October 15, 2018 Briefing

SMP Transactions Briefing:
Bitcoin – not a financial instrument after all?

On September 25, 2018, the Higher Regional Court of Berlin (Kammergericht) ruled, contrary to the administrative practice of the German Federal Financial Supervisory Authority (BaFin), that Bitcoin is not a unit of account, i.e. a financial instrument under the German Banking Act (KWG) and that, consequently, there is no obligation to obtain a permission under section 32 (1) sentence 1 KWG for trading or brokering Bitcoin.

This SMP Transactions Briefing briefly presents the decision of the Kammergericht and puts it into a practical perspective by analyzing which effects the decision could have on the future (regulatory) treatment of Bitcoin and other crypto token in Germany.

I. What is it about?

Since the publication of its guidance notice "Notes on financial instruments pursuant to section 1 (11) sentences 1 to 3 KWG" dated December 20, 2011, BaFin has treated Bitcoins as units of account within the meaning of section 1 (11) sentence 1 no. 7 KWG.

The legal term "unit of account" was introduced into the German Banking Act in 1993 by the larger implementation of the Investment Services Directive (Wertpapierdienstleistungsrichtlinie). However, this introduction was an overarching implementation (gold-plating) not prescribed by the European legislator. The concept of the unit of account, thus, represents an exclusively German approach. According to the legislator, the term unit of account also includes, amongst others, the IMF's special drawing rights and units of account which have the function of private means of payment in countertrade transactions (barter transactions).

Due to the classification as a unit of account, i.e. a financial instrument, certain commercial Bitcoin transactions are, in Germany, subject to licensing pursuant to Section 32 (1) sentence 1 KWG (this includes, for example, investment brokerage, financial commission business or operating an organized trading system). This was subject to criticism in the past both by practitioners and market participants alike: due to the inclusion of units of account, the definition of financial instrument in the German Banking Act is broader than the definition of financial instrument in the European requirements of MiFID II. By qualifying certain crypto tokens (such as Bitcoins) as units of account, BaFin deviates from the view of other European financial supervisory authorities, which - in the absence of a comparable concept for the unit of account - generally do not consider crypto tokens to be financial instruments. The BaFin approach leads to a number of unresolved regulatory issues in a cross-border context. Beyond this, this approach may, in individual cases, even cause a significant local disadvantage for companies operating in Germany.

II. What did the Kammergericht decide?

With the decision of the Kammergericht, a Higher Regional Court has now clearly positioned itself against the classification of Bitcoin as a unit of account by BaFin for the first time.

In a first step the Kammergericht interprets the term "unit of account" by referring to the legislative intent, i.e. the historical reasons for introducing the legal term expressed in the legislative documents. Furthermore, the Kammergericht, by means of a broader systematic interpretation refers to the comparability to foreign currencies expressly required by the legislator, by comparing the use of the term in other legal regulations (German Commercial Code; Air Traffic Act; Inland Navigation Act) as well as by referencing generally recognized units of account such as the IMF's special drawing rights or the European Currency Unit (ECU). In a second step, the Kammergericht comes to the conclusion that Bitcoin does not meet these requirements for the concept of a unit of account. The reasoning of the Kammergericht is essentially based on the following findings:

  • Bitcoin is not issued by a central bank or public authority, nor is there a universal issuer in the network. There is no superior and identifiable (legal) person who could exert a central regulatory influence on the distribution of Bitcoin. Rather, all participants themselves monitor Bitcoin transactions within the (blockchain) network.
  • Bitcoin has no representable or comparable value of its own. It is not a currency nor a means of payment which is accepted by law by everyone for the legally effective fulfilment of the obligations owed.
  • Bitcoin is merely a means of payment accepted by certain economic participants. The value of Bitcoin, therefore, depends mainly on how the users of the network assign value to it. Consequently, Bitcoin is subject to strong, unpredictable and incalculable fluctuations.

The Kammergericht concludes that Bitcoin, against this backdrop, lacks the general recognition required by the KWG framework and the corresponding predictable value stability. Hence, Bitcoin does not serve the general comparability of different goods or services. Since Bitcoin is not able to meet the comparability of units of account with foreign currencies required by law due to its (in the view of the Kammergericht) high volatility, the Kammergericht concludes that Bitcoin does not classify as a unit of account.

With regard to BaFin's view that Bitcoin is a complementary currency which should be included under the term unit of account, the Kammergericht has come to surprisingly clear conclusions: it is not the task of federal authorities to intervene in (criminal) laws in a legislative manner. This is the sole task of the legislator. By extending the concept of the unit of account to Bitcoin, BaFin essentially, in the view of the Kammergericht, violates the principle of legal certainty stipulated in Article 103 (2) of the German Constitution (Grundgesetz). This principle requires the legislator to formulate criminal provisions in such a way that the norm addressee (i.e. normal citizens) can, basically, foresee on the basis of the wording of the statutory provision whether a certain conduct is punishable or not. As a result of the this unconstitutional extension of the KWG's punishable licensing obligations to certain commercial Bitcoin transactions, the Kammergericht concludes that BaFin has exceeded its constitutional competence.

III. How can the decision be assessed and what are its implications?

Although word of the existence of the first instance decision had already spread among market participants, the decision of the Kammergericht remains surprising - in particular due to its strong wording. Market participants, who have seen a locational disadvantage for companies operating in Germany due to the BaFin approach to date, are likely to be sympathetic to the decision. It seems more likely now than ever before that BaFin may deviate from its classification of Bitcoins as units of account, which always appeared to be somewhat out of place. However, such conclusions are likely to be premature.

On the one hand, the criminal judgment of the Kammergericht has no direct binding effect on BaFin. The Kammergericht did not rule on the interpretation of the concept of unit of account from an administrative perspective.

On the other hand, it remains to be seen and is rather doubtful whether BaFin will take the decision of the Kammergericht as an opportunity to (fundamentally) change its previous administrative practice. This is not least due to the fact that BaFin recently tends to focus more strongly on the, by now, broadened spectrum of crypto tokens and applies a more differentiated approach when interpreting the term unit of account:

Pure payment tokens that are functionally comparable to conventional payment instruments (such as Bitcoins) are still regularly classified as units of account. The situation is different, however, with so-called utility tokens, which are designed as pure "usage" tokens. As a rule, these are not classified as units of account and, therefore, not as financial instruments within the meaning of the KWG. BaFin examines the distinction between payment and utility tokens in each individual case. This distinction, however, is often difficult to draw, not least because of the many hybrid forms of tokens on the market.

According to BaFin's current administrative practice, the necessary analysis of the token's functionality also depends, for example, on how decentralized the use of the token is (contractually) in the individual case. The distinction between payment and utility tokens, which is decisive for the classification as a unit of account, hence comes down to the question of whether tokens are only used as means of payment vis-à-vis a singular counterparty (usually no unit of account) or peer-to-peer between the users of a (larger) network (regularly unit of account).
It remains to be seen to which extent BaFin will actually see the decision of the Kammergericht as an opportunity to put this concept to the test and thus fundamentally rethink the classification of crypto-tokens in the structure of the KWG.

IV. Conclusion?

The Kammergericht has criticized BaFin's administrative practice, which has been in place since 2011, in an unusually clear manner. It remains to be seen, however, to which extent BaFin will reconsider its administrative practice on the basis of this criticism and whether this will result in any direct changes for market participants operating in Germany. Pending clarification at European level, the practice will probably have to adapt to the persistence of (cross-border) challenges in connection with the different classification of crypto tokens within Europe.

The SMP #TeamCrypto will report on further developments and is, of course, available for questions and discussion.

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