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Where to set up a Crypto Exchange – Part 3: Start a Coin Exchange in Europe

Flag Theory Weekly Letter – Friday August 31st, 2018

We’ve already reviewed some of the key factors that you must consider when choosing the right jurisdiction to establish your crypto trading platform and we talked about some of the most interesting jurisdictions in Asia-Pacific to set up a crypto exchange.

Today, in the third chapter of “Where to set up your crypto exchange”, we will review some crypto-friendly jurisdictions in Europe to establish the headquarters of your crypto trading platform.

Exchanges in Switzerland

Switzerland is a world leader in international financial services and is one of the go-to jurisdictions for crypto businesses.

Although there is no specific legislation for crypto, the regulator has published several guidelines and the country has attracted a large number of relevant players in the sector and developed a leading blockchain ecosystem.

If you are going to establish a cryptocurrency exchange operated from Switzerland it is advisable to request an authorization or advice from the Financial Market Supervision Authority of Switzerland (FINMA) to carry out the activity, like any other company that carries out financial activities.

If the exchange holds customer funds and allows money remittance, this would normally involve registering as a Directly subordinated financial intermediary (DSFIs) or being a member of a recognized self-regulatory organization (SRO).

SROs define the due diligence requirements under the anti-money laundering laws (AMLA) and monitor and establish controls to ensure affiliated financial intermediaries are compliant.

For their part, DSFIs are monitored directly by FINMA to ensure that they comply with their due diligence requirements in respect to money laundering.

To obtain a DFSI license, the exchange must have the appropriate organizational structure and internal regulations to comply with AMLA requirements and that it has the adequate resources to conduct the proposed business activity.

Companies regulated either as DSFI or SRO will have easier access to several Swiss, Liechtenstein and EU banking options.

A cryptocurrency exchange would usually be registered as a AG. The minimum share capital of an AG at the time of incorporation is CHF 100,000. The share capital must be fully subscribed upon incorporation and 20%, or CHF 50,000, whichever is greater must be paid up.

Companies are subject to a Federal effective tax rate of 7.83%. Each canton has also its own tax legislation and cantonal and communal income taxes at different rates. The combined effective tax rate is between 12.3% and 25.94%, depending on the corporate place of residence in Switzerland.

If you have a large amount of capital and resources, can handle high operating costs and you are good paying certain amount on taxes then Switzerland could be a really interesting option to run a world-class exchange in one of the most reputable jurisdictions worldwide.

Start a Coin Exchange in the UK

Although there is some confusion in this Brexit times, the UK still provides great access to European market.

Cryptocurrency exchanges are not regulated but according to the Bank of England (BOE), however they are required to meet the same anti-money laundering and counter-terrorism financing standards as other financial services companies.

Although cryptocurrencies are not regulated per se, the Financial Conduct Authority (FCA) requires any company offering fiat wallets that enable cash to be paid into or withdrawn from a payment account or enabling money remittance to be authorized as an Electronic Money Institution (EMI) and comply with the Payment Services Directive (PSD2) and the UK Payment Services Regulations (PSRs). Also, one would need to consider if certain tokens traded that look like or are in fact securities would require further licensing.

Authorized EMIs must have the adequate capital requirements, (usually a minimum initial capital of GBP 350,000 and an ongoing capital of 2% of the average outstanding e-money) safeguard and conduct of business rules, Governance arrangements, internal controls, risk management and money laundering controls.

Usually it takes about three to four months for the FCA to make a decision after receiving an application.

That being said, some exchanges are using third party EMI providers to process deposits, withdrawals and hold customer funds.

If the exchange allows trading of cryptocurrency futures, contracts for differences (CFDs) and cryptocurrency options, security tokens or any kind of tokenized financial instruments, it must apply for the relevant financial services licenses.

UK limited companies are subject to a corporate income tax of 19%. Dividends received and paid are generally tax-exempt, capital gains may be exempt subject to certain holding conditions and employers and employees social security contributions account for 13.8% and 12% of employees gross salary, respectively.

Set up in Liechtenstein

With a population of only 36,000 persons, this small Alpine state is one of the most reputable international financial centres globally. Traditionally oriented to asset protection and wealth management with its foundations (stiftung), private asset management structures, and its strong private banking industry, now Liechtenstein is embracing the crypto industry.

We’ve seen the Financial Market Authority Liechtenstein (FMA) grant licenses to several crypto funds, several ICOs conducted with local entities and now we are seeing also several exchanges setting up in the Principality.

At the time of writing, there is even a Liechtenstein bank planning to issue security tokens. We’ve heard from our connections that the state is quite interested in being a leader in the crypto space and believe that Switzerland has ‘over-regulated’ the crypto market.

A few months ago the head of state announced plans to enact the Blockchain Act to provide a legal framework for the tokenization of assets, ownership, transfer and storage of digital assets, licenses and initial coin offerings.

As of now there are no specific regulations for crypto exchanges and its licensing requirements must be clarified on a case-by-case basis.

In principle, cryptocurrency trading platforms and the exchange of crypto currency for fiat may not require a licence granted by the FMA but they are subject to Liechtenstein Law on Professional Due Diligence to Combat Money Laundering, Organized Crime, and Terrorist Financing (Due Diligence Act; DDA).

However, depending on the business model, there may be a licensing requirement. For instance if the exchange holds customer fiat funds and provides fiat wallet services it could be required to be authorized as an electronic money institution (EMI) or payment institution (PI).

As in the UK, EMIs and PIs require a certain initial capital (EUR 350,000 and from CHF 40,000 to CHF 250,000, respectively) and EMIs must maintain its own funds of at least 2% of the average outstanding e-money. They are subject to the similar safeguarding, safekeeping, accounting, external audits, governance and KYC/AML & CTF obligations as their UK counterparts. An EMI license is portable across all EEA countries.

Before taking any action, it is best to consult with the FMA to make sure about the licensing and due diligence requirements for your specific business model and exchange structure.

In terms of company formation and taxation, Liechtenstein AGs must appoint a resident director and corporate income taxes are relatively reasonable at 12.5%.

Exchanges in Luxembourg

Luxembourg is another well-known financial hub, especially for its private banking and wealth management industry.

Luxembourg is one of the most popular jurisdictions for setting up international investment funds due to its financial stability, sophisticated investment and financial services offerings and tax benefits (exemption from corporate tax, municipal business tax and withholding tax).

The jurisdiction is also emerging as one of the most crypto-friendly jurisdictions and its financial services regulator, the Commission of Surveillance du Secteur Financier (CSSF), is actively receptive to new blockchain projects.

Luxembourg has already attracted several well-known crypto exchanges and has a public-private initiative for the development of the fintech and blockchain industry, the Luxembourg House of Financial Technology Foundation.

As in the other countries reviewed so far, there is no specific crypto regulations, but, as it could not be otherwise, cryptocurrency exchanges are subject to current, existing regulations, especially to AML/CTF laws. As always, it is best to contact the regulator to make sure of the regulatory requirements for a given business model.

Normally, regulated exchanges hold a payment institution license or electronic money institution license. Only the most solid projects with the adequate resources and the most rigorous security systems and KYC/AML & CTF systems and policies will be licensed by the CSSF.

Luxembourg, perhaps with Switzerland, is the most reputable jurisdiction to establish a world-class crypto trading platform in Europe. In any case, as in Switzerland, the amount of resources required, operating costs and a strict licensing process means that Luxembourg is not for everyone. Luxembourg companies are subject to a 18% corporation tax.

Crypto Regulations in Gibraltar

Gibraltar has been a gaming and international financial hub for almost 20 years and last January released a legal framework for blockchain and cryptocurrency businesses to attract fintech companies working with blockchain technology.

Crypto exchanges are regulated by the Gibraltar Financial Services Commission (GFSC) and must obtain a Distributed Ledger Technology Provider license (DLT).

The DLT provider license is available for companies with a solid business plan, enough financial resources with reasonable allocated capital and adequate IT systems for risk management, protection of the client’s assets and security systems, KYC and prevention of money laundering and financial crime and data protection and high-standard security access protocols. The licensing process may take approximately 3 months.

Unless your coin exchange plans to offer fiat money remittance or prepaid cards linked to the account, supporting fiat wallets may be covered by the DLT provider license and it may not be necessary to acquire an additional electronic money institution license, as is the case in other countries of the EU and the United States.

If the exchange enables financial instrument such as bitcoin derivatives, or security tokens, it may be required to obtain a Stock Exchange license.

A coin exchange incorporated in Gibraltar under the DLT provider license is subject to a 10% corporate income tax. Capital Gains and Dividend income are exempt from taxation, foreign-source income derived from an activity other than those covered by the license may be exempt from taxation as well.

Exchanges in Malta

As Gibraltar, Malta is an online gambling center and also the jurisdiction chosen by a large number of international companies and holding companies to establish their headquarters and do business in the European Union due to its business-friendly policies and its favourable tax regime.

Malta is also one of the most popular blockchain hubs. This Mediterranean island approved several crypto regulations which are expected to come into force in the next months, which will set a legal framework for cryptocurrency exchanges.

Crypto exchanges in Malta will be under the supervision of the Malta Digital Innovation Authority (MDIA) and the Malta Financial Services Authority (MFSA).

To operate a regulated exchange in Malta companies will need to apply for a Virtual Financial Assets License which may be granted depending on the background of the promoters, the program of operations outlining their systems, security access protocols in place and the policies, procedures and systems established to meet KYC/AML & CTF legislation.

The assets traded on the exchange platform will need to pass a Financial Instruments Test by the MFSA which will determine if the exchange is subject to other capital market regulations such as the MiFID (EU Markets in Financial Instruments Directives).

If the exchange supports fiat currency wallets and holds customer funds or enables remittances, it may be required to obtain a Payments institution license or Electronic Money institution license under the EU Payments Directive, with similar requirements as in Luxembourg and other EU countries discussed before.

With regard to taxation, although its corporate standard tax rate is 35%, in practice there is a system of tax credits and refunds for individuals and corporate shareholders upon distribution of profits that may lead to a reduction of corporate tax to effective tax rates of between 5% and 10%, the lowest across the European Union.

Set up in Estonia

Estonia is commonly known as the “Digital Nation”, being the first country in the world to introduce the E-Residency concept, a transnational digital identity card for non-Estonian citizens issued and backed by the Estonian Government and digitizing the legislative body, voting, education, justice, health care, banking, taxes and policing areas under a single platform.

The country has been a technology hub during the last decade and has seen dozens of successful start-ups take off.

Certain cryptocurrency exchange activities are regulated under the Money Laundering and Territorial Financing Prevention Act and require obtaining two licenses issued by the Financial Intelligence Unit of Estonia (FIU) called the Virtual Currency Exchange Service License, which authorizes businesses to offer crypto to crypto or crypto to fiat trading and the Virtual Currency Wallet Service License, which authorizes providing fund custody services. This occurs when the company generates keys for Clients or keeps Clients’ encrypted keys.

Setting up a regulated exchange in Estonia is perhaps the most affordable option in the European Union. It may cost a few thousand dollars and there are no additional capitalization requirements other than the EUR 2,500 standard for all private limited companies.

Compare that with the cost of obtaining an EMI license in jurisdictions such as Switzerland, Luxembourg or Liechtenstein, which can amount to several hundred thousand dollars and higher capital requirements.

That being said, in order to obtain a license, the exchange must prove that it has enough resources to conduct the business activity according to its scope.

The FIU will assess the background of the promoters, the AML internal security measures and the rules of procedure which should include policies, processes and systems for the assessment and management of terrorist financing and money laundering risks, collection and maintenance of statutory records, performance of the notification obligations, internal control rules for checking adherence, identifying lower and higher risk transactions, due diligence and KYC policy and procedures, requirements and instructions for the compliance staff.

The Estonian corporation tax is simple and straightforward – no tax on undistributed profits and 20% tax on dividends distributed. However, bear in mind that Estonia has high labour taxes (over 30%).

Start a Crypto Exchange in Belarus

Belarus Decree No. 8 took effect last March, which created the High Technology Park (HTP) for fintech, blockchain and crypto businesses and provided tax holidays to entities established there.

Exchanges established in the HTP will require keeping a minimum capital in a Belarus-based bank of not less than BYN 1 million (approx. EUR 420,000). Belarus banks are willing to onboard companies dealing with crypto set up in their Fintech free zone.

HTP companies may benefit from an advantageous tax regime, a full tax-exemption from corporate tax (18%), VAT (20%), offshore duty (15%) and other tax and regulatory benefits such as the exemption from the requirement to obtain work permits for foreign employees.

Exchanges which are HTP Residents have the right to conduct transactions with electronic money and cryptocurrencies with barely any restrictions. However, as a downside, Belarus does not enjoy the reputation of the previous countries reviewed, nor is a member of the EU.

The Bottom Line

If you wish to set up a top-notch and reputable exchange, have direct access to a market of more than 500M people and strong banking options to provide an optimal service and you have considerable resources – then setting up your headquarters in the EU and obtaining an electronic money institution license is, perhaps, your best option.

These EMI licenses do not cover specifically crypto activities but will allow you to support fiat and be supervised by the regulator. But once “crypto” licenses become available, you would be ready to obtain one.

Crypto trading platforms remain unregulated in most EU countries but they are subject to existing laws. Ultimately, it is best to always seek advice from the regulator on what regulations you should adhere to and licenses you should apply for given your business model. This will provide you a higher degree of regulatory certainty and ensure you are doing everything correctly.

Whether you are setting up a regulated or unregulated crypto exchange, or funding it via an ICO, Flag Theory can help you set up a sound corporate structure choosing the most suitable jurisdictions and legal entities according to your requirements, priorities and goals and help you obtain licensing and bank accounts, as well as assisting in compliance matters. Contact us, it will be our pleasure to assist you.


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