Switzerland tweaks legal framework to accommodate DLT, digital assets (and some DeFi?)

The Swiss Federal Council continued its efforts to update its legal framework to accommodate Distributed Ledger Technology (DLT) and digital assets. New rules adopted on 18 June explicitly address the challenges of Decentralized Finance (DeFi) and impose anti-money laundering (AML) rules on certain types of wallet providers, pre-empting strict AML rules proposed by the Financial Action Task Force (FATF).

In September last year, Switzerland adopted the Federal Act on the Adaptation of Federal Law to Developments in Distributed Ledger Technology (DLT Act). One part of the DLT Act recognizes DLT-based securities as a new type of DLT-based uncertificated security (Registerwertrecht), in addition to the traditional intermediated security (Bucheffekten).

That part, amending the Swiss Code of Obligations, the Federal Intermediated Securities Act and the Federal Act on International Private Law, entered into force on 1 February this year.  

The remaining part of the DLT Act will enter into force on 1 August, together with a newly adopted Ordinance that amends ten ordinances to make them more DLT-compatible. This will lead to a couple of changes to the Swiss legal framework on DLT and digital assets.

The two main changes are amendments to insolvency rules (ensuring segregation of cryptoassets upon bankruptcy) and introducing tweaked rules for a new category of DLT-based trading facilities.

Insolvency rules: crypto-asset segregation

Insolvency rules are amended to provide greater legal certainty on the treatment of crypto-assets in case of bankruptcy. Changes to the Loi Fédérale sur la Poursuite pour Dettes et la Faillite (Debt and Insolvency Law) and Loi sur les Banques (Banking Law) stipulate that crypto-assets will be separate from the insolvent estate.

New category of DLT-based trading facility

A new licensing category has been created for DLT-based trading systems, amending the Loi sur l’Infrastructure des Marchés Financiers (Financial Markets Infrastructure Act). The amendments want to tweak the rules where the existing rulebook ‘does not make sense’ for technological reasons. The rules also clarify what ‘outsourcing’ means in the context of blockchain-based services, for example when a DLT-based trading facility relies on an external public blockchain like Ethereum, which is not operated by an ‘identifiable’ operator.

Bespoke rules or tweaking the rulebook?

Since the ICO hype of 2017-2018, lawmakers around the world have adopted different approaches to digital assets.

Some countries adopted crypto-bespoke laws, such as Malta or Cyprus, in the hope of bringing legal certainty and attracting crypto business. Adopting new laws takes time. The main risk of this approach is that such bespoke laws can create more legal uncertainty (for example, if the taxonomy is ambiguous) and that they risk being outdated quickly, as the sector develops fast.

Other jurisdictions did not adopt new laws, but interpreted existing laws and regulations as covering digital assets and DLT. Interpretative guidance can be issued more quickly than new laws. However, existing rules may not be a good fit for DLT and digital assets.

Switzerland, like some other countries, is taking a third approach: amending existing rules to make them more crypto- and DLT-compatible. The Swiss legal framework ‘is not fundamentally challenged’ by DLT, according to the commentary on the new Ordinance. Instead, ‘targeted amendments’ have been made. The commentary to the new Ordinance rejects suggestions to adopt bespoke rules on DLT, as  ‘incompatible with the aim of technology neutrality’.

The Swiss Federal Council looked beyond its own boundaries to draw inspiration from other jurisdictions. It noted that some jurisdictions (such as the US and the EU) do not have any DLT-specific rules, while an ‘increasing number’ of countries (such as Liechtenstein and Luxembourg) adopted crypto-specific rules.

AML

The new rules clarify when AML rules apply to crypto-asset activities. The Swiss Council clearly took at heart the AML updates proposed by FATF.

AML rules already applied to intermediaries that had certain control rights over assets (pouvoir de disposition). The new rules will no longer require such control rights. Instead, AML rules will also apply if the intermediary has a sustained business relationship (relation d’affaires durable) with the counterparty.

‘This is the case, for example, for trading platforms without access to the private key of the client, but which allow nevertheless for the transfer of virtual currencies by way of smart contracts, over which they have control.’ In other words: non-custodial (decentralized) trading facilities will not automatically escape AML obligations. This provision appears to cast the net wide.

Moreover, certain wallet providers may also be caught by the AML rules: there will be a ‘sustained business relationship’ between third parties and digital wallet providers, if the latter keep and have access to one of the private keys in a multi-sig set-up, and a signature with that private key is required to make a transaction.

Non-custodial wallet providers are not covered by the AML rules, if (and only if) they merely provide the logistics ‘but do not offer any supplementary service’. If such supplementary services are provided only to financial intermediaries already ‘subject to adequate supervision’, the wallet provider will not be bound by AML rules. The reasoning is that the financial intermediary will already be covered by AML rules in such case.

In addition, some other DeFi systems are excluded from the new AML rules: ‘systems that are entirely autonomous, which do not involve a sustained business relationship’, are not covered by the AML Law. ‘Moreover, trading facilities that merely put into contact buyers and sellers and on which transactions take place without smart contract implying the possibility of access by the platform’ are also not subject to the AML rules, ‘because it concerns an activity of pure intermediation, without virtual currency transfer’.

In a clear nod to DeFi, the commentary to the new rules acknowledges that crypto-transfers increasingly take place in a decentralized way. ‘In practice, this makes the work of supervisory bodies harder’, it says. The new criterion of ‘sustained business relationship’ is meant to ease the burden on supervisors, by avoiding the difficulty of legally defining when an intermediary has control over crypto-assets.

What’s next for crypto-Switzerland?

Switzerland has long been a frontrunner in the field of DLT and crypto, home to ‘crypto-valley’ Zug and initially attracting the Libra foundation. The current DLT Act and associated Ordinance fit that picture of a country eager to keep its pole-position to attract DLT- and crypto-activity.

Subscribe to our news Letter

Contact us

Subscribe to our news Letter

Subscribe to our newsletter

Thank you!