Last Friday something magical happened in Switzerland. The Federal Council of Switzerland passed a report about the legal framework for blockchain technology. The introduction to the report published on the website of FINMA (Swiss financial supervisory authority) states that the government wants to establish Switzerland as leading innovation and sustainability for blockchain and fintech companies.
In a nutshell, the report shows that fundamentally the current legal framework is flexible enough to accomodate innovative business models. The Council has also suggested precise adjustments for any lacking piece within the framework. These modifications are targeted at the enablement of new structures around digital and tokenized assets.
Whilst reading my way through the 170 pages of German, I was positively surprised about the extent and depth of the report. Within the summary, several key topics stood out to me, I share with you my thoughts on them below:
A new species and the taste of disintermediation
First and foremost, there is an announcement about the creation of a new license for exchanges, referred to as ‘new authorization category’ within Financial Market Infrastructure Law. Under this new exchange license a platform operator will be able to list and offer to trade any type of token (also security tokens), host retail and institutional players, and enable non-discretionary, multilateral trading. This is already a 100 light years forward from where we are today.
But this is not all. The most important aspect is that it is not a bank, nor a stock exchange, nor a custodian and neither is it a clearing house. It is all of them, in one! This is a revolutionary step into the future of financial services and disintermediation. Something that does not exist in the current institutional landscape today: a new species.
In the report this is referred to as ‘holistic approach’. Until now in most jurisdictions we have a sharp separation between exchanges, central custodian and clearing agents. With this new regulation, Switzerland becomes one of the first nations worldwide to recognize the power of DLT (Distributed Ledger Technology) and unleash the next massive wave of disintermediation in the financial services industry. The wave that will bring to extinction a lot of institutions that are so dominant and powerful in today's financial system.
I am very delighted about this new species, and even a bit in awe as to it really happening. For years I used to bring out this chart above and compare ownership transfer of Apple shares vs Ethereum, with a side note: “Now we don't need all these guys”. But the Wall Street is a power game. And those players will not let go easily. They are protected by the legal system that necessitates their existence. However their days are counted anyways as the new decentralized and disintermediated order is coming anyways.Because today it doesn't matter anymore where your company is headquartered or where your customers are. It is global and decentralized. This is true today for most industries, we all use facebook, google, uber and airbnb... Financial services, though being heavily regulated on local level, is on its way to become another global domain. There are already today, globally challenging brands such as Revolut, Wechat, Transferwise, Coinbase and many more. In this international business it does not matter where you company is, your customer base is the world. So you can pick the jurisdiction that provides the most suitable regulatory approach. In fintech, the jurisdiction in which you are based is a true competitive advantage. It sets the rules. The currencies are digital and borderless, value is becoming same as well. We are speaking about tokenization, the global internet of value. Who can set the rules there?
This is why we are seeing countries like Japan, Singapore, Liechtenstein, Malta and Switzerland adjusting their legal frameworks. They want this innovation to happen on their turf. They understand that it is a global business and thus means global competition. They understand that the next generation financial market infrastructure has just started to be built up. Governments and regulators understand that they need to be serious about it, and fast - so they are acting. According to the report, suggestions concerning law adjustments has been ordered to be worked out and submitted to Parliament within the next 3 months. A real sprint for a Swiss runner.
The 170 page report is one of the most thorough and comprehensive documents I have ever seen in this space. It analyzed practically every aspect of blockchain technology implementation in its current form. From custody and exchanges, over to tokenized funds and DAOs (Decentralized autonomous organization) to AML (Anti-Money Laundering) and investor protection - it touched on every single legal point relevant for new business models.
One prevailing example is the part on tokenized funds and tokenized real assets. The report touches on the necessity to adjust civil law to enable easy handling of tokenized assets and decentralized registries. It also confirms the goal to make Switzerland a more attractive place for investment funds. The report states: “The adjustments are needed for tokenized products to make the process of bringing out new financial products easier and cheaper”. Specifically the government has ordered the Ministry of Finance to introduce a new category of fund, the so called ‘Limited Qualified Investor Fund’. These funds will not need to be approved by FINMA if they are made available for qualified investors only.
The report also goes into detail about what needs to be approved by regulators and what not. I really like this part because until now this information was some kind of insider information, only brought to light in cosy lawyer offices. Now it will be public knowledge. So let me summarize it for you: 1. Today regulatory approval is not needed for distributed, P2P platforms 2. Regulatory approval is also not needed for centralized cryptocurrency platforms which do not trade security tokens.
With regards to the second point, there are limitations connected to custody. The goal of the segregation of funds and investor protection in bankruptcy cases is the central topic here. So it matters how your (centralized) custody is organized. Those are the more tricky issues with which I had to fight through three years ago as my team was applying for permission to operate XAPO, Bitcoin wallet and custody, out of Switzerland. If you store customers tokens in the so-called pooled accounts (co-mingled coins) it can be tricky to separate and then allocate them to individual users.
But in this minefield of legislation, there is finally light at the end of the tunnel. The report says that in the future, this kind of custody permissions should be included in the fintech licence. By the way, the fintech licence is the one that enables you to take up to CHF 100 million deposits from your customers without the need for a banking license. It was announced last month and will come into effect in just under 2 weeks, on the 1st of January 2019. This is a reason for us to celebrate at SMART VALOR, being the first marketplace for tokenized alternative investments and STO platform operated out of Switzerland.
Soft limits and flexible approach
In other great news, I was particularly delighted to learn about the fact that the fintech-license will not be hard capped to CHF 100 million. The fiat held by the platform can go above this amount in specific cases.
This question was raised during the 3rd Fintech Roundtable on the 15th of October 2018 in Bern, hosted by the Ministry of Finance and the Federal Council, Ueli Maurer, State Secretary Joerg Gasser and FINMA representatives. The goal of the roundtable was to get feedback on the suggested fintech-license and potential adjustments needed. Among the 20 invitees, only two other local startups and myself, representing SMART VALOR were there. During the session I raised the point that 100 million hard cap is not enough, as today the trading volumes on many exchanges are exceeding hundreds of millions per day. The working group took the notes. And now it is printed black on white in the report! It can exceed CHF100 million. I do not doubt, that there were more internal discussions and more written feedback. But the fact that we were invited and were asked, demonstrates a very important point: Switzerland is a true democracy where people, community and business are asked and heard.
For me personally this highlights a very important point: we are heard. We, as a tiny emerging industry, as startups, so small and fragile in the face of a huge banking lobby and Wall Street interests, we are listened to and taken seriously.
Back in 2015, as I started my career in crypto as part of the Xapo team, we were working on the first regulatory approval of Bitcoin’s Wallet/Custody business in Switzerland. Things were not easy. We were even sometimes a bit on the verge of despair. At some point we even thought that we were not going to make it. But we did!
We made it back then and we will make it happen again. Because we are fortunate enough to live and build in a country which is determined to enable the future of financial services. This is an incredibly great time to be alive. And I feel very grateful to all the people that make it happen.