Introduction
Technological progress and innovation often lead to legal questions being raised. Usually, standing legal frameworks offer solutions for how to regulate new technological phenomena. Specific bound-breaking developments such as distributed ledger technologies (DLTs) like blockchain and, more specifically, cryptocurrencies like Bitcoin (BTC) arguably require a thorough adaptation of the legal framework or an outright new set of rules if one wishes to regulate these phenomena.
Globally, different countries are forming a patchwork of different DLT regulations. These approaches have distinct advantages and disadvantages, but, in general, many jurisdictions seek to provide solid legal frameworks to catch up with the rapidly evolving nature of DLT. Those favoring regulating crypto assets may argue that the token economy needs more legal certainty and that national decisiveness is urgently needed.
For instance, Liechtenstein strives toward creating a holistic legal and regulatory framework for the entire token economy, covering, for example, token creation, custody, exchange and public token sales in an all-encompassing legal framework. In contrast, the Swiss legislator takes securities law as its starting point and has focused on DLT in its recent law amending standing legislation.
For Switzerland as a business location, it has been a goal to develop a legal framework that enables innovation and spurs the potential of new blockchain solutions. So, how are DLT and cryptocurrency regulated in Switzerland? To help answer this question, this article explores in depth the Swiss Distributed Ledger Technology Act on the adaptation of the federal laws to developments in Distributed Electronic Register Technology, or the Swiss DLT Act.
What is the Swiss Distributed Ledger Technology Bill?
Switzerland is a key financial center in the blockchain sector, being a top location for DLT and blockchain entities. The famous Swiss Crypto Valley was born out of a myriad of blockchain and fintech start-ups that settled in the city of Zug thanks to existing regulation and supervision of the Swiss Financial Market Supervisory Authority (FINMA), which issued the first licenses to said companies readily in 2015.
Interestingly enough, Switzerland did not have any cryptocurrency or blockchain-specific legislation until recently. Instead, the Swiss regulators applied an umbrella of existing laws and ordinances because the Swiss so-called principal-based legislation favored such an approach.
In 2019, the Federal Council, the executive body of the Swiss Confederation, opened the consultation on adapting federal law to answer to the rapid developments occurring in the DLT space. The Swiss DLT bill came into force in 2021 after a fast but thorough law-making process. The act went along with a general ordinance.
Simply put, the blanket act adapted various federal laws, seeking to put together different legal patches found in Swiss legislation. Generally, the DLT act aims to regulate decentralized digital ledger technology while balancing the need to protect investors and consumers. The DLT act applies to all companies, organizations and individuals within the jurisdiction.
The bill enabled the country to close the many gaps in its legal framework and created more legal assurance for crypto assets and custodians. The Swiss blockchain act affects tokenization, investments and capital markets. Notably, the DLT Act defines what constitutes an electronic record and introduces a regulatory framework for its proper use.
Additionally, it allowed de jure for the creation of blockchain digital assets. Interestingly, the DLT law describes how private entities should operate and what requirements they must meet to use DLT technology. For instance, the DLT bill requires all companies within Switzerland to provide information on their activities to ensure transparency.
Moreover, the Swiss DLT law improves the conditions for companies using blockchain alongside increasing legal certainty in the event of bankruptcy. According to the new legal framework, crypto assets can be segregated from other assets in case of a custodian’s default.
Crucially, this new approach allows banks and other financial institutions to hold crypto assets off balance sheets without triggering any negative implications for their capital requirements. The new rules will likely foster services for cryptocurrency custody, particularly among financial market players.
This quick overview illustrates how the Swiss DLT law uncovers new business opportunities and models. It fosters innovation for both new market participants and existing financial institutions.
DLT securities, according to Swiss Law
Ten federal laws were adjusted via the DLT law being a blanket act. For instance, the DLT act revises the law on securities prospectuses and provides several innovations. Specifically, the amendments to the Code of Obligations, the Federal Intermediated Securities Act and the Federal Act on International Private Law enable the introduction of ledger-based securities represented on a blockchain.
In light of the tokenization of assets, it is worth exploring in more detail a new legal category introduced in the Swiss Code of Obligations. The new legal class creates a robust basis for tokenizing assets and entitlements such as shares, bonds and other financial instruments. It bridges stocks and digital assets and enables the electronic registration of rights with similar qualities as traditional securities in the form of a token. Hence the name “ledger-based securities:” DLT securities, of course.
More precisely, it is now possible in Switzerland to use asset tokenization and the tokenization of securities for asset storage, transfer and trading. Financial institutions may directly transfer DLT securities via a technical transfer on a blockchain or distributed ledger. Uniquely, the bill allows for transferring the DLT securities over blockchain without requiring written documents. The law does require that the parties involved consent to the transaction.
The financial market infrastructure for DLT securities allows other companies and individuals to trade in addition to financial intermediaries.
DLT trading facilities, according to Swiss Law
Ultimately, the Swiss DLT act aims to regulate the use of DLT in securities trading. In addition to the new DLT securities category, it is no surprise that a new authorization category has also been created for (cryptocurrency) exchanges via a special license that facilitates multilateral trading in DLT securities. These so-called DLT trading facilities are fundamentally DLT or blockchain-based trading systems.
DLT trading facilities have been regulated following the existing laws applying to other Swiss trading facilities. DLT trading facilities offer services in trading, clearing, settlement and custody with DLT-based assets to financial market participants and private clients. Indeed, other than the “traditional” trading facilities such as, for instance, the stock exchange, the DLT trading facility can grant access to the markets not only to incumbent players but also to individuals.
Additionally, the DLT trading facility can provide custody, clearing and settlement services for DLT securities without needing a supplemental license. It is important to note that it will be mandatory for all entities that trade securities using DLT to register with the FINMA.
Crucially, the DLT trading facility must be operated by a Swiss entity, implying that a fully decentralized platform will most likely not be able to receive a DLT trading facility license.
The Swiss DLT Act and Anti-Money Laundering
The token economy’s development continues while the financial hub’s integrity is critical for Switzerland. Switzerland is committed to implementing the relevant international standards so that there are no legal loopholes and no oases for criminal business. Anti-Money Laundering (AML) regulation is vital hereto. AML refers to rules that stop criminals from masking illegally obtained funds as legitimate earnings.
The Swiss expressed that the same rules must apply to cryptocurrencies as to fiat money so to combat money laundering. The current AML regulations are significantly expanded. Switzerland’s DLT bill does respond to money laundering as the law contains adjustments to the Financial Services Act, the Money Laundering Act (AMLA) and the Banking Act. The AMLA now covers the DLT trading facility, which will be considered a financial intermediary subject to the AML rules.
AMLA’s scope regarding the provision of virtual currency payment services was also augmented, growing the spectrum of digital currency activities potentially subject to the AML rules. The legislation does not apply to software providers and licensors that do not have long-term business relationships with end customers.
Business innovations consistently lead to legal questions being raised, but legal innovations invariably lead to business considerations as well. Arguably, the expansion of AML regulation to decentralized finance (DeFi) business models, such as decentralized exchanges, may lead some DeFi business models to leave only the unregulated software development in Switzerland and relocate their remaining business to offshore jurisdictions without rules.
A future-proof DLT law?
Various jurisdictions pursue different approaches to creating a legal framework for DLT regulations. Many regulators lack an understanding of disruptive technologies like DLT. Governmental institutions are also usually slow by nature, leading to legal rigidity. With its DLT bill, Switzerland is one of the rare countries with clever and extensive cryptocurrency and blockchain legislation. Interestingly enough, Switzerland did not write any new laws. Instead, it adapted multiple existing laws.
This approach guarantees flexibility of the law where innovation rapidly surfaces. The DLT act offers financial institutions, intermediaries and individuals new business opportunities and creates the legal basis for trading and issuing rights represented in tokens.
At its very base, Switzerland’s holistic regulatory framework regards the custody of digital assets, the issuance of DLT securities and trading via the DLT trading facility. The legislation grants legal certainty to market participants and has a side effect that the DLT bill enhances the reputation of Switzerland as a financial center. The fact that DLT trading facilities may accept private and retail clients now arguably spurs adoption and financial inclusion. However, the long-term impact of the distributed ledger technology Act remains to be observed.