From December 30, 2024, the European Regulation on Markets in Cryptoassets (MiCAR) will require crypto service providers to obtain a MiCAR license from their competent authority before they are allowed to operate their business. Crypto service providers based in Germany will then require a BaFin license. One of the MiCAR regulated Crypto services is the portfolio management of crypto assets.
It occurs when a crypto service provider manages its customers’ portfolios on an individual customer basis in the sense that it is allowed to make investment decisions regarding crypto assets at its own discretion in accordance with guidelines agreed with the customers. In order to obtain the required BaFin license, the crypto portfolio management provider will have to meet the general requirements for issuing a MiCAR license. In this respect, he will have to have a proper business organization, have professionally qualified and reliable business managers and be able to provide proof of the regulatory initial capital of at least 50,000 euros.
In addition, he will also have to meet specific requirements in the way he conducts business. This includes, in particular, a careful examination of the suitability of recommended crypto assets for the respective customer. The crypto portfolio manager must take into account the clients’ investment objectives as well as their risk tolerance, financial circumstances and ability to bear losses. In addition, crypto portfolio managers are not allowed to accept any monetary donations from third parties that could influence the investment decisions made for the customer. In addition, crypto portfolio managers for crypto assets are obliged to inform their clients in detail about all crypto-specific risks.
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Interacting with DeFi protocols and smart contracts
In connection with the regulatory requirements to be met by crypto portfolio managers, it is exciting to see to what extent it is possible for them to interact with protocols that actually function decentrally from a regulatory perspective. For example, if a crypto portfolio manager were to implement investment decisions for his customers automatically using decentralized smart contracts from the DeFi sector, it would first have to be clarified whether this activity can still be classified as a “management activity” or whether it would require an execution action that the crypto The MiCAR license granted by the portfolio manager covers additional versions for customers.
Crypto portfolio management is essentially a consulting business. This is already evident from the fact that the special regulatory obligations of crypto service providers for crypto advice and crypto portfolio management are regulated jointly in Article 81 MiCAR. Classically, and apparently also according to the idea of the MiCAR regulator, crypto assets should be purchased as part of administrative activities regularly via third-party providers who are licensed to exchange crypto assets for other crypto assets. The crypto portfolio manager commissions them to deliver or accept certain crypto assets with effect for their customer’s wallet.
However, such third parties would not exist in DeFi. Due to the lack of European interpretive guidance that EBA and ESMA are currently producing, BaFin has not yet commented on how broadly the offense of crypto portfolio management should be interpreted. In the spirit of a cautious approach, crypto portfolio managers should therefore assume that execution actions are not covered for the time being. Crypto portfolio managers would therefore be on the safe side if they interposed a crypto service provider approved to carry out crypto transactions for the customer.
Problems with DeFi trades via liquidity pools
If the regulatory problems for the crypto portfolio manager are solved by interposing an execution service provider with the MiCAR license to exchange crypto assets for other crypto assets, they will arise again in a different guise with the execution service provider. This is because it is also subject to numerous supervisory obligations when carrying out its activities.
If a crypto service provider acquires crypto assets for a customer through an interaction with a DeFi protocol, it must also comply with anti-money laundering obligations. Since it is generally impossible to clarify the transaction partner in the case of an automated liquidity pool without a tangible operator, this can result in the executing crypto service provider being unable to carry out a corresponding transaction. Cases in which crypto assets are to be obtained systematically via DeFi protocols and decentralized liquidity pools are particularly problematic.
In these cases, the execution service provider will generally never be able to clarify the origin of the crypto assets coming from the liquidity pool. The development of an adequate and suitable administrative practice on this topic should therefore be carried out as quickly as possible by the responsible ESMA and EBA and, at the national level, by BaFin. Crypto service providers can accelerate this process by clarifying the relevant business models with BaFin in advance.
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