Crypto Custodian Insolvent? This law is designed to protect you

A longer version of this article first appeared as technical paper at Heuking Kuhn Lüer Wojtek.

The Federal Ministry of Finance (BMF) and the Federal Ministry of Justice (BMJ) have presented a draft law on the financing of future-proof investments (Future Financing Act or “ZuFinG”). In addition to introducing electronic shares, this draft also aims to strengthen customer rights in the event of insolvency of crypto custodians. In the future, the German Banking Act (KWG) will determine how crypto custodians must protect the customer assets entrusted to them and what happens to these assets in the event of insolvency.

Under the current legal situation, it is questionable whether German insolvency law applies to the insolvency of crypto custodians at all, since the data of the crypto assets are distributed worldwide due to the distributed nature of blockchain technology. In such cross-border cases, the European Insolvency Regulation applies, which applies the insolvency law of the Member State in which the insolvency proceedings are opened. If the crypto custodian is based in Germany, there is much to be said for the application of German insolvency law.

Insolvent crypto custodians: How the right of segregation protects customers

It is also crucial how crypto assets are to be classified under insolvency law and whether there is a right to separate these assets. A right of segregation allows customers to reclaim their crypto assets from the insolvency administrator. The right of segregation exists if the crypto assets can be segregated, the customer can assert a right against the crypto custodian that entitles them to segregation, and the object of the segregation is specific or at least sufficiently identifiable.

A right of separation is in the interest of the customer, since in this case he retains control over his crypto assets. Otherwise, the crypto asset would belong to the bankruptcy estate and the customer would only receive a pro rata repayment. The question of the eligibility of crypto assets depends on whether a value can be attributed to these assets. This understanding is already based on the legislature in its definition of crypto assets in the KWG. According to this, crypto values ​​are digital representations of a value that are accepted as a means of exchange or payment or serve investment purposes.

Omnibus vs. Single Wallets

A right of segregation can arise in the context of the crypto custody business if there is a trustee constellation in which a trusteeship agreement has been concluded between the crypto custodian and the customer. Such a trust exists if the trust mainly serves the interests of the customer (non-profit), the customer transfers control of the crypto assets to the crypto custodian (real component) and the crypto assets go directly from the customer’s assets to the assets of the crypto custodian (principle of immediacy). ). Compliance with the asset segregation principle is also important and depends on the type of custody, whether in single or omnibus wallets.

Crypto custodians often use omnibus wallets that can hold crypto assets from multiple customers. In such cases, a clear demarcation of the assets is required in order to guarantee the customer’s right of segregation. An internal inventory can help to record the allocation of the crypto assets in custody to the assets of the individual customers.

This is how crypto custodians are held accountable

The ZuFinG is intended to introduce certain obligations for crypto custodians in the future in order to protect customer assets. It establishes an obligation to separate assets and generally allocates the crypto assets to the assets of the customer. This gives the customer a right of segregation, unless the customer has agreed to disposal of his crypto assets. The ZuFinG thus creates legal certainty for customers of crypto custodians.

Crypto custodians must ensure that there is a clear demarcation between their own crypto assets and the clients’ crypto assets in custody. You can achieve this, for example, by using individual wallets dedicated exclusively to customers or by maintaining an internal inventory. However, the exact requirements for such inventories still have to be specified by BaFin.

In summary, it can be said that the ZuFinG gives more weight to customer rights in the event of the insolvency of crypto custodians. Customers can rest assured that they have a right of segregation over their crypto assets in custody. The law creates legal certainty and helps to protect the interests of customers.