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Officers, NCOs and other ranks serving as balloon observers on active frontline duty were eligible for this badge. It came in three classes graded on the basis of a points system. The 1. Stufe [1st level] (bronze) was for 20 points, the 2. Stufe [2nd level] (silver) for 45 and the 3. Stufe [3rd level] (gold) was for 75 points. Points were recognized as follows:
1. Flawless spotting of tactically relevant targets
a) that are of particular significance to the command authorities (such as stagings and major concentrations of troops, transport movements of every kind etc.) - 1 point per target
b) that were combated by heavy weapons (artillery or air force) (such as firing positions, groups of tanks, ammunition dumps etc.) - 1 point per target
2. Successful direction of adjustment fire - 1 point each
3. Balloon ascents on the frontline - 1 point per every 4 hours
4. Observation despite incoming fire from enemy aircraft or artillery
a) if no losses or damage were incurred - 2 points
b) if damage to the balloon or the ground station was incurred - 3 points
5. Emergency parachute bail-out from the balloon
a) first jump - 10 points
b) every subsequent jump - 5 points each
The badge was to be bestowed with an award certificate and to be worn on the left breast of the uniform. If the recipient held an assault badge, the Ballonbeobachterabzechen was to be worn to its left. As usual, only the highest grade was to be worn.
Awards of the badge - at least of the 1st level (bronze) - were definitely made on paper (i.e. in the form of the presentation of award certificates and the accompanying Soldbuch entries). The first known award date is 12 Dec. 1944; known awardees with that date are Oberleutnant Peter Stegmann, Oberwachtmeister Willibald Sellner and Wachtmeister Josef Schinkowski.
However, it is unknown whether it was actually manufactured and physically bestowed prior to the end of the war. (Most likely it wasn't; but this is a bit of a controversial subject, as are all allegedly wartime badges. Anyway, the badge is heavily faked.)
For what it's worth, the final edition of Dr. Heinrich Doehle's period standard reference Die Auszeichnungen des Großdeutschen Reiches includes the badge and lists the award criteria, but with a note that an illustration was not yet available when the book went to press (which was in late October 1944, so we know for sure that the badge hadn't yet been produced by that time).
In any case, there are no known wartime photographs of the badge in wear.
The Ballonbeobachterabzeichen was re-authorized for wear in de-nazified form along with the other wartime combat-, service- and achievement badges of the German armed forces by the Ordensgesetz of 26 July 1957. Its modified design - which eliminated the Wehrmacht eagle found on top of the wreath in the original design - along with those of all the other "1957er" awards, was regulated in the decree of the Federal Interior Minister and its accompanying manufacturing regulations of 1 February 1958, published on 28 February 1958.
Here is my 1957 model of the 3rd level (gold) badge (an early specimen made by Steinhauer & Lück):