This article is first on the Fin Law Blog appeared.
Decentralized finance (DeFi) has opened up numerous new sources of income for players in the crypto market for several years. While the generation of passive income in the crypto market at the beginning of the 2010s required the purchase and operation of high-performance mining rigs for participation in the proof-of-work mechanism, today the mere delegation of one’s own crypto values to a dPoS validator is sufficient, to earn prorated Block Rewards in the Proof of Stake consensus mechanism. Another way of generating passive income via DeFi protocols is the so-called yield farming.
Interested crypto users can temporarily make their crypto values available to a smart contract called a liquidity pool and receive a return in return. The return is achieved because crypto users looking for liquidity can have a loan in crypto assets granted by the liquidity pool. To ensure repayment, borrowers must deposit sufficient collateral in other crypto assets. Such loans are therefore not suitable for raising capital temporarily, but only for raising short-term liquidity in a specific crypto value. Yield farming is therefore interesting for both private investors and institutional liquidity providers. But can a license from BaFin also be required in individual cases for the provision of crypto assets for yield farming?
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Authorization requirements according to KWG and WpIG only for domestic commercial activity
The provision of activities regulated under the German Banking Act (KWG) or the German Securities Institutes Act (WpIG) only requires a permit if it is domestic and commercial or to an extent that requires a commercially organized business operation. BaFin always considers the domestic connection to be given if the service provider is based in Germany. If he acts from abroad, the domestic connection can be given if his offer is aimed specifically at German customers.
In the case of yield farming, there is therefore a domestic connection in any case if the liquidity provider has its place of residence or business in Germany. However, if he acts from abroad, it will rarely be possible to accuse him of an active offer to German customers, since he only makes his crypto assets available to a decentralized smart contract and not to a specific customer. Nor does he take care of marketing to specific borrowers. A commercial activity is given if the yield farming is not only provided temporarily and with the intention of making a profit, which will be the case for most liquidity providers.
Crypto loans are not a regulated lending business according to the KWG
The granting of loans is generally regulated in the KWG as a banking business that requires a permit. However, the legal basis for lending business in the KWG only refers to money in the classic sense and not to crypto assets. For this reason alone, activity as a liquidity provider cannot constitute a lending transaction under the KWG. There is also the problem that the crypto assets are made available to liquidity pools and thus decentralized smart contracts on a DeFi platform.
Liquidity providers therefore have no specific contractual partner who would be their borrower. The activities that are otherwise subject to permission under the KWG and WpIG are also not provided by the temporary provision of crypto assets to liquidity pools. The contribution of one’s own crypto assets to yield farming projects is therefore possible under German supervisory law without the permission of BaFin.
About Lutz Auffenberg
Specialist lawyer Lutz Auffenberg has specialized in the field of fintech and innovative technologies with his law firm Fin Law. In particular, the blockchain technology and its regulation is the focus of his work.
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