Over the last months, the EU regulators and the United States started to develop crypto asset regulations and frameworks that (are intended) to promote innovation and growth while protecting investors.

Let us report on the most recent and important events here.

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MiCA as part of the Digital Finance Package of the European Union

On 24 September 2020, the European Commission (EC) adopted an expansive new Digital Finance Package to transform the European economy in the coming decades.

The package aims to improve the competitiveness of the continent’s Fintech sector and technologies while mitigating risk and ensuring the financial stability of the European economy.

The new regulatory framework also includes a comprehensive new legislative proposal on crypto-assets, called Markets in Crypto-assets (MiCA). MiCA was developed to help streamline distributed ledger technology (DLT) and virtual asset regulation in the European Union (EU) whilst protecting users and investors.

MiCA proposes a legal framework for digital assets, markets, and service providers currently not regulated on an EU level and makes it possible to provide licensed services across the EU.

If adopted, the regulation will directly apply to all Member States.

The Eu Council and the European Parliament reached a provisional agreement on Regulation on Markets in Cryptoassets (MiCA) on 30th June 2022.

The  MiCA will focus strongly on rules to regulate currently out-of-scope crypto-asset types such as stablecoins and crypto-asset service providers, referred to as CASPs.

The main basis points reached for CASPs.

CASPs must be established with substantive management presence in the European member country where they request authorisation. The competent national authority (BAFIN for Germany, for example) will refuse permission if AML criteria are not met. Authorised CASPs will be able to “passport” their services into all 27 EU countries under MiCA.

CASPs must adhere to strict requirements to protect consumers.  Liabilities will fall on CASPs and other wallet custodians in the event of hacks or preventable operational failures.  So accountability is clearly defined. For tokens without issuers (such as Bitcoin), trading platforms will have to provide a white paper and be liable for any misleading information.

The proposed regulations will apply to any non-European CASP seeking to market to EU clients. Among the requirements will be a need for a legal entity in an EU country and a license, but there are other potential requirements such as additional licensing for what is deemed to be advisory functions, depending on the type of activity undertaken. MiCA is not a framework that only affects the EU; it will have global repercussions.

Rules for Stablecoins

“Stablecoin” holders are granted an unrestricted right to exchange, exercisable at any time, by the issuer, and the rules for handling the reserve also provide adequate minimum liquidity. The reserves will have to be legally and operationally segregated and insulated in the holder’s interest and will be fully protected in case of insolvency.

Large stablecoins will be subject to strict operational and prudential rules, with restrictions if they are used widely as a means of payment and a cap of € 200 million in transactions/day.

All so-called stablecoins are subject to supervision by the European Banking Authority (EBA), and it is a prerequisite for any issues that the issuer is located in the EU.

The development of value-referenced tokens based on a non-European currency as a widely used means of payment is restricted to preserve our monetary sovereignty. Issuers of value-referenced tokens must have a registered office in the EU to ensure proper supervision and oversight of public offerings of value-referenced tokens.

NFTs are excluded (except for NFTs with fractionalised ownership). The Commission will develop a new regime on NFTs within 18 months.

No ban on PoW crypto assets, But  CASPs will have to publicise data regarding the environmental impact of their activities.

DeFi is also out of the scope of MICA, but new proposals are expected on this within 18 months of entry into force.

EBA and ESMA: Crypto sheriffs

The European Securities and Markets Authority (ESMA) and the EBA will be in charge of monitoring crypto markets and will have the power to intervene in certain situations.  ESMA will be given powers to step in to ban or restrict the provision of crypto asset services by CASPs or distribution or sale of crypto assets, in case of a threat to investor protection, market integrity or financial stability.

ESMA will also establish a register of third country CASPs that operate without authorisation and together with the competent national authorities will have far-reaching powers against listed entities, including the possibility of shutting down their websites.

Money Laundering Issue

MiCA does not directly address anti-money laundering (AML) and Combating Financing of Terrorism (CFT) risks however, the proposal has been designed to further harmonize EU legislation with the Financial Action Task Force (FATF)’s 40 Recommendations by aligning its terminology and scope of service to a certain extent.

European Parliament and Council also reached a provisional agreement on the Transfer of Funds Regulation (TFR), which the EU plans to implement simultaneously with MiCA.

CASPs will be required to verify the source of funds before making any deposited funds available to their customers and will have to conduct diligence when dealing with CASPs outside of the EU. A list of non-compliant CASPs will be published, which EU CASPs must not interact with.

Unhosted wallets will not be banned, but any transaction over EUR 1,000 will require the CASP to verify if the unhosted wallet is owned or controlled by this customer. The rules do not apply to person-to-person transfers conducted without a provider, such as bitcoin trading platforms, or among providers acting on their own behalf.

CASPs have to provide information on the source and beneficiary of any transaction if required by an investigating authority, with no minimum transaction threshold. Current FATF standards only apply for transactions over the threshold of EUR 1,000.

European Council agreed to form an Anti-Money Laundering (AML) body (expected in 2024) that will have the authority to supervise certain high-risk CASPs.

Bipartisan crypto bill proposals in the United States

The US appears to be far away from any clear legislation on digital assets.  Only proposals on how they might get there and which entity would be responsible for regulating these markets have been published so far.

On 7th June 2022, Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced the Responsible Financial Innovation Act (the bill), which sets out to create the first complete regulatory and bipartisan framework for digital assets. The account is – like MiCA  – also intended to establish some legal clarity for regulators and the industry and to protect consumers by providing a range of disclosures and clarifying settlement conditions and rights over digital ownership.

But the Responsible Financial Innovation Act is still in the early stages.

The main proposals of the Act include:

•  A standard to determine which digital assets are commodities and securities, including formal definitions for digital assets, smart contracts, and digital asset intermediaries.
•  Authorisation rules to various crypto industry participants inc. crypto exchanges.
• Defi protocols are not explicitly covered.
•  CFTC is set as a watchdog for crypto exchanges.
• Safeguarding customer assets and preventing commingling of the customer and corporate funds.
• Consumer protections for stablecoin issuers, requiring full reserve (1:1 ratio) and detailed disclosure of how the stablecoin is backed. Redemption must be possible at request of the investor in recognised legal tender.
• Specific disclosure requirements for digital asset service providers.
• Act directs the Federal Energy Regulatory Commission to analyse and report on energy consumption in the digital asset space.

The second bipartisan bill, the Digital Commodity Exchange Act of 2022 (DCEA), was shared in April 2022. The DCEA also assigned regulatory authority over digital asset spot markets to the CFTC. The CFTC would be authorised to register and regulate trading venues (i.e., exchanges) offering spot or cash digital commodities, which would have to abide by specific requirements for safeguarding customer assets consistent with those currently applicable to futures.

FinCEN has proposed a new cryptocurrency regulation to impose data collection requirements on cryptocurrency exchanges and wallets, which may extend to unhosted wallets.

So what is next?

The regulators are eager to understand and develop a framework for crypto assets, so let us see how this develops.