On 5 October 2022, the Council of the European Union adopted the final text of the Markets in Crypto-assets Regulation (MiCA), more than two years after it was initially proposed as part of the European Commission’s Digital Finance Package. MiCA represents a significant piece in the wider regulatory architecture for Digital Finance in the EU and will set the course for the integration of crypto-assets into Europe’s mainstream financial system.
In over 350 pages, MiCA brings the following within scope:
- the issuance and distribution of stablecoins, which are categorised as electronic money tokens (EMTs) or asset referenced tokens (ARTs), and crypto-assets other than ARTs and EMTs;
- the liabilities and prudential responsibilities of crypto-asset service providers (CASPs) and the mechanism that prevents market abuse; and
- the supervisory architecture of the EU’s crypto-asset framework.
Over the last two years, XReg Consulting has closely followed the developments around MiCA and its impact on the crypto-asset sector. Here are some key takeaways on the potential implications for crypto-asset issuers and service providers.
MiCA is just one piece of the puzzle
Although MiCA has attracted a lot of attention from the crypto-asset industry, it is just one piece of a dense constellation of regulatory initiatives that make up the wider Digital Finance framework within the EU. In addition to the MiCA specific Level 2 legislation (more on that below), MiCA references the following EU regulatory frameworks that are currently in place or expected to come into force shortly:
- the three additional files of the AML Package (AMLR, AMLD6 and AMLA),
- the Transfer of Funds Regulation,
- the Digital Operational Resilience Regulation,
- the Taxonomy Regulation (reporting on the environmental impact of entities),
- the DLT Pilot Regime,
- the Markets in Financial Instruments Directive (MiFID II),
- the E-money Directive, and
- the Payment Services Directive.
Crypto-asset issuers and service providers who want to offer products and services in the EU will need to develop a holistic strategy that takes all regulatory touchpoints into account. A strategy that successfully navigates this complex EU regulatory framework in its entirety will be challenging, costly and time-consuming.
Level 2 measures
MiCA is a “Level 1” regulation which means that this is just the beginning. The details and guidelines for the implementation of MiCA will be adopted by the pertinent Supervisory Authorities and the European Commission through the process of the Delegated Acts (or what we call Level 2 regulation). The Level 2 measures will determine significant topics, like more specific whitepaper requirements, authorisation and licensing details, environmental impact disclosure requirements, reporting processes, and details around the investment of capital reserves for stablecoins.
If MiFID II is any indicator, we can expect an additional 800-1,000 pages of legislation and Technical Standards, a dizzying array of information. This will undoubtedly put a huge strain on the capacity and resources of the policymakers expected to draft the standards, the regulators expected to enforce the legislation and the businesses expected to comply. Not surprisingly, given its history, the EU has opted to take a complex and prescriptive approach to crypto-asset regulation. This approach will prove to be incredibly challenging considering the fast pace at which this sector is evolving. It runs the risk of becoming quickly outdated and stifling innovation.
What’s in vs. out of scope
MiCA is similar to MiFID in the sense that it regulates “instruments” (in this case, specific crypto-assets) and classifies these instruments based on how they are used. As the regulation took shape, the crypto-asset market evolved and introduced new instruments with new use cases. As a result, certain types of crypto-assets and crypto-asset activities explicitly fall outside the scope of MiCA including:
- non-fungible tokens (NFTs), as long as they are considered to be “unique and not fungible with other crypto-assets,” i.e., they are not fractionalised or interchangeable; a recital contained in the legislation mentions that if an NFT is part of a collection this is an indicator of fungibility; Technical Standards that will offer National Competent Authorities (NCAs) guidelines for determining fungibility are currently underway and will be issued in the next 18 months;
- decentralised finance (DeFi) and Decentralised Autonomous Organisations (DAOs), as long as the so-called protocol or organisation is fully decentralised; the European Commission will introduce guidelines to address the use case of protocols and organisations that are not fully decentralised in the next 18 months, but this does not necessarily mean we are going to have a regulation that addresses this case;
- the lending and borrowing of crypto-assets.
Although NFTs are largely out of MiCA’s scope, they remain a hot topic for EU lawmakers, and we expect a bespoke regime that addresses them to be forthcoming.
Since MiCA is a regulation that regulates centralised entities (in this case, issuers and CASPs), it would be contradictory for it to bring true DeFi, a case where there is no centralised authority to hold accountable, within scope. Thus, Bitcoin and other crypto-assets based on fully decentralised protocols are explicitly excluded from the Regulation. Many crypto-asset issuers and service providers that are actually controlled by centralised authorities but are operating under the guise of decentralisation may be held accountable under MiCA. The forthcoming guidelines from the European Commission should provide much needed clarity in this space.
The future of stablecoins in the EU
MiCA categorises stablecoins in two distinct groups, EMTs and ARTs. EMTs maintain a stable value by referencing the value of one official currency. ARTs maintain a stable value by referencing any other value or combination of values, including one or more official currencies or crypto-assets. Issuers of EMTs and ARTs will be required to establish an entity within the EU, submit a white paper and obtain authorisation from the EU in order to be eligible for trading on EU CASPs.
EMTs that reference the value of EU currencies will have no limits on usage. ARTs and EMTs pegged to “non-EU” or foreign currencies will be limited in the total value and volume of their transactions to €200M and 1M respectively. This means that only EU currency denominated stablecoins will be widely used in European markets, preventing other stablecoins from dominating the EU market or threatening the EU’s monetary policy. It will also create complications given that many stablecoins are dollar-denominated and even if issuers obtain authorisation in the EU, their usage on EU CASPs will be significantly limited.
EMTs will also be required to obtain a license as a credit institution or electronic money institution in the EU. Electronic Money Institutions (EMIs) are much more restricted than banks are in terms of what they are allowed to do with their reserve of assets. If EMTs will be subject to the same regulatory oversight as EMIs, are the standards issued surrounding their reserve of assets likely to be similar or will there be specific rules that govern assets held to stabilise the value of stablecoins? If the standards are the same, is Europe on a path to ultimately acknowledge stablecoins as a valid form of money? It still remains to be seen.
The law put forth by MiCA does not explicitly address algorithmic stablecoins, however, it is mentioned in the recitals that all crypto-assets that fall within the definition of an ART or EMT will be expected to comply with the requirements set out in Title III or IV (irrespective of how the issuer intends to maintain a stable value). It also states that algorithmic crypto-assets that do not aim to stabilise value by referencing one or several assets will be made to comply with the requirements for offerors or issuers of crypto-assets as defined in Title II. Ultimately, the responsibility will fall on the shoulders of the NCAs to determine how to categorise these assets and whether or not to authorise them for issuance in the EU.
We anticipate that MiCA will be published by the Official Journal of the EU sometime between February and April of 2023. Twenty days after it is published it will officially come into force. Issuers of ARTs and EMTs will have 12 months to comply (estimated deadline is February-April 2024). CASPs and issuers of crypto-assets other than ARTs and EMTs will have 18 months to comply (estimated deadline is August-October 2024).
Entities currently operating in the EU or planning to offer crypto-related services in the EU should start familiarising themselves with MiCA’s requirements in order to ensure their ability to continue servicing the EU market or a smooth transition from their current regulatory frameworks.
Will MiCA set the new standard for crypto-asset regulation around the world? Given that it brings much of the previously unaddressed crypto-asset market within its scope, we expect policymakers and regulators around the world to take note of MiCA’s approach. Considering the overly prescriptive nature of the regulation and the high cost of compliance, it is likely that many crypto-businesses will exit Europe in favour of a more flexible jurisdiction if they have no explicit need to target the EU market.
The regulatory approach taken by MiCA is largely prescriptive of the “same risks, same rules, same outcome” philosophy that has guided regulation in the past and is arguably a limited one. Do the same risks really apply here and if not, are we at risk of implementing fundamentally flawed controls? Can regulators continue to take a “technology-neutral” approach to crypto-assets when they are fundamentally about technology? If we do not take into consideration both the risks and benefits associated with DLT technology, we may be missing an opportunity to better achieve the desired regulatory outcomes of protecting consumers, mitigating financial crime, ensuring the operation of orderly markets and maintaining financial stability.
If you would like to discuss anything mentioned in this article, or otherwise related to MiCA, feel free to contact the XReg Consulting team at email@example.com.