Introduction
After months of parabolic gains, recent turbulent events have shook the cryptocurrency market. Just weeks ago, Chinese regulators issued a warning to financial institutions against accepting cryptocurrencies as payment or offering related services and products1. This coincided with Elon Musk suspending Tesla's acceptance of Bitcoin as an acceptable means of payment, citing environmental concerns2. Such developments did not go unnoticed and the total market cap of cryptocurrencies plunged by nearly one trillion US dollars in one day (19 May 2021) before regaining some its lost ground3. Not to be left behind by the Chinese, US financial authorities also announced their plans for a co-ordinated regulatory response to cryptocurrencies4. The recent increase and fluctuation in crypto-asset values suggests that the largely unregulated crypto-market has finally come of age, and in doing so has caught the attention of regulators around the world.
Closer to home and before these recent events, the European Commission published a draft Regulation proposing a comprehensive regulatory regime to govern crypto-assets within the EU. In this insight we examine the comprehensive scope of this proposed legislation, its new categorisations of crypto-assets and its proposed regulatory requirements.
Absence of Regulatory Framework
Currently, the regulatory landscape for crypto-assets in Ireland and Europe is sparse. Recent EU legislation has extended anti-money laundering and anti-terrorism financing measures to "virtual asset service providers" (previously covered in an RDJ insight here). However, aside from this, no existing legislation specifically seeks to target crypto-assets, their issuers or service-providers. An EU regulatory response to the increase in popularity of crypto-assets has been in the pipeline for some time and with the draft Markets in Crypto-Assets Regulation5 ("MiCA"), published last September, the current regulatory landscape for crypto-assets in Europe is likely to be changed considerably.
Key Aspects of the Crypto-Assets Regulation
MiCA proposes a fully harmonised, EU-wide regulatory framework, specifically for crypto-assets and crypto-asset service providers ("CASPs", each a "CASP") operating within the EU. Under MiCA CASPs will be required to be authorised by competent authorities (i.e. national regulators). Once registered with a competent authority, CASPs will be able to passport throughout the EEA.
While aiming to limit the risks of fraud and illicit practices within crypto-markets by imposing compliance requirements on CASPs, MiCA also aims to address potential financial stability and monetary policy risks that could arise from the mass-adoption of crypto-assets, particularly so-called "stablecoins" (i.e. a type of cryptocurrency whose value is tied to an outside asset). Under MiCA, stablecoins could be considered asset-referenced tokens or e-money tokens depending on how they are structured (addressed below).
MiCA further provides that when a crypto-asset meets certain criteria, it can be deemed to be "significant"6 under the legislation. A crypto-asset categorised as significant will attract additional regulatory requirements and will be subject to enhanced supervision. This aims to prevent the potential risk of financial instability that could arise from the mass adoption of a particular crypto-asset.
Categories of Crypto-Assets
MiCA categorises different types of crypto-assets and proposes to regulate their issuance, trading and storage. MiCA defines a crypto-asset as "a digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology". More specifically, MiCA differentiates between three categories of crypto-asset and outlines different requirements for their issuers.
- Asset-referenced tokens:
Asset-referenced tokens are crypto-assets which "purport to maintain a stable value by referring to the value of several fiat currencies that are legal tender, one or several commodities or one or several crypto-assets, or a combination of such assets7".
MiCA proposes that the issuers of such asset-referenced tokens will need to be authorised by their relevant competent authority. A draft "white paper" prospectus providing specific information about the token will also need to be approved by the competent authority prior to its publication. Once a white paper has been published, the issuer of crypto-assets can offer its crypto-assets in the EU or can seek to list its crypto-asset on a trading platform.
- E-Money Tokens:
E-Money tokens are crypto-assets which are intended to be used "as a means of exchange and that purports to maintain a stable value by referring to the value of a fiat currency that is legal tender". Therefore, in contrast to asset-referenced tokens, E-money tokens are pegged to a single fiat currency. It appears that well-known US-Dollar-pegged stablecoins such as Tether, USDC and BUSD, whose issuers claim that they are backed by US Dollars, would likely fall under this definition.
Under MiCA, E-money tokens will be required to be issued at par value to their pegged fiat currency. In addition, on request of the holder of an E-money token, the respective issuer is similarly required to redeem the E-Money token at any moment for par value in cash or by credit transfer8.
Under MiCA, issuers of E-money tokens will need to be authorised as a credit institution or an E-money institution before they can be offered to the public within the EU. As such, they will therefore be required to comply with the provisions of the revised Electronic Money Directive ("EMD II") 9. Before offering a crypto-asset in the EU, E-Money token issuers will be required to obtain approval for a "white paper" prospectus from their relevant competent authority. After approval, the white paper, will then need to be published on the e-money token issuer's website prior to offering the tokens to the public or listing them on trading platforms.
- Other Crypto-Assets:
This third 'catch-all' category includes those crypto-assets not captured by the other categories above (nor under the scope of existing EU financial markets regulations). Crypto-assets that are commonly referred to as utility tokens fall under this category. Utility tokens are tokens that are "intended to provide digital access to a good or service, available on DLT [distributed ledger technology], and that is only accepted by the issuer of that token10"
Issuers of other crypto-assets that fall under this third category are also prohibited from issuing their crypto-asset without first publishing a white paper; however, regulatory approval of such issuers' white paper is not a prerequisite.
Crypto-Asset Services
MiCA specifies the different type of crypto-asset services that will fall under this new regulatory regime. They include:
- the custody and administration of crypto-assets on behalf of third parties;
- the operation of a trading platform for crypto-assets;
- the exchange of crypto-assets for fiat currency that is legal tender;
- the exchange of crypto-assets for other crypto-assets;
- the execution of orders for crypto-assets on behalf of third parties;
- the placing of crypto-assets;
- the reception and transmission of orders for crypto assets on behalf of third parties; and
- providing advice on crypto-assets11.
Under MiCA, entities carrying out the above services will be required to register with their regulatory body and comply with certain regulatory obligations.
Consumer Protection Focus
Appearing to borrow from elements of the Markets in Financial Instruments Directive II ("MiFID II"), MiCA aims to impose strong consumer protection measures on CASPs, who will be obliged to act honestly, fairly and professionally in accordance with the best interests of their clients12. The proposed legislative measures include imposing a minimal capital requirement on CASPs, greater transparency as well as certain governance requirements. Insider trading and market manipulation will also be prohibited.
MiCA further proposes to implement safeguards surrounding the custody of assets and new licensing requirements for CASPs, including the establishment of an EU presence.
Updating Certain Aspects of MiFID
Currently, crypto-assets can be subject to regulation if they fall under the definition of "transferable securities" or "financial instruments" within MiFID II. MiCA proposes to clarify the existing definition of "financial instruments" within MiFID II, so that it also captures financial instruments based on distributed ledger technology.
MiCA's Balancing Act
In MiCA, policy makers in Brussels are seeking to strike a balance between fostering innovation and protecting investors. However, striking that balance is no easy task; imposing comprehensive (and burdensome) regulation on any industry whose very existence stems from innovation in an unregulated environment runs the risk of hampering that innovation and stifling growth.
There is a risk that the additional cost of regulatory compliance could serve as a barrier to new entrants - those being the firms which history has shown as often being the most innovative.
One of the core objectives of MiCA is to provide legal clarity while promoting the safe development of crypto-assets and the use of distributed ledger technology in financial services13. Despite making it harder to offer many crypto services without being authorised, MiCA will encourage and facilitate cross-border trade across the common market.
Another of MiCA's objectives is to support innovation and fair competition by enabling a framework for the issuance and provision of services related to crypto-assets. This is likely to lend the crypto-asset industry greater credibility and will help both consumers and institutions to build a greater degree of trust in crypto-assets. In this way, the proposed Regulation on MiCA can be seen as a natural step in the growth cycle of a developing sector.
Legislative Process
It is worth noting once more that MiCA, in its current form, is only a draft Regulation. While various bodies14 have issued opinions on MiCA since its publication, MiCA will next be deliberated by the European Parliament and the Council. While MiCA's provisions may be amended, we are unlikely to see any dramatic revision of its provisions.
While it is not possible to offer any certainty on the likely duration of the legislative process at European level, once MiCA comes into force, the regulatory regime will be operational only after an 18-month period15. During this 18-month period, CASPs will be required to obtain a licence from their relevant competent authority. It is worth noting here that issuers of E-money tokens and asset-referenced tokens will be required to comply with MiCA immediately when it comes into force (i.e. they will not be permitted to avail of the 18-month transitional period). For several reasons, crypto-asset issuers and service providers would therefore do well to prepare for, and even adopt the standards set out in MiCA ahead of time.
Risk of Hampering Innovation and Deterring New Entrants
MiCA will represent a radical shift in how crypto-assets in Ireland and the EU are regulated. Through the imposition of new authorisation requirements and the introduction of governance standards, MiCA aims to protect investors while also facilitating the continuation of the sector's growth.
The burden and constraints that a new EU regulatory framework will present to the crypto-asset sector is likely to cause some angst within the sector. Meeting the requirements of a financial services regulatory authority in any EU Member State will necessitate the formalising or even development of comprehensive systems and controls, a greater focus on the areas of risk and compliance as well as the need to lend a greater degree of priority to consumer interests.
That crypto-assets would at some point be grasped by Brussels' regulatory tentacles was inevitable. Brussels invariably makes haste slowly; there is often a time-lag between the development of technology-driven innovations and their capture within the regulatory framework. On this occasion the recent growth and prominence of cryptocurrencies has taken many by surprise and the pace of developments may serve to inject a greater urgency into the task of advancing the Commission's draft Regulation.
While the crypto-asset sector may grimace at the prospect of being brought within the ambit of a new EU-wide regulatory regime, they can take some solace from the fact that EU policy makers do not share their Chinese counterparts' more hostile regulatory approach to their activities.
Footnotes
3 https://www.reuters.com/business/bitcoin-slides-below-40000-ether-tumbles-2021-05-19/
4 https://amp.ft.com/content/a2c13ce0-6e66-4751-aa65-6c668d303101
5 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52020PC0593
6 Article 39(1) MiCA.
7 Article 3(1)(3) MiCA.
8 Article 44(4) MiCA.
9 Article 43(1)(a) MiCA.
10 Article 3(1)(5) MiCA.
11 Article 3(1)(9) MiCA.
12 Article 59(1) MiCA.
13 1.4.1. Legislative Financial Statement, MiCA.
14 For example: European Central Bank https://eur-lex.europa.eu/legal-content/GA/TXT/?uri=CELEX:52021AB0004 and the European Economic and Social Committee https://data.consilium.europa.eu/doc/document/ST-6627-2021-INIT/en/pdf
15 Article 126(2) MiCA.
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