As the cryptocurrency world matures with more and more jurisdictions legalizing it and ensuring crypto becomes an industry standard, cryptocurrency receives a quality mark that proves that it can earn users’ trust. Over the next four years, the European Union will introduce new rules that will allow the introduction of blockchain technologies and crypto assets into the traditional financial sector.
For now, however, the need to obtain regulatory approval for financial activities remains the main obstacle to entering the market, which is also associated with a large waste of time and money for startups — although this is not always the case. Additionally, each business model requires a specific type of license.
Crypto regulators and types of authorization
The Swiss Financial Market Supervisory Authority, or FINMA, regulates banks, crypto and fintech projects. There are five types of authorization for financial activities in the country — licensing, recognition, authorization, approval and registration. Commonly, though, only two of these are being used by fintechs — recognition and authorization.
Types of authorization include: permitted activities; client onboarding options; the jurisdictions in which you can attract users; documents accepted for user identification; ways of storing customer information; most of the Anti-Money Laundering procedures; transaction limits; capital requirements; regularity and methodology of audits, among others.
When you choose and apply for the right type of authorization for your business, keep in mind that this will determine your business opportunities and degree of responsibility for many years ahead. At the beginning of the journey, it all might seem so overwhelming and hard to understand that you will feel like leaving everything up to your lawyers.
In practice, however, delving into this and starting to closely interact with specialists will help you create the most effective legal model and forge the best strategy for its development without requiring huge initial legal cost investments while speeding up the launch of the product on the market.
Step one: Sandbox
You can start a crypto service in the so-called FINMA sandbox. Depending on the project’s infrastructure, the startup can entirely develop a product, accept customer money, sell financial services, issue bank cards, and can carry out many other activities even before obtaining authorization.
Fintechs that meet the following requirements qualify to get into the sandbox:
- The total amount of assets received from clients does not exceed 1 million Swiss francs, or $1.1 million.
- The received funds are not invested, and interest is not paid (in this case, you can use your own company assets, earn on them and, if your model provides this, pay interest to clients).
- Depositors must be informed in advance that FINMA does not supervise fintechs, and the safety of funds deposited is not guaranteed by the insurance (this rule applies to all types of authorization, except for banking activities, where supervision by FINMA and deposit insurance is mandatory).
If a startup meets these requirements, the company can temporarily do without authorization from the regulator. It is imperative to prepare a legal memorandum about this, which professional lawyers will help with.
However, when the company outgrows the sandbox restrictions, the issue of obtaining authorization from FINMA will become the cornerstone for further development of the fintech and is one of the decisive factors for accelerating the commercial launch of the product.
Step two: Self-regulatory organizations
Most startups do not have the millions of Swiss francs required to obtain a full banking license from FINMA, including meeting the minimum capital requirement. In this case, you can join one of the 11 self-regulatory organizations, or SROs, operating in Switzerland and receive the status of a financial intermediary.
A financial intermediary requires regulatory approval for each individual type of activity instead of all of them at once, as would be the case with a bank. Only the services as part of the declared product structure that have passed the authorization can be performed. If the product structure changes, you need to get approval from FINMA or the relevant SRO again.
SRO members can conduct more than 10 types of activities. These include asset management, foreign exchange transactions, money transfers, along with insurance and new payment methods, including cryptocurrency operations and others. Companies can provide services to clients located in Switzerland and abroad, and to both enterprises and individuals.
To join an SRO costs several thousands of Swiss francs, which includes a number of annual payments, audit fees, etc. For example, in our case, with 60,000 users, the total cost of an SRO is about 100,000 Swiss francs, or approximately $110,000, per year. This is still much less than a banking license would cost.
If you decide to join an SRO, be prepared to pay large legal support costs, which can range from 150,000 to 400,000 Swiss francs, or $165,000 to $435,000. This will pay your lawyers to correctly describe the model of your product and compile dozens of mandatory applications and forms, proving to the SRO that this form of regulation is suitable for your crypto service.
It takes three months from the date of application to join an SRO. If you need to speed up the process, you can use the fast-track processing option that takes just two weeks for 1,500 Swiss francs, or $1,600.
Another aid in reducing the regulatory burden may be the “exceptions” that may apply depending on the model of the fintech product.
Exception # 1: A company is not considered to be banking if it meets the requirements that apply to participants in the regulatory sandbox (in accordance with the new edition of “Ordinance on Banks and Savings Banks (Bank Ordinance, BO)” article 6, paragraph 2, letter (a)).
Exception # 2: A license for savings is not required for assets that arise in payment systems and neobanks and are recognized as “non-deposits” if the following conditions are met:
- Peer-to-peer operations are prohibited — i.e., transfers from card to card.
- The maximum balance per client does not exceed 3,000 Swiss francs ($3,299).
- No interest is paid on funds.
The exception applies in accordance with article 5, paragraph 3, letter (e) of the “Ordinance on Banks and Savings Banks (Banking Ordinance, BO)” and subject to clarification No. 18 FINMA-Circular 2008/3.
Exception # 3: Settlement accounts, which are opened for some non-bank companies participating in SROs (dealers, asset managers and other financial intermediaries) are also not deposits if:
- Companies hold a deposit to execute a client’s transaction.
- No interest is credited to the account.
- The duration of the transaction is limited.
The exception applies in accordance with article 3, paragraph 3, letter (c) of the “Ordinance on Banks and Savings Banks (Banking Ordinance, BO).”
A wide variety of fintechs can take advantage of the regulatory sandbox, get a membership in self-regulatory organizations, and participate in legal exemptions. However, there are also a few points that concern only crypto services.
Choose the right architecture
Since crypto projects occupy a special place between the world of traditional finance and the world of digital assets, there are additional requirements for crypto companies in many countries, and Switzerland is no exception.
When registering our crypto service with the self-regulatory organization VFQ, we thoroughly studied the regulations that govern the Swiss Federal Council and FINMA. If we sum up all the important points from the “Legal framework for distributed ledger technology and blockchain in Switzerland” and the “FINMA-Fact Sheet / Virtual Currencies” documents and requirements, crypto services can accept fiat money without obtaining a banking license when the following conditions are met:
- Settlements for the purchase or sale of cryptocurrency and temporarily arising obligations to fulfill them fall under one of the exceptions given above.
- The fact of ownership of cryptocurrency by each client is reflected in the blockchain directly and separately from the company’s funds.
- Each cryptocurrency deposit can be attributed to a specific client at any given time.
All this should be taken into account by crypto startups during the product development stage. Moreover, the correct design of the cryptocurrency storage architecture is another reason that will help to avoid the need to obtain a banking license while remaining legal.
According to the Swiss regulator’s general approach, a deposit is defined as a service in which a client transfers funds and/or digital assets to an organization and can then dispose of them only by interacting with its representatives. If the functionality of the service allows you to remove intermediaries from the decision-making chain for the disposal of the client’s funds, this option is not considered a deposit.
In practice, this means that the storage should be designed so that the user, at all times, owns the private key, and the crypto service receives this key only “on lease.” Simply put, it is necessary to exclude the e-wallet provider from the process of managing the client’s funds. However, such a solution can only be used for cryptocurrency due to its technological features. For fiat deposits and accounts which we do not yet have, it will not work.
The flexible approach of the Swiss regulator to licensing fintechs once again proves that the path of startups is not at all about copying what has already been done before. For each business model, you need to look for your own optimal authorization method that will allow you to bring the product to market faster and at lower costs. Legal companies will certainly help with this, but the result will largely depend on how well the founder understands the issue.
This article is for general information purposes and is not intended to be and should not be taken as legal advice.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Alex Axelrod is the founder and CEO of Aximetria and Pay Reverse. He is also a serial entrepreneur with over a decade of experience in leading world-class technological roles within a large, number-one national mobile operator and leading financial organizations. Prior to these roles, he was the director of big data at the research and development center of JSFC AFK Systems.