law. According to the official statement of the CSSF „Financial Innovation: a challenge and ambition for the CSSF” published on 8 February 2021, entities, who are established or provide services in Luxembourg, have to register with the CSSF in case they are providing one or more of the following services on behalf of their clients or for their own accounts:
- exchange between virtual assets and fiat currencies, including the exchange between virtual currencies and fiat currencies;
- exchange between one or more forms of virtual assets;
- transfer of virtual assets;
- safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets, including custodian wallet services;
- participation in and provision of financial services related to an issuer’s offer and/or sale of virtual assets.
Any entity, including any entity already licensed/registered by a competent authority and in particular licensed financial institutions, which offers or intends to offer any of the virtual asset services described above as from 30 March 2020 has to register beforehand as a VASP and comply with the professional obligations and the conditions described in the AML/CFT Law, as amended by the March 2020 Laws. The requirement of registration for applicants, who are established or provide services in Luxembourg, is without prejudice to any other license/registration or other status required either in Luxembourg or by other European or third countries for any other activities performed by the applicant. It’s worth to say that CSSF’s role for the VASPs registered in Luxembourg is limited to registration, supervision and enforcement for AML/CFT purposes only.
BitFlyer Europe has been granted a Payment Institution license in 2018 and has been the first company to get officially registered as a VASP in Luxembourg.
LUXEMBOURG HOUSE OF FINANCIAL TECHNOLOGY
Luxembourg has a dedicated national FinTech centre where finance and technology interact to foster innovation and develop solutions to shape the future of financial services – Luxembourg House of Financial Technology (LHoFT). Offering Fintech incubation, co-working and a soft-landing platform, the LHoFT also connects, engages with and creates value for the broader Fintech ecosystem: financial institutions, IT industry, investors, research and academia as well as regulatory and public authorities.
For investors, the platform helps connect investors to hosted and member Fintech firms that are seeking capital. It provides access to both solutions and the related market for its own Fintech companies through roadshows, accelerators, seminars and other forms of cooperation. The LHoFT also makes connections with other FinTech nodes around the world, encouraging domestic and international collaborations, working groups and initiatives. Without a doubt, Luxembourg has many sources of private and public funding available to boost the development of FinTech companies, not just as start-ups but throughout their life.
Recently Luxembourg has growing experience in servicing alternative assets funds, giving the green light to the activities of investment funds with exposure to crypto. This step is a great opportunity for funds waiting to expand their portfolio with a new type of assets. For investors, this means a reduction of legal risk of investment.
As of now, there is no uniform meaning of virtual monetary standards, either at national or European level. While there are no specific regulations for crypto funds, this does not mean that these funds operate in a regulatory vacuum. On 29 November 2021, in issuing composed of a statement and an FAQ (UCIs, credit institutions), CSSF introduced its general guidance on virtual assets
(the “Guidance”). The CSFF specified that an alternative investment funds (the “AIF”) managed by an authorised alternative investment fund manager (the “AIFM”) can invest directly in virtual assets under the following cumulative conditions: the AIF markets its units, shares, interests only to professional investors and the authorised AIFM obtains an extension authorisation from the CSSF for this new strategy.
The CSSF also draws attention to the integration phase of virtual assets in the investment policies of AIFs and reiterates the importance for AIFMs of having adequate internal control functions and their key role in the approve of new products/investment strategies, prior to applying for an extension authorisation from the CSSF for this new strategy. Given the broad range of virtual assets available, investment managers need to make a case-by-case assessment of the impact of these investments on the risk profile of AIFs they manage.
The Guidance also indicate that the CSSF pre-allows such arrangements with certain requirements. Initiators of AIFs that intend to invest in virtual assets should present their respective project beforehand to the CSSF. Authorised AIFMs wishing to manage AIFs investing in virtual assets must obtain a prior authorisation from the CSSF for the strategy “Other-Other Fund-Virtual assets”. Consequently an application must be submitted to the CSSF and, among others, the following information/documents must be provided:
- description of the project and of the different services providers/delegates involved;
- information on whether investments in virtual assets will be made directly or indirectly (by the means of derivatives for example);
- an updated risk management policy including in particular how the risks in relation to the virtual assets are managed;
- an updated valuation policy including the rules as to how the value of the virtual assets will be determined;
- a description of the experience of the portfolio manager (and other involved entities in the investment management process) in investments in virtual assets;
- a description of how the custody of the assets will be organised by the depositary;
- information regarding targeted investors, as well as any information on the distribution channels of the AIF;
- a description of the AML/CTF controls put in place by the authorised AIFM, on the assets side.
The Guidance state that should the AIFM (or any other participant) be involved in the control of the virtual assets by means of access to/control over the cryptographic keys, a complete application file for registration as a virtual asset service provider needs to be submitted to the CSSF before commencing any activity. Investment in virtual assets as defined by the AML/CTF legislation may be compatible with funds aimed at professional investors, as long as such investment does not prevent application of and compliance with existing regulatory requirements.
What is more, Investing in virtual assets as defined in the AML/CTF law of November 12, 2004 is not suitable for all types of investors or investment objectives, so UCITS or other funds targeting non-professional customers and pension funds may not invest directly or indirectly in virtual assets. However, assets that qualify as financial instruments, including shares of companies active in the virtual asset ecosystem, are not subject to this restriction and may be eligible investments for UCITS.
According to the CSSF, investing in virtual assets increases the money laundering and terrorist financing and proliferation financing risks. Therefore, measures must be put in place to mitigate the increasing risks accordingly.
Moreover, any activity involving virtual assets entails specific risks pertaining to their volatility, liquidity, technological risk, counterparty, custody or even reputation. Any entity under the prudential supervision of the CSSF interested in pursuing an activity involving virtual assets bears the responsibility to carry out a thorough due diligence and to carefully weigh up the risks and benefits associated with the proposed virtual assets activity with respect to the entity’s existing business model and risk appetite.
The CSSF's Guidelines also recall that the regulatory environment related to virtual assets is changing rapidly, and professionals should adapt their business and operational activities to such changes.
It is worth emphasizing that a key component of crypto funds is to interplay of three strategic elements: AIFM, depositary and crypto custody. What is more, actors involved in the cryptocurrency process must work together to find the balance between innovation funding and investors protection. Depositary liabilities are limited to losses that results of the depositary’s negligent or intentional failure to properly fulfil its obligations and depositary setup may include sub-delegation of the crypto-assets safekeeping duty to a third party.
An important novelty in crypto funds was introduced on the basis of a updated document issued by the CSSF on 4 January 2022 - “FAQ Virtual Assets – Undertakings for collective investment”. In accordance with the position of the authority, Luxembourg fund depositaries may be mandated to act as depositary for investment funds investing directly in virtual assets. However, a necessary condition to be met is the notification to the CSSF prior to commencement of operations and the implementation of an appropriate operating model and appropriate organizational solutions, considering the specific risks related to the safekeeping of virtual assets.
A depositary providing administrative and depositary services to an investment fund investing in virtual assets triggers an obligation to register as a virtual asset serviceprovider within the meaning of the AML/CFT law, if the depositary directly provides services related to the safekeeping or the administration of virtual assets, including the custodian wallet service, to its client). In relation to depositary services, for virtual assets that qualify as “other assets”, the depositaries’ liability in its depositary function is limited to safekeeping duties regarding ownership verification and record.
Prior to the CSSF position, Azimuth got approval to invest in virtual assets such as Bitcoin, Ethereum and other sub-asset classes such as DeFi tokens indirectly. The fund is intended only for professional investors. The representatives of Azimut said: “Digital Assets will allow exposure to cryptocurrencies in a dynamic, diversified way and within an active risk management framework. The portfolio will be managed to extract returns from an active allocation to sub-asset classes and will allow investors to participate in the full range of opportunities offered by digital assets without having to manage the technical and financial complexities typically associated with a new investment vehicle. The Fund will be managed by the Group's investment hub in Singapore, an Asian country that is recognised as a world leader in digital assets.” Moreover, Giorgio Medda, Co-Ceo and Global Head of Asset Management for the Group, commented: “The licence is a source of great satisfaction and recognition of the commitment and work we are doing to meet the needs of our customers now and in the future and to find new sources of revenue. We have been approaching the world of virtual assets for some time, exploring their underlying technologies and potential, following a global approach of risk and opportunity management on which the AZ RAIF II - Digital Asset fund is also based. The product initiative is aimed at long-term investment objectives over longer diversification horizons for our clients' portfolios in an extremely dynamic market environment for this asset class”.
An interesting fact is that FundsDLT - a investment funds distribution by leveraging on leading-edge technologies such as blockchain, cloud and APIs has announced that it is now in production with its blockchain-based platform that aims at simplifying fund distribution and fostering financial inclusion and savings. The first asset manager to go live on the platform will be mentioned Azimut Investments. Azimut Investments will be using the FundsDLT platform to benefit from full straight-through processing and process automation, as well as real-time cash reconciliation, also enabling the activation of new distribution channels, including digital. The platform enables a co-operative ecosystem between all actors in the distribution chain to exchange data in real time and remove redundant activities. FundsDLT aims to reduce costs through automation by sharing funds data in a permissioned fashion between the asset manager, distributor and client investor.
CRYPTO PERSPECTIVE FOR THE FUTURE
As PWC rightly argues,  as time goes on, investors are becoming more and more convinced of crypto assets as a full-fledged asset class. Both institutional and retail investors will be looking for active and passive investment vehicles, exposure to a basket of crypto assets to meet diversification criteria, crypto asset derivatives for risk management considerations and other more complex products.
The Luxembourg cryptocurrency market is constantly developing, pretending to be an important European financial center. Crypto asset management, digital funding, tokenization, crypto-funds or DLT market infrastructure are areas that make Luxembourg really stand out. Luxembourg is becoming the place to be for cryptocurrency investments and ideal environment for FinTech with an engaged and accessible ecosystem, a multilingual workplace fluent in French, German and English, and a truly international orientation. Regulators, public bodies, market players and traditional actors are maturing on crypto-related matters. Striving to ensure a transparent regulatory framework and appropriate business support may turn out to be activities that provide the state with a well-deserved crypto podium in the long term.
r.pr. Tomasz Matczuk
r.pr. Filip Suchta
apl.adw. Małgorzata Dąbrowska
 3rd Annual Global Crypto Hedge Fund Report 2021 published by PWC.
 Art 2 (1) 16 Luxembourg AML/CTF Law.
 Art 7-1 (1) Luxembourg AML/CTF Law.