New Crypto Rules in the European Union — Gateway for Mass Adoption, or Excessive Regulation?

From Zero to MiCA in just Two Years

For some, the crypto market in Europe is still nothing more than an often-talked about, but financially insignificant, nerdy niche. So how did this legally binding and directly applicable regulation emerge in the EU? In my view, MiCA is the result of three key developments of the last two years, each of them reinforcing the others.

  1. At the end of 2017 and the beginning of 2018, within the framework of the EU FinTech Action Plan, the EU Commission instructed the European financial supervisory authorities (EBA, EIOPA, ESMA) to examine the applicability of EU financial law to these new types of crypto-assets (e.g., Bitcoin). This was no sooner said than done — the European Banking Authority (EBA) published its Report with Advice for the European Commission in early 2019. According to this report, crypto-assets do not fall under EU law to a large extent, while at the same time posing non-negligible consumer protection and money laundering risks. The mandate was clear: the EU must take action.
  2. And the EU has taken action, at least in part. Under the 5th Anti-Money Laundering Directive, the EU Commission obliges its member states to take action by early 2020 at the latest. However, this results in a veritable patchwork of national initiatives. Countries such as Germany, France, Lithuania, and Malta have adopted very different rules, while other states have done nothing at all. Ostensibly, the still-young crypto sector has gotten more and more fragmented — a clear locational disadvantage for the EU.
  3. Diem (formerly Libra), the global stablecoin project initiated by Facebook in June 2019, was a real wake-up call for regulators worldwide. One interpretation of Diem’s emergence is that the blockchain space has clearly grown out of its infancy, with global corporations now working on crypto-initiatives. The realization amongst EU regulators was clear: a fully harmonized, comprehensive, and binding legal framework was needed in order to prevent regulatory loopholes and a fragmented market.

Which rules apply to crypto-assets under MiCA?

Crypto-asset categories:

  1. Crypto-assets generally, as a “catch-all” category (e.g., bitcoins, ether, litecoins, etc.)
  2. Utility Token (e.g., Filecoin token, Basic Attention Token, etc.)
  3. ART — Asset-Referenced Token (e.g., Libra Basket Coin, etc.)
  4. EMT — E-Money Token (e.g., USDC, Libra Euro, etc.).

A Political Milestone for Crypto Adoption — If Key Criticisms are Addressed

Let us start with a positive outlook. The MiCA will create a fully harmonized European crypto-asset market. It aims at establishing legal certainty throughout the EU via clear classification of assets and transparent guidelines for service providers and issuers. Thanks to this new legal framework, more institutional investors and resources will enter and grow the market. Plus, due to the size and relevance of the EU internal market with its nearly 450 million customers, the MiCA can potentially set global standards and shape regulation internationally, similar to what the General Data Protection Regulation (GDPR) has achieved in the data protection sector.

  1. The regulation of utility tokens and the question of technology neutrality. Utility Tokens are defined in MiCA (art. 3 (5)) as a “type of crypto-asset which is intended to provide digital access to a good or service, available on DLT, and is only accepted by the issuer of that token”. The scope of this definition clearly includes non-financial types of assets, for example DLT-based mobility vouchers. Currently, voucher-like assets such as frequent flyer miles or Ebay vouchers do not fall under EU financial regulation (see EU directive 2016/1065). Hence, in order to ensure a technology-neutral policy approach, they shouldn’t be included in the scope of MiCA either, only because they are based on DLT. The commission should reconsider the scope of the regulation here, otherwise that could prevent a lot of interesting non-financial blockchain use cases in the real economy due to regulatory hurdles (whitepaper, etc.), compliance costs, and tax reasons.
  2. The regulation of Decentralized Finance (DeFi) and decentralized token issuances. The issuance of a crypto-asset in the EU requires, amongst others, the publication of a white paper and notification to a supervisory authority and the establishment of a legal entity in the EU. DeFi token projects such as Uniswap, Compound, or Maker could clearly never comply with these standards. While they might benefit from the grandfathering clause (crypto-assets issued before the entry into force of MiCA will not need to comply, with the exception of ART, and EMT), future DeFi tokens will not. And as a result of their incapacity to comply due to their decentralized nature, crypto trading platforms under MiCA won’t be allowed to list them any longer. Obviously, this would also be true for all well-known crypto-currencies such as Bitcoin, Ether, Litecoin, etc., if — hypothetically — they were to be issued after MiCA’s entry into force.
    The DeFi ecosystem is a — if not the — crucial driver of innovation in the crypto space. If the EU wants to enable a thriving EU crypto market and EU crypto-asset service providers to be competitive, it clearly shouldn’t put an end to the legality of future DeFi tokens and projects. Nevertheless, this whole concern depends on the definition and interpretation of an “issuer of crypto-assets” who according to MiCA (art. 3 (6)) is “a legal person who offers to the public any type of crypto-asset […].” The EU Commission or the EU financial supervisory authorities should clarify that decentralized projects don’t fall under the definition of a “legal person” and should thus be exempted from the aforementioned regulatory obligations.
    Obviously, the difficulty will be the definition and operationalization of “decentralization” criteria. Once established, on the other hand, it would not only provide clarity with regards to decentralized token issuances, but also to decentralized financial services such as decentralized exchange, borrowing, lending etc. and their applicability within MiCA. Otherwise, projects like Uniswap, Compound, Aave and others are doomed to a long-term regulatory gray area.
  3. The regulation and effective banning of stablecoins in the EU. The MiCA proposes almost insurmountable challenges for stablecoins. As one example, issuers of e-money-tokens (EMT) must be authorized as a credit institution or an e-money institution and comply with e-money-institutional requirements, separate from the newly introduced EMT-specific requirements regarding a necessary white paper authorization, redemption rights, operational obligations etc.
    Plus, under MiCA’s thresholds, most of the relevant stablecoins on the market (Tether, USDC, Dai, etc.) would currently count as “significant”, since they easily exceed one billion market capitalization and/or 100 million daily trading volume. That means that they would need to meet additional obligations, e.g., own capital funds of at least 3% of the average amount of the reserve assets (art. 41 (4)). Tether, for example, with currently approximately 25 billion US Dollars backing its stablecoins, would have to hold at least 750 million(!) of own funds.
    The issuance of stablecoins is, in most cases, not a very profitable undertaking. But even without this knowledge, it seems quite clear that no issuer of the most used stablecoins on the market will be able and willing to comply with all those obligations and apply for EU licences. That means, however, that they can’t be listed on EU trading platforms, a heavy locational disadvantage for EU trading platforms. Of the 30 trading pairs with the highest trading volumes of the biggest crypto trading platform Binance, 26 include a stablecoin. Over half of all Bitcoin trades are effectuated with Tether alone. This effective banning of basically all relevant stablecoins for EU crypto asset service providers would hence not only radically limit the competitiveness of EU-regulated companies, but presumably drive many EU consumers towards non-EU regulated foreign exchanges, thereby largely thwarting the EU’s goal of better consumer protection.
    My understanding of the harsh stablecoins regulations, which cover a big part of the MiCA proposal, is that the EU stakeholders’ fear of the economic and monetary implications of the Diem project made them abandon their otherwise reasonable and proportional approach towards crypto and set a sign of political strength. This becomes even clearer when considering that the EU openly accepts to create an overlapping regulatory framework for e-money-tokens, where both the E-Money-Directive and the MiCA apply. For all other crypto-assets including security tokens, where only MiFID II applies, a clear and unique regulatory handling was the explicit goal. Without further changes — namely lower and more proportionate requirements and, for example, changes to the definition of “algorithmic” stablecoins so that it could at least apply to the DAI-stablecoin (“algorithmic” stablecoins do not fall under the definitions of EMT & ART and would therefore benefit from the grandfathering clause and lower requirements) — the MiCA will basically suppress stablecoins and damage EU companies as well as customers.

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