Interest in Crypto: A regulated activity?

This article first appeared on the Fin Law Blog.

The crypto depository company has been a regulated financial service in Germany since January 1, 2020. Companies wishing to offer their customers storage, management or security of crypto assets or the associated private cryptographic keys must first be licensed to operate the BaFin business model. In the constantly evolving crypto market, crypto depot is a service of particular importance, which is a mandatory component in all centrally designed crypto business models.

As crucial as crypto depot may be for the mass adoption of crypto, it is not the core of the services that the market demands. Against this background, it is more an accessory to other service offerings such as crypto exchanges or lending / betting models. The profit margins for the actual storage of cryptocurrencies are relatively low. The question arises as to whether cryptocurrencies are allowed to offer customers interest on the cryptocurrencies stored in the custodian, in addition to just the custodian on the basis of their crypto license.

Crypto custody license covers three different business activities

BaFin’s license to operate the crypto depository business not only allows crypto depository service providers to store crypto assets and associated private keys. On the contrary, the facts about the crypto depository business regulated by the German Banking Act (KWG) also cover two other business activities with the administration and security of crypto assets. BaFin, like the German legislature, understands the management of cryptocurrencies as the management of rights from cryptocurrencies for others in the broadest sense.

Crypto asset protection refers to the storage of private cryptographic keys on storage media, whether the storage media is digital (cloud storage) or physical (USB stick or even paper). Like the other two variants, the security variant also requires the provider to have access to its customers’ crypto assets through the deposit of the private keys. As BaFin interprets the administrative action alternative broadly, the question arises as to whether the allocation of interest also falls under the variant and thus may be covered by the crypto-depositary license.

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Crypto-administration only conceivable in triangular constellations?

Although BaFin interprets the variant of the administration in the offense of crypto depository business very broadly, there are good arguments against registering the interest rates on crypto assets of the crypto administration. Because the exercise of rights, both in BaFin’s published administrative practice and in the explanatory memorandum to the draft law prepared before the introduction of the crypto depository business, basically requires the crypto administrator to assert his client’s right vis-à-vis a third party who is different from custody.

On the other hand, the allocation of interest on the crypto assets held in custody would be a right for the customer directly vis-à-vis the custodian bank, which the custodian bank could not assert against itself. According to this argument, interest on crypto assets will not be classified as crypto administration within the meaning of the second variant of the crypto depository business.

Is it then possible to pay interest on cryptocurrencies without regulation?

Although the allocation of interest on crypto assets could not be classified as crypto administration, a similar activity may still represent a licensing transaction depending on the individual case. It is conceivable that the interest rate provider would operate the authorized financial portfolio management if, at its own discretion, it was allowed to use its custodian clients’ crypto assets in order to generate profits to finance the interest rate.

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