Crypto Currency Exchange — Part 2 — Legal issues in Malta

Cryp­to-exchanges are cur­rent­ly the most excit­ing area of the cryp­to-sphere. In the first arti­cle of our three-part series about cryp­to-exchanges we have there­fore focused on their basic func­tion­al­i­ty and prop­er­ties. In addi­tion, we con­sid­ered advan­tages and dis­ad­van­tages of cen­tral and decen­tral­ized exchanges. Whether cen­tral­ized or decen­tral­ized, cryp­to-exchanges are con­front­ed with a mul­ti­tude of prob­lems and chal­lenges.

That’s why in today’s arti­cle we are going to look at the dif­fi­cult frame­work con­di­tions under which Exchanges have to oper­ate. The pri­ma­ry focus will be on finan­cial and legal issues. But there are also grounds for hope. We will also show what pos­si­bil­i­ties there are for solv­ing the prob­lems of cryp­to-exchanges.

Challenges with Fiat Currencies and Crypto Exchanges

A major prob­lem for cryp­to exchanges is the crit­i­cal and neg­a­tive atti­tude of gov­ern­ments and reg­u­la­tors towards their oper­a­tions and cryp­to cur­ren­cies in gen­er­al. This rejec­tion can take the form of restric­tions or even a ban on the oper­a­tion of cryp­to exchanges. In Chi­na, for exam­ple, the state banned the oper­a­tion of exchanges and blocked access to for­eign exchanges via ISP block­ing.

The biggest prob­lem for the ongo­ing oper­a­tion of cryp­to cur­ren­cy exchanges, how­ev­er, is low liq­uid­i­ty due to a lack of sup­port from banks. Exchanges must have suf­fi­cient liq­uid­i­ty to set­tle trades in var­i­ous cur­ren­cy pairs — and these can only offer flex­i­ble and filled bank accounts. Exchanges must have suf­fi­cient reserves when there are no more coins to sell. Only high liq­uid­i­ty can cush­ion fluc­tu­a­tions in sup­ply and demand.

How­ev­er, most banks are very con­ser­v­a­tive, risk-averse and have so far been reluc­tant to sup­port the inter­est­ing and poten­tial­ly lucra­tive cryp­to-exchange busi­ness. For exam­ple, Bit­bay, one of the lead­ing cryp­to-exchanges now estab­lished in Mal­ta, stat­ed that it had been forced to close its oper­a­tions in Poland fol­low­ing the ter­mi­na­tion of a con­tract with a Pol­ish bank.

Anoth­er prob­lem, of course, is secu­ri­ty. Every few weeks, anoth­er hack of a cryp­to-exchange makes head­lines, caus­ing fear and inse­cu­ri­ty among traders. Accord­ing to a report by Reuters, a total of around USD 4 bil­lion has been stolen in recent years from wal­lets locat­ed at cen­tral exchanges. Such hacks of course dam­age the Exchange indus­try immense­ly — they pre­vent exist­ing users from con­tin­u­ing to trade and pre­vent inter­est­ed par­ties from becom­ing traders or users at all. As we already explained in the last arti­cle on the dif­fer­ences between cen­tral­ized and decen­tral­ized exchanges, decen­tral­ized exchanges can­not be eas­i­ly hacked, but they are all the more con­front­ed with low liq­uid­i­ty.

Anoth­er prob­lem that affects all cryp­to-exchanges equal­ly is the gen­er­al volatil­i­ty of cryp­to cur­ren­cies. As observed at the end of 2017 but also in the last few weeks, cryp­to cur­ren­cies can reg­u­lar­ly show rate fluc­tu­a­tions of 10% per day (!) or even more. This in turn places high demands on the liq­uid­i­ty of exchanges. Strong price fluc­tu­a­tions lead to large buy­ing or sell­ing peaks for traders, which are usu­al­ly not off­set by suf­fi­cient reserves of the Exchanges. It comes to “slip­page” — trades may not be exe­cut­ed, traders them­selves must pay high­er sur­charges so that Exchanges can cov­er the slip­pages.

Possible solutions for financial and legal issues

In view of these enor­mous chal­lenges for cryp­to-exchanges, the ques­tion nat­u­ral­ly aris­es as to how these can be met. Are there ways to address these chal­lenges? Are there any coun­tries where cryp­to exchanges are wel­come? Are there coun­tries where a legal frame­work has been put in place that pro­vides cryp­to-exchanges with clar­i­ty and secu­ri­ty? Coun­tries where leg­is­la­tors and reg­u­la­tors are in prin­ci­ple open to blockchain tech­nol­o­gy, cryp­to cur­ren­cies and cryp­to exchanges?

The answer, of course, is yes. In con­trast to China’s posi­tion, some coun­tries have adopt­ed an open and even proac­tive approach to the set­tle­ment and estab­lish­ment of blockchain com­pa­nies and cryp­to exchanges. While this also applies to Switzer­land and Liecht­en­stein, one coun­try stands out in par­tic­u­lar: only Mal­ta has cre­at­ed the basis for offi­cial licens­ing of cryp­to exchanges by estab­lish­ing its own license class. But there is much more that speaks for…

Malta as an attractive location for crypto-exchanges

The Blockchain island Mal­ta is par­tic­u­lar­ly inter­est­ing as a loca­tion for cryp­to-exchanges. The Mal­tese gov­ern­ment has recog­nised the future poten­tial of this still young indus­try, but espe­cial­ly of Exchanges, and is the first gov­ern­ment in the world to have adopt­ed a cor­re­spond­ing legal frame­work. The basis for this was cre­at­ed by three cor­re­spond­ing legal acts, includ­ing the Mal­ta Dig­i­tal Inno­va­tion Author­i­ty Act and the so-called Vir­tu­al Finan­cial Assets Act (VFAA).

With the Mal­ta Dig­i­tal Inno­va­tion Author­i­ty Act, a sep­a­rate reg­u­la­to­ry and super­vi­so­ry author­i­ty was cre­at­ed for the emerg­ing area of vir­tu­al finan­cial assets. The Vir­tu­al Finan­cial Assets Act pro­vides for the intro­duc­tion of 4 dif­fer­ent license class­es, which dif­fer in terms of the autho­riza­tions grant­ed and the lev­el of invest­ment. The VFAA Class 4 is a license designed espe­cial­ly for Exchanges and in high demand.

In order to set the course, the Vir­tu­al Finan­cial Assets Act (which we pre­sent­ed in detail) pro­vides for a sep­a­rate license class for Exchanges. Hold­ers of such a license are grant­ed per­mis­sion to oper­ate an exchange for vir­tu­al finan­cial assets and to hold or con­trol the mon­ey, VFAs or pri­vate cryp­to­graph­ic keys and cus­tody or nom­i­na­tion ser­vices of cus­tomers only in con­nec­tion with the oper­a­tion and activ­i­ties of that VFA exchange. Any­one wish­ing to acquire such a license must pay a one-time appli­ca­tion fee of €25,000 for annu­al sales of up to €1,000,000, or an addi­tion­al €2,500 for each addi­tion­al €1,000,000 annu­al sales (up to €100,000,000).

They will also need a cer­ti­fied and reg­is­tered VFA agent to sup­port their appli­ca­tion. In addi­tion, of course, the strict guide­lines of the MIFD must also be observed. In total, one should allow about 12 months for the entire process from the first con­sul­ta­tion to the final licens­ing.



About Philipp Sauerborn

In 2005, Philipp Sauer­born joined the firm of St. Matthew in Lon­don, one of the lead­ing Ger­man account­ing firms in Eng­land renowned for its exper­tise in cor­po­rate, com­mer­cial and tax law, as a depart­ment head. After three years, he was a part­ner and man­ag­ing direc­tor.
Towards the end of 2011, he decid­ed to move to Mal­ta, where he first worked at inter­na­tion­al law firms and con­sul­tan­cies in an employed and con­sult­ing capac­i­ty. Since the begin­ning of 2013, he has been a senior employ­ee at Dr. Wern­er & Part­ner. Mr. Sauer­born is cur­rent­ly com­plet­ing his ADIT ‑Advanced Diplo­ma in Inter­na­tion­al Tax.

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