The first cornerstone: the adoption of the Markets in Crypto-assets (“MiCA”) regulation
On 30 June 2022, the European Parliament and Council reached a provisional agreement on the MiCA regulation (the "MiCA Regulation"), providing a long-awaited legal framework for crypto-assets. The MiCA Regulation seeks to “establish uniform rules for crypto-asset service providers and issuers at an EU level” and to “replace existing national frameworks applicable to crypto-assets”.
It is expected that the MiCA Regulation will foster the innovation and adoption of distributed ledger technology ("DLT") in Europe whilst ensuring the protection of consumers and investors. The regulation distinguishes between three types of crypto-assets whose issuers would be subject to registration:
- E-money tokens or “stablecoins” (e.g. USDC) – a token that can be used as a median of exchange and maintains a stable value by referring to the value of a fiat currency (e.g. Dollar)
- Asset referenced tokens (e.g. USDT) – a token that maintains a stable value by referring to several fiat currencies, commodities or a range of asset classes
- Utility tokens (e.g. BNB) – a token providing access to a good or service using DLT, and only being accepted by the issuer.
The main focus: E-money tokens or “stablecoins”
E-money tokens or “stablecoins” which are pegged to a fiat currency like the Euro seems to be a key focus of the MiCA Regulation. In the explanatory memorandum of the proposal, the European Commission explained that "while the crypto-asset market remains modest in size and does not currently pose a threat to financial stability, this may change with the advent of global stablecoins".
The MiCA Regulation shall impose significant regulatory requirements which must be met by both e-money tokens and asset referenced tokens. Under the MiCA Regulation, stablecoins issuers are required to hold 1:1 reserves which means that the same amount issued as e-money has to be held as reserve in fiat or other assets. Crypto-Asset Service Providers ("CASPs") will also not be allowed to collect interest on savings schemes using stablecoins.
Another aspect of the developing digital asset industry is Decentralised Finance (“DeFi”), which describes DLT financial services, which operate without a centralised intermediary. The MiCA Regulation does not specifically regulate assets issued by DeFi protocols, however, these do qualify as crypto-assets and therefore shall be subject to the MiCA Regulation. More specific regulatory frameworks tailored to DeFi will likely follow at a later stage. DeFi cuts out any intermediary and allows, for example, the borrower and lender to use smart contracts to execute obligations directly and autonomously. Such assets are not limited to, but include, for example, interest received on a borrowed amount of crypto-assets.
Some key points of discussion during the drafting/review process
- Proof-of-work (“PoW”) under debate but not banned
The debate leading up to the provisional agreement on the MiCA Regulation was centred on the question as to whether DLTs using a PoW consensus mechanism should be subject to a blanket ban: such a blanket ban would have stunned the European digital asset markets, as the most prominent PoW blockchain remains Bitcoin, the only "blue chip" crypto currency. The fight against PoW stems from the denunciation of the crypto mining industry and the energy intensive nature of mining. Indeed, the processing power and therefore energy required to mine Bitcoin has exponentially increased over the past decade, because the difficulty to mine Bitcoin increases as more Bitcoin is mined. Nevertheless, no general ban was included in the approved version of the regulation, as the commission preferred to deal with PoW as a necessary part of the industry.
- Increasing consideration of ESG standards
Although PoW based DLTs were not banned, the European Commission has become aware of the environmental impact caused by PoW based DLTs. As a result, it has developed strict new disclosure requirements for CASPs to comply with the European Environmental, Social and Governance standards. These standards include the obligation to publish a whitepaper, which explains the consensus mechanism used by the token or coin and its future purpose. Further standards will be determined by ESMA.
- A possible special regime for Non-Fungible Tokens (NFTs)
NFTs are non-fungible, which means that they are unique. These tokens represent proof of ownership and can also serve as proof of authenticity. They can be considered as being at the other end of the spectrum from fungible tokens, like Bitcoin, which are identical to each other and are therefore primarily used as payment methods. NFTs will not fall under the scope of the MiCA Regulation. Nevertheless, it remains to be seen whether the European Commission will introduce a special regime for NFTs in the near future given the use of NFTs in an increasing range of fields. For example, memberships, music and entry tickets (to concerts, games, transport, etc.) could be transformed into an NFT. While the MiCA Regulation steers clear of regulating NFTs themselves, the regulation shall regulate NFT marketplaces as CASPs.
A Growing Regulatory Umbrella
Once in force, the MiCA Regulation will join the ranks of a growing number of legislative texts, which are gradually starting to form a comprehensive umbrella of European digital asset and DLT regulation. The MiCA Regulation will complement the EU's Regulation (EU) 2022/858 on a pilot regime for market infrastructures based on DLT (the "Pilot Regime"), which was published in the Official Journal of the EU on 2 June 2022. The Pilot Regime regulates entities that provide securities trading and settlement infrastructure to crypto-assets, which qualify as financial instruments under MiFID. This legislation may be particularly important for Luxembourg, especially because the Luxembourg Stock Exchange recently opted to permit the issuance of security tokens through its platform (for more info see our newsletter on the topic here).
Lastly, there are also ongoing negotiations at an EU level relating to Regulation (EU) 2015/847 of the European Parliament and of the Council of 20 May 2015 on information accompanying transfers of funds (the "TFR"). According to the TFR, KYC obligations may be imposed on any centralised crypto platform that sends funds to an "unhosted" digital wallet. This could potentially impose a disproportionate burden on retail customers who hold funds in digital wallets that are not hosted by a centralised CASP.
In conclusion, the EU is pioneering the construction of a legal framework for digital assets that will serve as a basis for countless jurisdictions worldwide. However, in going down this path, EU legislators should be careful not to stunt the growth of the market by "over-legislating" the industry.