A few weeks ago, the Swiss Financial Market Supervisory Authority (FINMA) announced a change in practice regarding staking. Service providers newly require a full banking license. In response to the outcry from the blockchain industry, FINMA argued that their staking implementation is precisely regulated in the Swiss DLT Act.
The term "staking" refers to the practice of depositing a certain amount of cryptocurrencies to support the operation of a blockchain. In return, participants are typically rewarded with an additional yield in the same cryptocurrency. For example, staking on the second-largest blockchain, Ethereum, is rewarded with an annual yield of around 5%. Swiss crypto banks have also been offering their customers this opportunity for passive income for some time. However, according to FINMA's recent change in practice, staking providers will need a banking license in the future. Industry representatives in Switzerland quickly opposed the new regulations, as reported by CVJ.CH in early September. FINMA on the other hand justifies the new requirements with the DLT Act, as the supervisory authority informed the financial publication tippinpoint.
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Staking: custody as a licensed bank?
The Swiss DLT Act, widely celebrated by the blockchain industry, has allowed custodians to segregate their customers' crypto assets in the event of bankruptcy since its introduction in 2021. In addition to this bankruptcy-related privilege, the legislation relieved service providers of certain regulatory requirements. Custodied cryptocurrencies of customers can be treated as "custody assets" similar to traditional assets off the balance sheet, eliminating the need for additional capital reserves. However, it is required that the crypto assets be available at all times, a condition that the FINMA has pointed out is no longer met in the case of staking services.
"Prerequisite for this bankruptcy protection is that the custodian keeps the crypto assets available at all times. In other words, the custodian must have 'continuous' control over the assets (cf. DLT proposal message p. 292).
Certain staking business models are not compatible with the requirements of the DLT proposal concerning bankruptcy and regulatory privileges for crypto custody. In these cases, providers do not keep crypto assets available at all times. This poses the risk to customers that their assets may be locked up for an extended period (lock-up risk) or even slashed (slashing risk)." - FINMA spokesperson to CVJ.CH
Therefore, in the case of staking services, the assets should be regulated as public deposits for which the acceptance requires a banking license under Swiss banking law. According to FINMA, these regulations are clearly and precisely defined in the DLT Act documents, leaving no room for regulatory discretion in implementation. The authority had referred to these provisions through the usual channels as part of its supervisory activities.
Blockchain industry objects to new staking practice
In response to the practice change, the Swiss Blockchain Federation (SBF) and the Crypto Valley Association (CVA) issued a warning statement. They argued that staking is in no way related to transformation services and, therefore, cannot be compared to the core banking activities. The intended practice change would jeopardize the legal certainty achieved through the DLT legislation. The Swiss Blockchain Federation emphasized to CVJ.CH that, in their view, staked crypto assets also fall into the category of custody assets.
"The Swiss Blockchain Federation (SBF) firmly believes that the provisions of the DLT proposal, which have clearly established bankruptcy protection for customers of crypto service providers, also apply to staked crypto-based assets. We have extensively outlined the reasons for our view in the Staking Circular. While staking with the support of a service provider is a riskier activity compared to mere custody, it is crucial that customers are informed about the specific risks of staking. If the customer agrees, they should have access to Swiss providers." - Swiss Blockchain Federation to CVJ.CH
The extent to which FINMA's scope for coordination with other international authorities could not be utilized is likewise unclear to the federation. In particular, there are no international standards in the area of the staking of crypto assets that would dictate or restrict FINMA's discretion.
Is FINMA tightening the grip on regulation?
The Swiss Financial Market Supervisory Authority (FINMA) has been notably proactive in the blockchain space from an early stage. The regulator is credited with playing a crucial role in the development of today's Crypto Valley, thanks to its pioneering guidelines in Switzerland at the time. However, during the past two years, an increasing number of industry representatives have been expressing criticism of FINMA. For instance, in July, the crypto-broker Bity filed a complaint against the regulator due to the stringent implementation of the Travel Rule. Nevertheless, FINMA maintains that it has remained faithful to its technology-neutral approach. Perhaps, we are just seeing the side effects of quick regulation.
"FINMA has been quick in implementing regulatory rules for the Swiss crypto industry. Their approach of applying the same regulations for crypto assets as traditional ones is unsurprising. The upside of the fast implementation is regulatory certainty, but the downside is an additional operational burden, which companies operating from nearly all other jurisdictions don’t have yet." - Lucas Betschart, CEO and Co-founder of compliance specialist 21 Analytics
