The crypto paper – big throw or overregulation?

Fachanwalt Lutz Auffenberg has specialised in the field of fintech and innovative technologies with his law firm Fin Law. In particular, block chain technology and its regulation is the focus of his work. In his guest article, he takes a critical look at the draft law on the introduction of electronic securities.

With the draft law on the introduction of electronic securities, the Ministries of Justice and Finance also proposed the creation of a new regulatory regime for Bitcoin Future cryptographic securities this summer. This will be a special form of electronic securities, which, according to the definition in the current draft law, will differ from other electronic securities only in that it is registered in a register of cryptographic securities.

Crypt security registers are to be kept by companies that are appropriately supervised by the financial supervisory authorities. According to the current idea of the draft bill, they must be kept on a decentralised, forgery-proof recording system in which data is recorded in chronological order and stored in a manner protected against unauthorised deletion and subsequent modification. According to the draft’s explanatory statement, the concept of the cryptographic paper register is open to technology. However, since according to the definition only decentralised storage methods may be used, only recording systems based on distributed ledger technologies will ultimately be considered according to the current state of the art. However, the use of public blockchains is unlikely to be considered for cryptographic paper registers, as the risk of a hard-fork event, for example, would be unmanageable. Therefore, only private block chains should be practically usable.

What information should be stored in the cryptographic paper register?

Comprehensive information on registered securities should be stored in cryptographic paper registers. According to the draft, cryptographic paper registrars must in particular store the unique identification of the security (e.g. ISIN), information on the issuer, the holder, obstacles to disposal, rights of third parties and information on whether the cryptographic paper is registered in the name of a securities trading bank or the custodian (collective custody) or in the names of the individual holders.

The new regulation is intended to ensure that the holder identified in the register of cryptographic securities is also legally regarded as the holder. Disposals of cryptosecurities should only become effective once they have been entered in the underlying cryptosecurities register.

Do tokenised securities have to be entered in a register of cryptosecurities?

The new rules for cryptographic securities would not be mandatory for the issue of tokenised securities. As things stand at present, it would still be possible to issue „classic“ security tokens on a public block chain, which would be linked to certain investor rights via underlying token terms. However, the great advantage of cryptosecurities over unregistered security tokens would be their ability to be acquired in good faith and without encumbrances. This property, which is not possible under current securities law without the physical embodiment of a security, could make cryptower securities marketable.

To what extent is a central register necessary?

First of all, it should be made clear that the arrangement of a decentralised storage method would not change the fact that the crypt securities registrar would maintain a central database. In addition to introducing the provisions on the crypt value paper register, the draft law also provides for a legal fiction according to which electronic securities should be considered as objects in the sense of the German Civil Code. The elevation of virtual securities to objects in the civil law sense is already quite sufficient to enable the application of the rules on acquisition in good faith and without encumbrances even in the case of tokenised securities.

A central register is not required for this purpose. The introduction of central registers for cryptosecurities would rather mean a legislative rejection of the technical innovation possibilities offered by tokenised securities, as the potential for increasing efficiency by omitting usually required intermediaries such as central securities depositories would be prevented by regulation. In the case of certificate-based securities, it may make sense to register with a CSD in order to enable electronic trading of the actual physical securities. However, the mandatory use of a central database is not feasible in the case of allocation relationships that can in any case be traced on publicly visible block chains.