In Germany, many financial market observers tend to be defeatist and view the country as having failed in various aspects. This perception extends to the regulation of the financial industry, with claims that the BaFin (Federal Financial Supervisory Authority) and the legislators are out of touch. However, it overlooks the fact that these institutions managed to break free from sluggishness after initially being caught off guard by the first fintech wave. Germany is even an European pioneer in cryptocurrency regulation, creating favorable conditions for innovative business models.

Indeed, BaFin foresaw the rise of cryptocurrencies early on: In December 2013, it published a document titled "Bitcoins: Regulatory Assessment and Risks for Users" under the "Consumer Protection" category. According to BaFin, Bitcoin (BTC) is to be understood as a "legally binding financial instrument," specifically in the form of computational units under Section 1, Paragraph 11, Sentence 1 of the Banking Act. "These units are comparable to foreign exchange and do not represent legal tender." Additionally, Bitcoin is considered "not electronic money within the meaning of the Payment Services Supervision Act (ZAG) because there is no issuer."

What may sound technical had significant implications for the industry. BaFin, in this way, early on delineated the boundaries for cryptocurrencies. Commercial dealings with Bitcoin, as per BaFin, may require authorization. This applies, for instance, to proprietary trading when a company announces regular buying and selling of Bitcoin, or for the mining of new Bitcoin if revenue shares from the created units are traded in exchange for computing power. The mere use of the cryptocurrency, however, does not constitute a licensable activity, initially applying to mining as well.

This early definition provided clarity for the industry, prompting some German start-ups to enter the scene. Noentheless, a few pioneers faced bankruptcy during the crisis, like the fintech Bitwala, which has now returned to the market as Nuri. Despite the hype generating interest, many banks still preferred to stay away from the world of cryptocurrencies.

As the use of blockchain as financial market infrastructure became evident, and international players like Coinbase entered the significant German market, legislators and regulators created the conditions for regulated institutional business. This sentiment is also observed in the credit industry.

In 2020, Germany passed a law requiring all crypto exchanges operating in the country to obtain a license from BaFin. This law also outlined rules for crypto custodians, including the requirement to hold a minimum amount of capital and ensure compliance with anti-money laundering laws. Traditional custodian banks now play a role in this regulatory framework. Trading and custody must be separated, mirroring the traditional financial system. Eight crypto custody licenses have been issued so far, with Commerzbank being the latest recipient.

Bitpanda holds the most extensive license arsenal, possessing the most comprehensive crypto license from BaFin since late 2022. This license includes crypto custody and proprietary trading of crypto assets. As a Virtual Asset Service Provider (VASP), Bitpanda covers Austria, Germany, France, Spain, Italy, Czech Republic, Norway, and Sweden. Additionally, Bitpanda holds licenses for EU directives Mifid II and PSD2, enabling operations across Europe. This aligns with BaFin's fundamental approach: The regulation of the crypto world is based on the frameworks of traditional securities and investment laws.

Europe follows suit: Starting mid-2024, the Markets in Crypto Assets Regulation (MiCAR) will come into effect in Europe. All market participants are preparing for this, with those experienced in national regulations and processes having an advantage. The technical implementation, involving input from industry representatives and experts, is under consultation by the EU regulatory authority ESMA and is expected to conclude by the end of the first quarter of 2024.

Germany is now set to align its national crypto regulation with the MiCAR framework to comply with the European framework. For this purpose, the German Ministry of Finance introduced a draft for the Financial Market Digitalization Act at the end of October. It outlines the introduction of a new law, the Crypto Markets Oversight Act (KMAG draft), and amendments to existing laws like the Banking Act (KWG).

The custody of digital assets will be subject to either the KWG draft or MiCAR, as per an analysis from Heuking Kühn Lüer Wojtek. Cryptocurrency custodians would thus need two permits in the future if they want to store all forms of digital assets, as explained by the legal experts.

Regulators face detailed work, addressing concepts such as crypto assets in MiCAR and German law, distinguishing MiCAR from the EU framework Mifid II, and categorizing various financial instruments.

With the existing Electronic Securities Act, conditions are in place for the emergence of a mass market for tokenized securities based on Distributed Ledger Technology (DLT), such as blockchain. However, the regulations are technologically neutral, not favoring a specific infrastructure for trading digital assets.

Interest in the technology is widespread across the securities industry. Many entities anticipate the coexistence of traditional and new structures. Tokenizing ordinary instruments like stocks, bonds, or derivatives, as well as tangible assets like real estate and various applications, is under consideration.

Germany appears well-positioned to offer banks and fintechs new business opportunities. While France has also been active, Paris is currently facing repercussions for luring entities like Binance with its European headquarters and advocating for them to operate initially based on provisional permits. France is now making efforts to push back against Binance after the company reached a settlement with the US Department of Justice.

In contrast, BaFin is known for imposing additional requirements even with regards to EU passporting when foreign providers seek access to the German market. The general rule is that alongside local risk management, adequate customer support must be in place. Despite these challenges, the sheer size of the German market attracts financial service providers.

According to Alexander Höptner, former CEO of the Stuttgart Stock Exchange and crypto exchange Bitmex, Germany is "the place to be." He is involved in the Allunity joint venture, which is backed by DWS, and aims to launch a stablecoin. His message is clear: Regulation and supervision provide security for the industry.