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.
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) while 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 in all Member States.
Details of the provisional agreement
The EU Council and the European Parliament reached a provisional agreement on Regulation on Markets in Cryptoassets (MiCA) on 30th June 2022.
MiCA governs, among other things, the custody and administration of crypto assets, the operation of trading platforms, the exchange of cryptoassets for legal tender as well as for other cryptoassets including stablecoins. In addition the execution of client orders as well as the provision of advice in this regard will be covered by MiCA.
Cryptoassets covered by MiCA!
Mica basically distinguishes between different types of crypto tokens:
– Asset Referenced Tokens (ART), whose value is linked to a basket of other assets,
– stablecoins (Eelectronic Money Tokens, EMT), whose value is linked to a single fiat currency,
– all crypto assets that are not ART nor EMT,
– and utility tokens, which are designed to provide digital access to a good or service.
Extensive rules for cryptoasset service providers, referred to as CASPs, are foreseen.
The provisional agreement provides that CASPs must be established with substantive management presence in the European member country where they request authorization. CASPs will need to undertake stress-testing exercises, meet minimum capital requirements and safeguard customer funds. The competent national authority (BAFIN for Germany, for example) will refuse permission if the set requirements are unmet. Accompanying MiCA through the EU’s legislative process are amendments to the separate Transfer of Funds Regulation (TFR). This governs how CASPs must treat cryptoasset transfers for anti-money laundering (AML) purposes.
Authorized CASPs can “passport” their services into all 27 EU countries under MiCA.
CASPs must furthermore 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. .
CASPs will only be able to list cryptoassets that meet certain conditions, such as having a white paper that explains a token’s primary use, technological features and risks. For tokens with issuers (unlike Bitcoin), trading platforms will have to publish the relevant white papers 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 to be met for such CASP, will be a need for a legal entity in an EU country and a license. Still, there are potential requirements, such as additional licensing for what is deemed to be advisory functions, depending on the type of activity undertaken.
Stablecoins or crypto-assets that seek to retain a fixed value through a peg to other assets
MiCA creates two new definitions that will apply to most stablecoins. Asset-referenced tokens (ARTs) are those that seek to maintain a fixed value “by referencing several currencies that are legal tender, one or several commodities, one or several crypto-assets, or a basket of such assets”. A separate category that will apply to many major stablecoin issuers is e-money tokens (EMTs). These are stablecoins pegged to one single fiat currency, such as the euro. As the name suggests, EMT issuers will be subject to rules that are similar to those faced by e-money issuers under the EU Electronic Money Directive.
Both EMT and ART issuers will need to ensure that their tokens are fully backed by reserves at par, and that they can guarantee the redemption rights of token holders. EMT issuers will be regulated by the European Banking Authority (EBA) and must also obtain a separate e-money licence. ART issuers will be approved and supervised by the European Securities and Markets Authority (ESMA), except where deemed to be systemically significant, in which case the EBA will supervise them.
“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 funds 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 used widely for payment and a cap of € 200 million in transactions/day.
All so-called stablecoins are subject to supervision by the European Banking Authority (EBA), which is a prerequisite for any issues that the issuer is in the EU.
Not yet addressed by the proposed MiCA
NFTs are excluded (except for NFTs with fractionalized ownership). The Commission will develop a new regime on NFTs within 18 months.
No ban on PoW crypto assets, But CASPs will have to publicize 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 monitor crypto markets and have the power to intervene in certain situations. ESMA will be given powers to ban or restrict the provision of crypto asset services by CASPs or the distribution or sale of cryptoassets 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 authorization. The competent national authorities will have far-reaching powers for listed entities, including possibly shutting down their websites.
Transfer of Funds Regulation (TFR)
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.
So when approval on MiCA is reached European Parliament and Council also will reach 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 due 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.
Under the TFR, CASPs will be required to apply enhanced monitoring to transactions with unhosted wallets, and must verify the identity of the originators or beneficiaries behind unhosted wallets for transfers of more than 1,000 euros ($1,000). This requirement exceeds the FATF standards, which only require the collection — but not verification — of data on unhosted wallets.
CASPs must 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) with the authority to also supervise certain high-risk CASPs.
BiPartisan crypto bill proposals in the United States
The US appears to be far, far clear on legislation on digital assets. Only submissions 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 legal clarity for regulators and the industry and protect consumers by providing a range of disclosures and clarifying settlement conditions and rights over digital ownership.
The Responsible Financial Innovation Act
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 entire reserve (1:1 ratio) and detailed disclosure of how the stablecoin is backed. Redemption must be possible at the investor’s request with recognized legal tender.
- Specific disclosure requirements for digital asset service providers.
- Act directs the Federal Energy Regulatory Commission to analyze and report on energy consumption in the digital asset space.
Digital Commodity Exchange Act (DCEA)
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.
