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Feb 25, 2019

Crypto-Switzerland: Matching a Decentralized Government with a Decentralized Currency

Switzerland has become a hub of cryptocurrency innovation because of its tradition of decentralized government and flexible financial regulation.

Switzerland Crypto

The crypto phenomenon is of global magnitude. Public blockchain networks such as Bitcoin or Ethereum are not controlled by any state or company. They connect people from different contexts across national borders. Yet despite this high degree of decentralization and the primacy of the digital, the new crypto world needs points of contact with the physical world. In other words, even the blockchain needs a home, ideally in a decentralized government.

Johann Schneider-Ammann, a former member of the Swiss Federal Council, extended an invitation to the crypto world by announcing “Crypto Nation Switzerland” at the beginning of 2018. He called on the industry and government to take all steps necessary to make Switzerland one of the world’s most important crypto hubs. Many crypto visionaries and blockchain enthusiasts regarded this proclamation from the highest authority in Switzerland as a clever move that yielded nearly immediate results. According to the consulting firm PriceWaterhouseCoopers, a total of $1.46 billion (US) was raised through 33 different Initial Coin Offerings (ICOs) in Switzerland, including four of the six largest ICOs in the world. Furthermore, Switzerland’s regulatory agency FINMA was the first regulator worldwide to publish concise guidelines for ICOs. Banks such as Swissquote and Flacon Private Bank as well as Swisscom, a public-private telecom company, began to focus on either crypto or blockchain technology. The Swiss Federal Council itself published a detailed report at the end of 2018, in which it discussed important legal issues on the blockchain topic.

In the meantime, managers, CEOs, functionaries, and politicians all over Switzerland are jostling with each other to make a name for themselves in this new field. Politicians in particular are congratulating themselves on having skillfully promoted the crypto nation. But those in the political realm, despite undisputed relevance overseeing urgent regulatory issues, would not suffer much from swallowing a healthy dose of humility. Politicians are reaping the harvest from technological developments that they have for the most part neither planted nor watered.

Switzerland Values the Individual

The fact that Switzerland has a respectable crypto scene today is mainly due to the great commitment of various private individuals. At the beginning of the movement in Switzerland around 2011, there were a few computer freaks and anarcho-libertarians who were interested in this new phenomenon for technical or philosophical reasons.

Also, in the early days attention was focused solely on Bitcoin - there were no other cryptocurrencies yet. The first alternative projects did not emerge until about five years after the creation of Bitcoin in 2009. It is therefore not surprising that the first Swiss crypto start-up was named Bitcoin Suisse AG and the first crypto and fintech association was given the name Bitcoin Association Switzerland. While the former was founded in 2013 by Niklas Nikolajsen, a native of Denmark, the latter was started by economist and computer scientist Luzius Meisser. Together with Alexis Roussel from Bity, which is also a financial provider for crypto services like Bitcoin Suisse AG, they did the pioneering work. What these pioneers all had in common was a libertarian attitude and a sense for financial freedom. Today, Bitcoin Suisse AG already employs almost 100 people and has been able to poach several heavyweights from the traditional banking world.

An important milestone in the development of the Swiss crypto scene was the decision of the Ethereum Foundation to settle in Zug. In this context the work of the consulting firm MME under the leadership of Luka Müller deserves special mention. Ethereum had a strong pull effect: more and more clever minds sought proximity to the Ethereum community and used the Ethereum blockchain as a platform. At the same time, they benefited from networks established in Zug and other cantons.

Switzerland’s Decentralized Government and Flexible Legal System

The fact that Ethereum opted for Switzerland and not Singapore was explained by the fact that Switzerland, with its decentralized state structure, best reflects the idea of decentralization underlying the crypto movement. Because of this, many tech-savvy people often compare blockchain technology to the political economy of Switzerland in order to illustrate their point about decentralization. Due to the decentralized structure, it is easier to reach authorities in Switzerland than in a centrally managed country and politicians and bureaucrats are more open to discussion. For crypto-enthusiasts from all over the world, the cantonal authorities are therefore regarded as cooperative service providers; they in turn regard start-ups as partners rather than mere petitioners.

Another important factor that attracted many crypto enthusiasts to Switzerland right from the start was its flexible legal system. Flexible, abstract laws could be applied to the new challenges with relatively little effort. In Switzerland, tax and other financial questions can be answered more quickly and in more innovative ways than, for example, in the EU. In comparison to other EU states, Swiss law, due to its abstract and general nature, is leaner.

One concrete example concerns the application of the value added tax (VAT) requirements. In the neighboring country of Germany, this kind of tax is regulated by more than 150 pages of EU regulations and by another 100 pages of laws unique to Germany. Interestingly enough, concerning the topic of the value added tax, the basic body of law composed of abstract rules is more complex than the higher-order regulation on it. Unlike in Germany, the Swiss VAT laws are about 120 pages in total, of which the basic body of rules is leaner than that of the higher-order regulation.

So, it is this setup that allowed the Federal Tax Administration in Switzerland to decide under its own authority that Bitcoin is a means of payment and therefore no VAT is payable on sales. The German tax authority did not have this freedom. While Swiss regulators have more freedom to apply the general legal principles to specific cases, German regulators are hamstrung by complicated, overly-specific rules. Accordingly, it took a few years longer until this supposedly simple question was also clarified in Germany.

Switzerland is Simply Slower

The fact that blockchain-based projects were able to gain a foothold in Switzerland also has to do with its national history and thus the cultural DNA of its people. In Switzerland, more than in other countries around the world, there is a cultural affinity for decentralized solutions. A unique set of spontaneous processes created Switzerland which may not be readily replicable in other countries with more centralized governments. In general terms, the nature of Switzerland and that of its citizens is based on two topoi: The refusal to be ruled, because being ruled always means losing a certain degree of self-sovereignty. That skepticism towards centralized power is combined with the insight that there are common problems that should be solved together, as flexibly as possible, done cooperatively and without outside interference.

This is the inheritance that still seems to be more firmly anchored in the Swiss consciousness than it is elsewhere. Switzerland is therefore considered one of the most decentralized countries in the world. The crucial question is: What has been its recipe for success?

The secret of the Swiss federal state’s success was that it started as a minimal state. In the early days of the modern Swiss state in the 19th century, there were really only a dozen professional civil servants. They did not have the ability to levy any direct federal taxes, which meant that the federal state only had a minimal budget based on customs duties alone. A high degree of cantonal and local autonomy with functioning political microstructures was thus maintained. These structures did not spring from the common will to have a “lean government” but from the fact that there was simply no money in the public purse and thus few civil servants and little central bureaucracy. The right things were done because the financial and human resources were not available to do the wrong things.

This is also why Switzerland remains so decentralized compared to other countries today; while the Swiss central government continues to grow, its rate of growth is slower than anywhere else in the world.

However, even in Switzerland the tradition of skepticism about centralization is on the retreat. Not least because of pressure from abroad, the federal state is being strengthened at the expense of its decentralized structure. The reduction of political decentralization has been accompanied by attempts to harmonize Switzerland’s financial sector with the international financial system. In the wake of the 2008 financial crisis, the International Financial Stability Board was established by the G20. Its task was to make the global financial system more centralized and thus - in the eyes of these functionaries at least - more secure by means of uniform regulation. Of course, centralizing financial activities does not necessarily make them more secure at a fundamental level; rather, it centralizes risks in a single location, which ultimately creates a “single point of failure” and leads to systemic uncertainty.

In the case of crypto, one new piece of legislation has been particularly severe. In 2016, the Financial Market Infrastructure Act was passed in Switzerland. From the point of view of many crypto advocates, this new act brought about a significant deterioration by bringing the Swiss legal situation into line with that of the European Union and thus making legal interpretation more laborious and diffuse. With the passage of this act, Switzerland gave up a much of the aforementioned flexibility in matters of financial market law. Because of this EU-compatible law, Switzerland has to devise a new and flexible authorization category for blockchain-based financial market infrastructures. Under the old legislation before 2016, the Swiss regulator could have permitted things like blockchain-based exchanges at its own discretion. The Financial Market Infrastructure Act has taken away this discretionary leeway.

The Swiss financial sector has been adversely affected by this development. The value of the Swiss financial industry as a percentage of GDP fell from 8.2 percent in 2007 to 4.6 percent in 2017. Some crypto-enthusiasts are therefore convinced that blockchain technology is a way to breathe new life into the dying Swiss financial sector and a way to make Switzerland a leading player in the financial system of the future once more.

Prominent bankers are therefore increasingly turning their back on the traditional financial world in order to work for a blockchain start-up or to set up one themselves. Arthur Vayloyan, former banker at Credit Suisse and most recently at Falcon Private Bank, joined Bitcoin Suisse AG in November 2017 as their new CEO. With the exit of Andreas Amschwand, the Julius Baer Group lost a long-standing board member to the newly founded crypto bank Seba. And the former head of the Swiss Stock Exchange, Christian Katz, also flirts with the crypto world as the Chairman of the Board of Directors of the new Swiss Crypto Exchange (SCX).

Blockchain in Switzerland is Gearing Up

At the beginning of this year, the crypto ecosystem in Switzerland and Liechtenstein already counts over 750 companies. Four of these crypto projects, which come from Switzerland or are still rooted here, are already ‘Unicorns’; Bitmain, Cardano, Dfinity and Ethereum are valued at one billion dollars or more. Around 480 people work in Switzerland and Liechtenstein in the 50 largest blockchain companies. Overall, the industry employs more than 3,300 people.

For a long time, Zug - now known worldwide as Crypto Valley - seemed to be the heart of the Swiss crypto scene. The Crypto Valley Labs, which opened in 2017, were able to further increase international investment. And just recently an incubator called Crypto Valley Venture Capital (CVVC) was founded by creating it out of the Zug-based blockchain consulting company Lakeside Partners. Over the next five years, between 50 and 100 million dollars are to be invested in emerging crypto start-ups via this new accelerator.

But that’s not all. In April of this 2018, Zurich’s first Blockchain hub, Trust Square, moved into its offices on the world-renowned Bahnhofstrasse. Approximately 40 Blockchain start-ups—from one-man outfits to start-up companies with more than 50 employees—are headquartered there, right next to the Swiss National Bank and not far from the Paradeplatz. The Zurich initiative is not only of interest to start-ups; the Lord Mayor of London and a delegation from the Mayor of Seoul have visited in hopes of copying the Swiss success story. In order to make the blockchain even more open to the public, Trust Square is striving for intensive cooperation with local politicians.

There is also close cooperation with universities in Switzerland. Research about the blockchain topic is carried out at ETH Zurich, the University of Zurich, the University of Basel, and the University of Applied Sciences in Rapperswil. Particular mention should be made of the University of Basel, where blockchain lectures have been offered for several years as part of the “Center for Innovative Finance” research unit. The focus is on an interdisciplinary mix of economics, computer science and cryptography. Given the combined efforts of institutions of higher education, the financial industry, and the government, truly Switzerland and its people are living up to its nickname as the “Crypto Nation Switzerland”!

The Potential Dangers of Government Decentralization

Yet this real hope for decentralized reform in the Swiss state and its financial industry could alternatively become a nightmare for every liberty-minded citizen of Switzerland. What if the current blockchain enthusiasm does a disservice by bringing about the abolition of cash, a vacuum that might be filled by a Swiss digital full-reserve currency issued by the central bank? Such a move could be sold to the citizens as a fancy blockchain project, gaining their trust more easily. However, as any crypto expert knows, a completely decentralized, public, and censorship-free blockchain would never make sense for a central bank, since it would curtail its power to tinker with the money supply – an advantage that no central bank would willingly give up.

This is a classic Swiss paradox: because Switzerland’s institutions are embedded in a decentralized governance structure, they have historically had to work hard to gain the trust of the citizenry. And they have done so quite effectively over the past generation. The institutionalization of money with the Swiss national bank on top has gained a lot of trust too. Many people seem to forget though, that the institution of money is set up as a monopoly and is therefore structurally different from other Swiss institutions like cantons and municipalities.

It is this deep reservoir of trust that gives the central bank leeway to further cement its control of the currency either through the creation of a faux decentralized currency or the abolition of cash entirely. In light of such a dystopian possibility, it is our reasonable duty to support public, censorship-resistant blockchain projects such as Bitcoin. Due to its non-centralized structure, Bitcoin could one day become a trusted alternative. The fact that Bitcoin is commonly described as a decentralized blockchain, as it was at the beginning of this text, actually does an injustice to Bitcoin. Bitcoin is not decentralized, it is non-centralized. Although hardly ever recognized, there is a major difference between these two terms.

As a matter of fact, decentralization always presupposes a center and thus remains bound to the disease for which it is the cure. Switzerland has a central government body, the Confederation, and is therefore not non-centralized, which makes the development towards ever greater centralization inevitable, as history shows. Not so with Bitcoin. There is hope that a mathematically and cryptographically secured, non-central system like Bitcoin can resist this dynamic.

Acknowledgments for helping to flesh out all the ideas incorporated in this text go out to Luzius Meisser, Christian Decker and various other people from the Swiss Crypto nation.