Switzerland has made waves in the world of cryptos and digital assets. Its “crypto valley” in Zug is now one of the more recognised centres of this space. Industry figures are becoming concerned about how the regulator intends to enforce new legislation. We talk to parties on all sides in this detailed feature.
Switzerland has pivoted from being a secretive international
banking centre. As it adapted, the European nation pushed its
credentials as a fintech powerhouse. And that’s included becoming
one of the world’s hottest places for cryptocurrencies and
digital assets.
But there’s a potential fly in the ointment.
With the European Union having recently unveiled its Markets in
Crypto Assets Regulation (MiCA) – Swiss authorities know they
can’t rest on their laurels. And it seems that the industry in
places such as Zug’s “crypto valley” face a potentially
significant regulatory challenge to do with what is called
“staking”.
“Staking” refers to depositing a certain amount of cryptocurrency
to support the operation of a Proof of Stake – a consensus
mechanism.
FINMA, the Swiss financial regulator, is considering a change to
its current practice, which means that crypto service providers
offering staking services shall hold a banking licence, arguing
that digital and traditional banking risk factors should be
treated equally. FINMA fears that assets may not be available to
be always used during the staking process – creating the
risk of a potential breakdown. Given some of the high-profile
scandals and problems in the crypto world, such as the collapse
of the FTX crypto-exchange, regulators want to be careful. FINMA
intends to interpret 2021 Swiss legislation, the “DLT Act”, to
mean that bank licences must be involved in the system. (“DLT” is
“distributed ledger technology,” aka blockchain.)
In principle, Swiss crypto service providers are not subject to
licensing by FINMA, but are affiliated to a self-regulatory
organization that carries out anti-money laundering controls.
While in some ways a technical financial sector issue, the
controversy shows how financial jurisdictions such as Switzerland
are trying to balance risk management, safety, and healthy
innovation. A parallel kind of debate can be seen around
AI.
The danger that Swiss enforcement might push providers out of the
business is not a trivial matter at a time when financial hubs
are trying to capture a slice of this business. However, with
memories of the 2008 financial crisis still in the background,
more recent episodes such as the FTX scandal and the meltdown of
certain “stablecoins,” regulators are mindful of avoiding
problems. (There are also anti-money laundering and know-your
client concerns about the use of cryptos and the way in
which this sector operates.) This publication has written a
number of articles (see here
and
here) about Switzerland’s digital assets space, and banks
that operate in this sector, such as SEBA Bank. (See an
interview here.)
The problem
Raphael Züger, Zurich-based attorney-at law at LINDEMANN LAW, who
leads its digital assets practice interprets FINMA’s intended new
practice as follows:
“The core of the new approach envisaged by FINMA is the potential
temporary blocking of digital assets during the staking process
(so-called lock-up period) and the possible confiscation of
digital assets in the event of false validation
(so-called `slashing’). In FINMA’s view, this characteristic
of staking means that the digital assets are no longer available
at all times, which is required under Swiss laws for segregation
purposes of digital assets. Following this interpretation, staked
digital assets do not qualify as held in custody, but as deposits
from the public which triggers a licensing requirement.”
In Züger’s view the “slashing” risk as well as potential lock-up
periods truly present a certain risk for investors, but he
said FINMA’s technical interpretation jeopardises legal certainty
and restricts Switzerland’s innovative strength and
competitiveness in international comparison. He warned that
this new interpretation might lead to Swiss customers staking
their digital assets with foreign crypto service providers with a
lower level of investor protection.
FINMA’s proposal is not in response to specific problems that
have arisen in the market, but rather a new general
interpretation of staking under Swiss banking law, Züger
said.
FINMA’s position
WealthBriefing quizzed the regulator.
“The DLT Act provides legal clarity on a risk-based and
comprehensive approach. It brings legal clarity in the use of
blockchain solutions on different aspects related to financial
regulation, but also on questions such as the treatment of
bankruptcy with regard to crypto assets or the validity of
transactions under private law,” a spokesperson at the regulator
said. “Legal clarity and mitigation of the specific risks linked
to crypto and DLT enhance the protection of clients, their trust
in these products and at the end the competitiveness of serious
service providers and the Swiss fintech.”
The regulator said new legislation distinguishes between
different kinds of crypto-custody on a risk-based approach, it
said.
“The higher the risks, the stricter are the licensing
requirements (banking licence, fintech-licence or AML licence).
The treatment of the DLT Act under financial regulation is
also consistent with the treatment under bankruptcy law,” the
spokesperson said.
Blow to competition
Jesper Johansen, CEO and Founder of Northstake, a custodial,
digital asset service provider helping institutions mitigate risk
and take part in staking, said competition will suffer, and rival
centres such as in the EU could profit.
“We’re seeing increased inbound inquiries from Swiss based crypto
investors, who do not have an EU-onshore regulated staking
provider. While FINMA has not yet enforced its updated
interpretation of the DLT Act they now strongly underline that
staking service providers are required to hold a banking licence
in the jurisdiction and should be able to make the asset
available at any time.” Johansen said in a statement.
“This represents several challenges from a risk management
perspective for the banks, which they are unlikely to accept.
This also risks creating a capital inefficient system – weakening
the Swiss digital asset landscape. The Swiss Blockchain
Federation and Crypto Valley Association have pushed back, so far
unsuccessfully. A timeline for enforcement has not yet been
established,” Johansen continued.
Concerns
“Our current pool of Swiss based clients has been increasingly
expressing concerns about this change in practice from FINMA. We
continue to work with our Swiss based clients to ensure the
implications are limited, however, it does demonstrate that
investors need to price in the regulatory risk when assessing
their counterparties in crypto,” Johansen continued.
“EU-onshore regulated VASPs [Virtual Asset Services Providers]
will not face similar issues, because EU law (MiCA) defines
virtual currencies broadly, unlike the narrow definition by Swiss
law. This is not set to change within the foreseeable future even
with full implementation Markets in Crypto Asset regulation set
to take full effect in 2024,” he added.
Dr Rolf Weber, Zurich-based attorney-at law, Bratschi, and member
of the Swiss
Blockchain Federation, was asked by WealthBriefing
if he thought the way FINMA will enforce the DLT Act will squeeze
the number of providers.
“The DLT Act contains several chapters and only a certain part
concerns financial market (for example DLT Trading Facilities).
Whether a service provider needs a licence for an activity
depends on the Banking Act or the Financial Institutions Act (not
the DLT Act). The key question is, which crypto activities are
bank-like and consequently can only be offered by a firm having a
banking licence,” he said. “The DLT Act was implemented with the
objective to make the Swiss financial markets more attractive for
crypto businesses. A good example is the surrender of digital
assets from the bankruptcy estate of a service provider. A
similar effect can be seen in the possibility of implementing DLT
Trading Facilities (so far no license granted, but to be expected
soon).”
“The staking approach of FINMA being very restrictive would
jeopardise the attractiveness of Switzerland. In contrast to
FINMA, SBF [Swiss Blockchain Federation] is of the opinion that
most of the staking services are not bank-like services,” he
said.
The EU’s MiCA regime isn’t more liberal than the Swiss one but it
does realise a different regulatory approach, Dr Weber
said.
“The EU is rules-based…Switzerland principles-based. The
extremely detailed MiCA rules give a high degree of legal
certainty which is partly liked by financial services providers,
but the Swiss regulations are more flexible and open to
discussion with FINMA,” he said. “The competitive “disadvantage”
can occur over time since MiCA does not contain market access
rules, i.e. Swiss offerors cannot directly contact EU customers
and have to look for alternative, indirect solutions.”
Getting the balance right
This news service asked FINMA how it is trying to balance
regulatory risk control with the need for innovative
vigour?
“The DLT Act and the approach `same business, same risks, same
rules’ (which can also mean sometimes `higher risks, stricter
rules’, for example in the AML field) fosters legal clarity, risk
mitigation and client protection, but also enhance the trust of
clients in such products and the competitiveness of serious
service providers as well as the whole Swiss fintech,” it added.
