European regulation of cryptocurrencies: MiCA, brake on innovation or appropriate framework?

The European Parliament’s Committee on Economic and Monetary Affairs (ECON) has taken on the difficult task of propose harmonized rules to regulate the thriving cryptoactive sector. The draft regulation, called MiCA for “Markets in Crypto-Assets”, is part of a package of measures aimed at “unlocking and strengthening the potential that digital finance can offer in terms of innovation and competition, and at the same time limiting the risks “, according to the Commission’s justification in its September 2020 proposal.

In fact, on the contrary, this ambitious and hotly debated MiCA project could limit rather than amplify the potential of this thriving ecosystem. In any case, this is the vision shared by a large number of players in the sector, represented in France by the ADAN (Association for the Development of Digital Assets).

This content is brought to you by Léo Schenk and Pierre Gineste, consultant and senior manager at Nexialog counseling.

What is the context for MiCA?

“An asset whose perceived or intrinsic value depends primarily on cryptography and DLT (Distributed Ledger Technology) or similar technology, which is not issued or guaranteed by a central bank or public authority, and which can be used as a medium of exchange or for investment purposes”.

Definition of the term cryptoactive. European Parliament, 17 March 2022.

The MiCA Regulation is part of a global fintech action plan. Following the increase in the capitalization of cryptocurrencies in 2017, the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) were tasked with assessing the adequacy of the existing regulatory framework. According to the 2019 opinion, the legislation was not only difficult to apply but could also hamper the development of the sector.

Meanwhile, different member states have legislation on issues relating to cryptocurrencies in scattered order: taxation, supervision of related activities, registration with national supervisory authorities, etc.

As the European market was thus fragmented, it was necessary toestablish a harmonized legal frameworkoffering investors an appropriate level of protection, ensuring financial stability and fair competition, while supporting innovation.

History of the MiCA Act

It is in this context that a first proposal was prepared by the Commission in September 2020. Subsequently, the German MEP Stefan Berger was appointed rapporteur for the project. The latter presented an initial report in February 2021, and following the opinions of the European Central Bank, the Economic Committee and the European Data Protection Supervisor, a final version was put to the vote in ECON in March 2022.

Although the proposal was accepted after being amended, it must now be submitted to the European Commission and the Council of Europe. If adopted after this trialogue, players in the cryptocurrency market will have 18 months to fully comply with it.

Christine Lagarde, President of the European Central Bank, in front of the EU flag.
Christine Lagarde, President of the European Central Bank.

What does the MiCA project contain?

MiCA incorporates some of the rules that apply to so-called “traditional” financing, ie. MiFID, Market Abuse (MAR) and prospectuses, and adapts them to the specific conditions of the cryptocurrency market.

The regulation covers four main areas:

Offer cryptocurrencies (other than stack coins or e-money tokens) to the public

This activity will be reserved for legal persons, which has prepared a white paper that describes, among other things, the issuer’s project, the type of cryptoactive, the underlying technology and, of course, the risks involved. This document does not require validation by the supervisory authority, but the latter must still be notified. Commercial communications will also be regulated. The funds obtained in return for the offer will be transferred to a credit institution or an approved custodian bank for crypto assets. Investors will benefit from a right of withdrawal.

The issuance of this type of cryptoactive will be subject to approval if a certain amount is exceeded and its offer is not exclusively intended for qualified investors. Approval will be granted under certain conditions: management and risk management systems, internal control mechanisms and capital requirements (maximum amount between € 350,000 and 2% of the average value of the reserve). A white paper must also be notified to the competent authority.

Because this stablecoin type is primarily intended to be used as a means of exchange. It thus competes directly with replicated fiat money. The rules here are the most restrictive. Actuallythe issuer must be approved as a credit institution or electronic bank. It must also be able to repay token holders at any time and at face value in the replicated currency. The assets in own account and those used to cover the tokens issued must be separated, these reserves must be audited and subject to a strict investment plan in order to maintain sufficient liquidity. Finally, the issuer may not offer to honor the holders of the token via payment of interest linked to the holding period.

In the two previous cases, if stablecoin is considered to be “substantially important” according to a list of established criteria (market value and trading volume for example), the issuer will be required to comply with additional regulatory constraints as well as supervision by the European Banking Authority.

4. Crypto Asset Service Providers (PSCAs)

This section is very inspired by French scheme for digital asset providers (PSAN) relates, inter alia, to custodian banks, trading platforms, investments on behalf of third parties or advisory providers.

These activities, which are reserved for legal entities, require approval before they can be practiced within the union. To achieve the latter, service providers will be subject to several rules: the integrity of managers, complaint handling procedures, management system, internal control, prudential requirements, guarantees of “best execution” of orders as well as various rules regarding market abuse.

Finally, service providers will have to comply with their obligations regarding money laundering and terrorist financing under Directive (EU) 215/849. A KYC procedure will be required, as well as some traceability of funds. These measures may prove difficult to apply given the decentralized and pseudonymous nature of the blockchain when the funds pass through addresses not contained by companies.

Note that MiCA does not apply to “security tokens”, defined as “classic” financial assets within the meaning of MiFID. For this type of product, a pilot scheme is being developed to facilitate testing of the use of DLT in financial instruments. Several tests have already been carried out in France, in particular by SG Forge, as part of a call for experiments at the MBNC (National Currency of the Central Bank) in the Banque de France.

Also note that NFT (Non-Fungible Tokens) are excluded from the text, provided that they do not fall into any previously defined category.

With MiCA - Markets in Crypto-Assets - European regulators want to set a framework for the crypto ecosystem
MiCA Bill

MiCA: A very controversial regulation

MiCA makes it possible to lay the foundation for the necessary regulation of the ecosystem. Like the “Wild West”, this gold rush attracts a number of dishonest players against whom investors are currently poorly protected. This strongly criticizes the content of the regulation:

  • The most worn part of the text risked leading tobanning the consensus method by “proof of work”, which is mainly used by Bitcoin, is considered to be polluting and subject to minimum standards for environmental sustainability. This amendment was finally rejected by ECON vote on 14 March 2022, much to the relief of ecosystem actors.
  • That Credit institutions would be exempted from the approval of the issuance of stack coins, which should greatly favor established financial players and create a major barrier to entry, thus limiting competition and innovation.
  • The subject of DeFi (decentralized economy or open economy) is not addressed in the text, resulting in de facto legal vagueness or even the illegality of certain algorithmic stack coins or other projects carried out by Decentralized Autonomous Organizations (DAOs) that would not have a legally established structure while issuing cryptocurrencies .
  • At the same time, the European Commission is working on the legislative package to combat money laundering and on 31 March adopted a proposal which would have a full impact on the crypto-active sector with an obligation for service providers to verify the information. of proprietors, wallets not hosted on their platform. This measure, which consists in extending the Transfer of Funds Regulation (TFR) to include cryptocurrencies, would call into question the anonymity or at least the “pseudonymity” of personal portfolios, an essential building block of the ecosystem. In addition to the administrative burden that would weigh on the sector, there would be the problem of securing user data.
  • Finally, European rules are considered too restrictive in relation to what is done internationally. In the United States, a “sandbox” approach has been used so far, leaving providers to evolve outside the traditional regulatory framework. While in the UK, the FCA (Financial Conduct Authority) is launching a public consultation called “crypto-sprint”, to reflect with the players in the crypto-asset ecosystem on the constitution of the future regulatory regime.

More than 40 European companies and organizations in the crypto-active sector sent a letter to the finance ministers of the countries of the European Union on 13 April, asking them to relax the rules proposed by the MiCA and TFR rules. It argues that the application of these texts as they are would compromise the expansion and competitiveness of the sector in Europe with more complex and restrictive regulations than in the rest of the world.

For his part, Emmanuel Macron said in an interview with the specialized media The big whale :

“France will pay close attention to ensuring that the text does not hinder innovation and remains as technologically neutral as possible.”

These are the challenges of this project. Will the EU succeed in producing a text that is likely to satisfy both ecosystem actors, “traditional” financial institutions and politicians? And will it do so, while guaranteeing the security of investors as well as the financial and monetary systems, all without compromising the potential of this moving sector with exponential growth? The equation is complex and the stakes are high for Europe if it does not want to be missed revolution promised by Web3.

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