BaFin Investigations against DeFi Wallet - What is regulated in Germany?

Last week, Finance Forward reported that BaFin had launched an investigation into the crypto platform Uniswap. The focus is on a tweet from the Uniswap Twitter account, which calls in German to download Uniswap's new wallet.

Below we explain what is problematic about this and how we support our clients in ensuring that such problems do not arise with the respective supervisory authorities.

What is the problem with offering a wallet?

A wallet is used to store private keys to crypto assets such as bitcoin or ether. There are different types of wallets; the distinction between custodial wallets and non-custodial wallets is particularly relevant. With custodial wallets, a third party takes over the storage and management of the private key. In the case of non-custodial wallets, the tokens are stored by the holder her/himself. The distinction is often not very simple and it is not the name used in marketing that is important, but the technical solution.

In Germany, the custody, administration or safeguarding of crypto assets or private cryptographic keys, crypto custody, is a financial service requiring a licence. Only with the permission of the Federal Financial Supervisory Authority (BaFin) it is legal to provide financial services, and as such also crypto custody, on a commercial basis or to an extent that requires a business operation set up in a commercial manner. Providing financial services without a licence is a criminal offence punishable by up to five years' imprisonment.

In the case of Uniswap, BaFin will now assess whether it is a wallet requiring a licence.

Therefore, no custodial wallet should be offered without permission. We help our clients with the question of whether a permit is required for a wallet and accompany our clients with permit applications for the provision of crypto custody and other regulated crypto services.

But that's DeFi. That is unregulated.

Uniswap is a DEX (decentralised exchange). In a DEX and other DeFi (decentralised finance) applications, there is not one central person who controls everything. The network itself operates using smart contracts, without any person exercising control. If the network were left alone, it would continue to operate automatically and independently. Accordingly, the person to whom regulation can be attached is missing.

Often, however, these are so-called decentralisation theatres or so-called fake DeFi. This means that, contrary to what is portrayed, there is ultimately a person (often the original initiator) who exercises significant control and thus becomes the operator of the system. The obligation to obtain a permit can be linked to or intervene with this person.

BaFin will now investigate whether Uniswap is a genuine DeFi or whether there is a person to whom a duty of authorisation attaches. The first challenge will be to find the right addressee.

We advise our clients on such questions as to whether there is a duty to obtain a licence, and we regularly and gladly coordinate planned business models with BaFin.

But that's not in Germany.

Uniswap does not have a German company or branch. However, this is not necessary for BaFin to apply German financial market regulation. BaFin assumes that German regulation applies when someone approaches the German market - regardless of where in the world someone is located. Addressing the German market is always the case when potential customers in Germany are approached. Against the background of a borderless World Wide Web, this naturally poses challenges and demarcation is often not easy. In the case of the Uniswap tweet, however, there are various points that speak for addressing the German market: for example, the use of the German language and a German flag.

However, if the German market is not addressed, foreign service providers may accept German customers under specific circumstances if the customer contacts the service provider abroad (vice versa to addressing German customers from abroad) (so-called reverse solicitation).

BaFin will include the tweet in its assessment. This will be one of many building blocks in BaFin's investigation.

We regularly advise clients on whether German supervisory law applies to their activities and whether they can accept German residents as clients.

Conclusion

It is currently unclear how far the BaFin investigations have progressed and what the results will be. There is no official statement on the BaFin website so far. From our point of view, however, such investigations (and such tweets) can be avoided if you have obtained sufficient legal advice in Germany.