Crypto Nation Switzerland Boosts DLT Regulatory Framework

The so-called Crypto Valley, usually meaning the area covering Switzerland and Liechtenstein, is the home of 919 crypto-related companies with around 4,784 employees. In the midst of them, there are already 6 Unicorns – i.e. projects valued at more than USD 1 billion: Ethereum with USD 25.3 billion, Cardano with USD 2.2 billion, Dfinity with USD 2 billion, Tezos with USD 1.8 billion, Polkadot with USD 1.2 bio, and Libra with USD 1 billion Many existing players in the Swiss crypto industry have recently been successful in raising significant additional funds, such as Bitcoin Suisse AG with USD 48 million, 4ART Technologies AG with USD 45 million, METACO SA with USD 20 million, Crypto Finance AG with USD 14 million, or Near Protocol with USD 12.1 million (figures from CV VC Top 50 Report H1/2020).

In view of this massive impact of the crypto industry since early on, it is not surprising that the Swiss Financial Market Supervisory Authority (FINMA) was one of the first regulators to tackle crypto projects such as Ethereum, Xapo or Bitcoin Suisse in 2013. It published its internationally well-known, accepted and – at times – copied practice regarding International Coin Offerings (ICOs) and token qualification in 2017 and 2018; the stablecoin amendment in 2019; and it granted the world's first full banking licences to the two crypto banks SEBA and Sygnum after already having granted one of the first fund asset manager licences to Crypto Fund AG in 2018. The Swiss government has also published several reports about virtual currencies, distributed ledger technology (DLT) and blockchain since 2014 and in September 2020, both chambers of the Swiss Parliament approved unanimously a new DLT bill amending 10 different laws targeting specifically necessary points, such as the introduction of new register value rights being transferable over the blockchain; a new category of DLT trading systems; and clarifying the possibility to segregate crypto assets or access data (such as passwords or private keys) in case of an insolvency or clarifications in treating certain decentralised business models under Anti Money Laundering (AML) regulations.

Switzerland will continue to evolve its already high standard regulatory framework for crypto into one of the most advanced in the world once the DLT bill will come into force, presumably on 1 August 2021. However, all provisions regarding the new register value rights will definitively enter into force earlier on 1 February 2021. The government's explicit approach is to create the best possible framework conditions so that Switzerland can establish itself and evolve as a leading, innovative and sustainable location for fintech and DLT companies.

The following gives a short overview of the Swiss legal framework for crypto:

Swiss Approach Of Regulating Crypto

Switzerland has no crypto-specific regulation because it decided to apply its existing laws also to crypto. This is possible because Swiss law is a principle-based law and the Swiss government and the Swiss regulator FINMA ensured that the law complies with the principle of technology neutrality. In view of this, FINMA decided early on to categorise crypto assets based on the underlying economic function and to apply the already existing financial market regulations to the crypto asset itself, its issuance and transfers as well as to business models related to crypto assets. Further, FINMA follows the principles of same business, same rules and substance over form, similar to the widely known US saying, "If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck".

Token Categorisation

FINMA differentiates from a financial market regulatory point of view between three distinct types of crypto assets (which it refers to as tokens):

1. asset tokens that function like a security with claims against its issuer;
2. payment tokens having the function of being a means of payment; and
3. utility tokens which often grant some sort of access rights to its holder.

Of course, a token can have more than one function at a time (a so-called hybrid token) or evolve over time into other functions, e.g. a protocol token being originally qualified as a utility token and, later on, additionally taking up a payment function.

From a civil law point of view, two types of token can be distinguished: first, there are tokens that primarily represent a value in itself in the blockchain context (e.g. cryptocurrencies such as bitcoin). According to the prevailing view, these so-called ‘payment tokens’ represent purely factual, intangible assets. The second category of token covers those that represent a legal position (e.g. a claim or membership) and fulfils a similar function as securities, sometimes also described as "I-owe-you-tokens".

Payment – Maintaining Accounts, Transacting, Borrowing And Lending

Although payment tokens such as bitcoins are not considered legal tender in Switzerland, they are treated as means of payment like other currencies because they follow – more or less – the three functions of money: means of exchange, unit of account, and store of value.

Therefore, Swiss AML regulations, as well as banking regulations, apply regardless of FIAT currency or crypto currency being involved.  For example, money exchange or money trans-/remittance are subject to AML regulations regardless of the exchange being FIAT-to-FIAT, FIAT-to-crypto or crypto-to-crypto.

The core of banking is the interest difference business: granting loans on the active side of the balance sheet for interest revenues and financing these loans by taking in deposits of customers on the passive side of the balance sheet for paying slightly lower interest rates. The bank-run issue comes up because there is a period-mismatch between these two: mid-to-long-term loans are financed by short-term deposits. Therefore, banking regulations are the most complex, regardless if banking is done with FIAT currency or payment tokens. If one acts as custody wallet provider, i.e. one has access to the user's private keys for wallets with bitcoins or other payment tokens in it, and if the bitcoins are not properly segregated per user in different wallets, such payment tokens are considered public deposits like any other claim with debt character (e.g. loans), which triggers the requirement of a banking licence.

The new DLT bill will ease the segregation requirement insofar as that it will be sufficient for not requiring a banking licence if the payment tokens can, at every time, be individualised per user solely based on records. However, for such pooled accounts with payment tokens one will need a Fintech licence which allows conducting the activity on the passive side of the balance sheet without doing so on the other side, i.e. investments/loans.

Pure lending – be it with FIAT or crypto currency – is subject to Swiss AML regulations only. However, if the lending (active side of the balance sheet) is re-financed either by public deposits or by more than five banks for more than CHF 500 million (passive side of the balance sheet), a banking licence is required.

Regardless of the underlying of a credit, debit or prepaid card being FIAT or crypto, issuing such card is at least subject to Swiss AML regulations and requires the issuer to join one of the currently 11 Swiss self-regulatory organisations (SRO) recognised by FINMA under the Swiss AML Act. Finally, transacting with payment tokens on behalf of third persons (e.g. FX brokerage) is usually subject to AML regulations. Even in decentralised structures or in business models based on smart contracts, the decisive element is the possibility of control over the smart contract, the wallet, and/or the tokens in it.

Investing, Trading And Custody

Asset tokens are considered as being only one of several forms of securities: there are certificated securities, uncertificated securities, book entry securities or tokenised securities. Whatever can be securitised according to Swiss civil law can also be tokenised: e.g. every type of contractual claims, shares of corporations, bonds, warehouse certificates, and promissory notes. However, property rights like ownership rights can neither be securitised nor tokenised.

The new DLT bill will ease the legal requirements for transferring asset tokens validly according to Swiss civil law: at the moment, transferring legal claims in Switzerland – including asset tokens – requires a written assignment with wet signature, which is a no-go in the digital DLT-world. The DLT bill will therefore introduce a new register value right, which is entered and transferred only over such register, e.g. a blockchain, without any further formal requirements.

Trading asset tokens on behalf of clients is subject to a securities house licence from FINMA. Placing asset tokens on the primary market or issuing derivatives in the form of asset tokens requires a securities house or banking licence. Pure custody of asset tokens is subject to Swiss AML-regulations only.

Financial Market Infrastructures

Switzerland differentiates between three types of regulated trading platforms: stock exchanges for multilateral trading of listed securities/asset tokens; multilateral trading facilities (MTF) for multilateral trading of non-listed securities/asset tokens; and organised trading facilities (OTF) for multilateral/bilateral trading of other (tokenised) financial instruments than securities. Direct access to stock exchanges and MTFs is limited to regulated participants.

The DLT bill will introduce a fourth type, the DLT trading facility, which is basically an MTF with direct access for retail clients and which is also allowed to perform clearing, settlement and custody services within the same legal entity.

Outlook

The new DLT bill will elevate the already very favourable Swiss crypto regulatory framework to one of the most advanced globally, in particular by introducing the new register value rights, the new DLT trading system, and easier segregation requirements for payment tokens.

Dr. Reto Luthiger
Reto Luthiger is a Partner with MLL Legal and Co-Head of the Regulatory, FinTech & DLT Team. He is a financial market regulatory as well as a DLT/blockchain specialist. He advises and represents domestic and international clients in financial markets regulatory and civil law matters as well as proceedings before FINMA, self-regulatory organisations (SROs), supervisory organisations (SOs) other authorities and courts. He has wide-ranging experience in banking, securities brokerage, anti-money laundering, financial services, financial markets infrastructures and collective investment schemes as well as FinTech, InsurTech and DLT/blockchain.