The EU’s Markets in Crypto-Assets Regulation: a regulatory tectonic shift for the crypto economy
Kochański & Partners, Warsaw
The Covid-19 pandemic and the war in Ukraine have had a significant impact on the global economy, demonstrating that the geopolitical situation significantly affects all asset classes, including currencies. Faced with falling exchange rates, many have begun to look for alternative forms of security for their assets with some deciding to change their savings into cryptocurrencies. One example of this is seen in Ukraine, which, at the beginning of the conflict, placed the equivalent of $100m in cryptocurrencies, which was initially used to support the armed forces. In crisis situations, it turns out that cryptocurrencies can be much more stable than ‘traditional’ currencies and shows how relevant cryptocurrencies can be on a global scale.
However, with the rapid development of the crypto-asset market, risks regarding the trading of crypto-assets have begun to emerge. These risks include speculative phenomena affecting the value of individual crypto-assets, the lack of transparency regarding the legal nature of these assets, increasing regulatory fragmentation regarding crypto-assets in individual EU Member States, a lack of specific legislation, and technological advances, which have left many people confused as to how to approach these innovations. It is all these risk factors that prompted the EU to create its own comprehensive piece of legislation.
These concerns are all addressed within the EU’s Markets in Crypto-Assets Regulation (MiCA) project - a future regulation on crypto-asset transactions within the EU.
MiCA is currently a European Commission project, which will result in the entry into force of the Regulation of the European Parliament and of the Council on Markets in Crypto-Assets, amending EU Directive 2019/1937. It is one of the pieces of legislation introduced as part of the so-called Digital Finance Package, an EU strategy that aims, among other things, to unify the digital market for financial services and stimulate innovation, as well as provide stability and protect investors from risk. Other documents included and worth noting are: the Regulation of the European Parliament and of the Council on the operational digital resilience of the financial sector (DORA); the Regulation of the European Parliament and of the Council on a pilot system for distributed ledger technology (DLT)-based market infrastructures; and the Communication on the EU Retail Payment Strategy.
What is the scope of the regulation?
Among the crypto-assets covered by this regulation, one can distinguish: (1) utility tokens, ie, assets that are not treated as money, but as a right to a future product or service. By definition, these act as digital vouchers; (2) asset-linked tokens (so-called stablecoins), that is crypto-assets that, by definition, should maintain a stable value by reference to another asset (eg, to another cryptocurrency or the dollar exchange rate). According to the EU legislator, such cryptocurrencies generate the greatest risks because they aspire to act as a means of payment; and (3) tokens that are e-money, whose main purpose is to be used as a means of exchange, and whose value is maintained by reference to the value of a fiat currency.
Somewhat controversially, several items have also been excluded from the MiCA regulations, including: (1) decentralised finance ('DeFi') which includes, for example, cryptocurrency exchanges operating on the basis of smart contracts; (2) central bank digital currencies (CBDCs), which are the equivalent of fiat currencies issued by central banks based on blockchain infrastructure; and (3) non-fungible tokens (NFTs), except where they qualify under existing cryptocurrency categories.
In terms of entity scope, MiCA's coverage includes two categories of entities - issuers of crypto-assets and providers of crypto-related services. The starting obligation for issuers of regulated assets (except for, among others, issuers of NFTs or crypto-assets offered for free) is the publishing of a so-called white paper, a document that is a simplified equivalent of a prospectus. The white paper will have to be delivered at least 20 days before the first issuance to the relevant financial market supervisors in a given EU country, such as the Komisja Nadzoru Finansowego (KNF), the Financial Supervision Authority in Poland. The authorities will then allow or prohibit the issuance of the crypto-asset in question. In addition to this, in the case of stablecoins, the issuer will be required to have an offering licence and explicit prior approval of the white paper by the national financial supervisory authority.
Competitive advantage of functioning institutions over new market entrants
The entry into force of this legislation will create a new financial reality that will primarily benefit financial institutions that are already regulated and can be issuers interested in providing services throughout the EU. Obtaining authorisation in one country will enable the provision of services throughout the EU, which will make it much easier for these entities to operate due to the lack of a need to obtain a licence in each country. In addition to this, the regulation removes from currently regulated players some of the obligations that new players in the market will have to fulfil. For countries such as Germany, where licences already exist for certain cryptocurrency-related financial services, simplified authorisation procedures will be introduced to update these licences. This could prove to be a major competitive advantage for EU countries that are already pioneers in the crypto space. Service providers operating in these countries will be able to obtain new licences faster.
High standards for significant issuers
On the other hand, MiCA serves stablecoin issuers with a package of additional obligations. In addition to the obligation to develop the previously mentioned white paper, the EU requires, among other things, filing with a supervisory authority, obtaining the status of a credit or e-money institution and meeting the institutional requirements for e-money.
It should be noted, however, that not all stablecoin issuers are equal. MiCA provides additional requirements for those entities that qualify as so-called issuers of significant tokens.
According to the current draft of the MiCA, such entities would be required to meet additional requirements such as the obligation to implement a special remuneration policy that promotes prudent risk management. According to the draft, regulators should develop technical standards that specify the minimum content of the required policy. Stricter requirements will also apply to the amount of own funds required. The entry into force of the requirements in question may limit stablecoin issuance, while reducing risks to the EU's financial stability and monetary policy. On the other hand, however, such shaping of the regulations may disrupt one of the main objectives of the EU, namely the promotion of innovation in the financial sector.
Cryptocurrency market players will also be obliged to provide information on their environmental and climate footprint.
Within two years, the European Commission will have to report on the environmental impact of cryptocurrencies, as well as the introduction of mandatory minimum sustainability standards for the consensus mechanism, including proof-of-work.
MiCA also places a strong emphasis on consumer protection. Issuers of stablecoin will be required to create a sufficiently liquid reserve with a ratio of 1/1, partly in the form of deposits. Any stablecoin cryptocurrency holder will be able to receive a claim from the issuer for free at any time, and the rules governing the reserve will also ensure adequate minimum liquidity. In addition, all stablecoins will be under the supervision of the European Banking Authority (EBA), and a condition of any issuance will be the presence of the issuer in the EU.
The development of stablecoins based on a non-European currency as a commonly used means of payment will be restricted, which is aimed at strengthening the sovereignty of the eurozone. Issuers of such tokens will also be required to maintain a registered office in the EU to ensure adequate oversight and monitoring with regard to public offerings of asset-linked tokens.
MiCA will create a harmonised European crypto-asset market, which aims to establish legal certainty across the EU through clear asset classification and transparent guidelines for service providers and issuers. If the regulations meet with widespread acceptance, one can cautiously predict that more institutional investors and resources will enter the market. This could help the market develop further. In addition to this, MiCA, due to the scale of the European single market, could follow in the footsteps of the General Data Protection Regulation (GDPR) and also become a contributor to shaping similar regulations in other parts of the world.
The Council Presidency and the European Parliament have reached a preliminary agreement on the draft MiCA. The European Parliament and the Council of the EU must now formally approve the agreed text, and only then will we have access to the final version of MiCA. The regulation is expected to enter into force in late 2023 or early 2024.