Swarm Markets launches what it claims is the world’s first regulated DeFi platform

Berlin-based Swarm Markets has staked a bold claim: it says its new crypto trading platform, which launches today, is the world’s first regulated decentralized finance (DeFi) platform.

The business has secured licenses from the Federal Financial Supervisory Authority (BaFin), the German regulator.

“There’s no one else, that we know of at least, that actually has applied for a license that covers a decentralized exchange or a crypto exchange for that matter,” said Philipp Pieper, co-founder of Swarm Markets.

Swarm Markets operates a decentralized exchange (DEX) that has been built on the Ethereum network, somewhat in the style of Uniswap, a leading DEX.  

But Swarm Markets believes it has built a regulated alternative fit for both institutional and retail traders. Because of its various regulatory permissions, the DEX is even touting the capacity to support trading in both crypto and traditional assets, like stocks and shares.

Specifically, Swarm Markets — through sister firm Swarm Capital GmbH — holds the following provisional licenses under the German Banking Act (KWG): Commission Business, Agent Broking, Trading on own account, and Custodian Business.

“The licenses are not DeFi specific, that’s correct, but the way we described them in the licensing process was DeFi specific,” said Pieper.

The Swarm Capital entity has been integral to securing these licenses because it was in operation early enough to be “grandfathered” from changes to the German Banking Act made in early 2020. These amendments defined crypto assets as a new category of financial instrument, as well as introducing a new licensing requirement for crypto custodians.

The rocky road to regulation

Swarm has a long and complex past during which it has taken many guises. The first of those was a Swarm that launched in 2014 and was dead and buried within a few years, and is “not relevant” to the current iteration, according to a spokesperson. This early version of Swarm was focused on “crypto equity” and ran on the Bitcoin blockchain. 

Pieper and fellow co-founder Timo Lehes revived the project when they set up Swarm Network as an open infrastructure for issuing security tokens in 2017. Swarm Network is a non-profit Decentralized Autonomous Organization (DAO) which creates open-source issuance technology for use on permisionless blockchains. 

Later that year, an entity called the Swarm Foundation ran an initial coin offering (ICO) for the SWM token, which is still around but not doing much (CoinMarketCap puts its market capitalization at around $5.5 million). Swarm Foundation received grants from Swarm Network, in keeping with community-based governance proposals, to carry out proposals linked to the creation of open-source technology. And just to add one more Swarm entity into the mix, a security token investment platform called Swarm Invest was released within three months of the ICO.

It wasn’t until March 2019 that Pieper and Lehes set up the for-profit entities Swarm Capital and Swarm Markets. In June of that year, they established the so-called Swarm Masternode network to work towards decentralizing the network’s operations and governance. From there, 400 nodes were set up within six months.

Meanwhile, in April 2019, BaFin announced its proposed changes to the German Banking Act. These changes were to take effect in January 2020. In March 2020, BaFin made the possibility of grandfathering known — and the two new Swarm entities submitted their applications to the regulator.

Pieper said the amendment to the German Banking Act was seen as a threat by many crypto firms, but for Swarm Markets it “meant that there’s a big jurisdiction with a credible outfit that is actually taking a leap forward to bring it into the fold and become a blueprint for things to come in Europe, and maybe even beyond.”

By May, BaFin had confirmed that Swarm Markets could proceed with its DeFi project under the provisional licenses held by Swarm Capital.

Breaking down barriers

In a press release announcing the latest in the long line of Swarm launches, Swarm Markets pointed to the need to verify counterparties as “one of the biggest barriers” to further institutional adoption of crypto. The DEX hopes to solve that problem with anti-money laundering (AML) and “know your customer” (KYC) protocols, which will verify traders on the platform while maintaining their privacy.

According to Pieper, the authorization process has been an “eye-opener” for BaFin, which had been assessing applications with such things as traditional reporting standards in mind. But reporting standards are not relevant for a DEX, Pieper said, because regulators “have full direct access because that is transparent on the blockchain.” 

Questions around how assets are held in custody were similarly moot, he said, because crypto assets trading on Swarm Markets will be held in self-custody by users.

“All we introduce are what we call ‘compliance wrappers’. So we ringfence certain things in that use case when it applies to who can participate, what assets we enable to be worked on, and what type of financial procedures can be enabled to be worked on,” said Pieper.

“So we do have full control in collaboration with the regulators to restrict and to control what’s happening. However, there’s no way for us to take custody of the assets themselves, which is a very, very big change to any kind of classical model that falls under normal financial institution licenses.”

Up and running

The platform now launches with $15 million in pledged liquidity from more than 250 individuals signed up to its liquidity provider program. It is a minuscule sum by the standards of a large DEX. Uniswap, for instance, currently sports 24-hour trading volumes of close to $300 million, according to CoinMarketCap.

But Swarm Markets is, of course, brand new. It hopes to integrate fresh capital, new market participants and additional assets in due course. And even now the platform is operating under certain restrictions.

“We’ve started internal alpha tests with real money... And so our plan is now to gradually include users from a closer group around the company and then to expand that during the third quarter to a wider base of liquidity providers as well as traders,” said Lehes.

The co-founders have placed a lot of faith in the belief that this more gradual route to market will ultimately pay dividends.

“We’ve had the permits and the provisional license to be the first [regulated DEX] for a while, but we haven’t had the product that we wanted to bring to market until now,” Lehes added.