The new EU Crypto-asset legislation (“MiCA”) – are the Wild West days of Crypto about to end?

The Swedish Financial Supervisory Authority (the “SFSA”) issued a new warning in relation to crypto-assets as recently as on the 24th of May. The warning was the latest in a series of warnings from the SFSA and other authorities e.g. EBA and ESMA, in relation to crypto-assets. The SFSA reminded that products based on crypto-assets are not appropriate for most if not all consumers. According to the SFSA, the consumer protection is inadequate and crypto-assets are difficult or impossible to value in a reliable manner. The risk that a consumer will lose his invested money is considerable. The SFSA also pointed out that these types of products are not covered by the consumer protection legislation that other types of investments are.¹

Agreeably, there is reason for concern over the risks crypto-assets pose for consumers. As an example of how volatile the crypto market can be, the cryptocurrency dogecoin lost more than a third of its price in early May, after Tesla chief and cryptocurrency supporter Elon Musk called it a ’hustle’ during his guest-host spot on the ”Saturday Night Live” comedy sketch TV show.²  Furthermore, there are significant risks in relation to money laundering and terrorism financing due to lack of transparency in many crypto-assets.

At the same time, there is no doubt that crypto-assets show significant potential as a means to make financial services more efficient and that innovation in the crypto-asset space cannot be overlooked.

Risks and uncertainties in the crypto-asset market today

As noted above, there are significant risks for consumers in relation to their investments in crypto-assets since the crypto market can be highly volatile and there is no consumer protection legislation in place that e.g. ensures consumers access to sufficient information to make adequate investment decisions. Also, the lack of appropriate legislation and transparency may attract less serious actors to the crypto-asset market and increase the risk of fraud, money laundering and terrorism financing.

In addition, the entrepreneurs who do want to run their business by the book may struggle with the uncertainties of what is actually “right”, e.g. it is not always evident if their crypto-asset services are considered to be regulated financial services and if they need a license from a supervisory authority for their business.

In this respect, a key consideration of the legal qualification of crypto-assets is whether they may qualify as financial instruments under the second Markets in Financial Instruments Directive (“MiFID II”)³. This is due to that the existing EU financial regulation establishes a comprehensive regulatory regime governing the execution of transactions in financial instruments.⁴ Furthermore, crypto-assets may qualify as electronic money under the sedond Electronic Money Di-rective (“EMD2”)⁵.⁶ If so, such assets also qualify as “funds” under the second Payment Services Directive (“PSD2”)⁷, which in turn may incur that a crypto-asset service provider is providing payment services subject to license or registration requirement with the Financial Supervisory Authority.

That being said, many crypto-assets and the services related to them fall out of scope of EU financial services regulation altogether. The novelty of the crypto-asset services in connection with the complexity of tech- and EU legal landscape however gives rise to many uncertainties for the market actors.

How MiCA may improve the current situation

On the 24 September 2020 the European Commission adopted a new Digital Finance Package, including e.g. a Digital Finance Strategy and legislative proposals on crypto-assets, including the Markets in Crypto-Assets Regulation  (“MiCA”) proposal. The expressed intent from the Commission was to provide for a competitive EU financial sector that gives consumers access to innovative financial products, while ensuring consumer protection and financial stability.⁹

Purpose

MiCA covers such crypto-assets that fall outside existing EU financial services legislation. MiCA has four general objectives. The first objective is one of legal certainty. For crypto-asset markets to develop within the EU, there is a need for a sound legal framework, clearly defining the regulatory treatment of all crypto-assets that are not covered by existing financial services legislation. The second objective is to support innovation. To promote the development of crypto-assets and the wider use of Distributed Ledger Technology, it is necessary to put in place a safe and proportionate framework to support innovation and fair compe-tition. The third objective is to instil appropriate levels of consumer and investor protection and market integrity given that crypto-assets not covered by existing financial services legislation present many of the same risks as more familiar fi-nancial instruments. The fourth objective is to ensure financial stability. Crypto-assets are continuously evolving. While some have a quite limited scope and use, others, such as the emerging category of ‘stablecoins’, have the potential to become widely accepted and potentially systemic.¹⁰

Creation of crypto-asset categories

Under MiCA various crypto-asset categories are created:

• Crypto-assets generally, as a  “catch-all” category (e.g., bitcoins or ether)
• Utility Token (e.g. Filecoin token)
• ART – Asset-Referenced Token (e.g., Libra Basket Coin)
• EMT – E-Money Token (e.g., USDC or Libra Euro).
ART and EMT pertains to what is commonly referred to as stablecoins, depending on whether they are pegged by a single fiat currency (e.g., Euro, U.S. dollar, etc.) (EMT), or are linked to several fiat currencies, commodities such as gold, or the value of other crypto-assets (ART).¹¹

License- and regulatory requirements for crypto-asset issuers and service providers

MiCA will also create a new European licensing regime for crypto-asset issuers¹² (“Issuers”) and crypto-asset service providers¹³ (“Service Providers”) in relation to the above crypto-asset categories.

An Issuer is a legal person who offers to the public any type of crypto-assets or seeks the admission of such crypto-assets to a trading platform for crypto-assets. Issuers of ‘significant’ crypto-assets will be subject to supervision by the Europe-an Banking Authority (“EBA”) while others will be supervised by their national competent authorities. Issuers must publish a white paper regarding the crypto-assets to be issued and send it in advance for notification to the financial supervisory authority in their home member state. In addition, depending on the crypto-asset category, different regulatory requirements will apply for Issuers, e.g. an authorisation requirement to issue ART.

A Service Provider means any person whose occupation or business is the provision of one or more crypto-asset services to third parties on a professional basis. Service Providers are subdivided into: i) Service Providers that provide crypto-asset trading platforms; and ii) Service Providers involved in the placing of cryp-to-assets. Service Providers will be required to be authorised in at least one EU member state. Provided that such authorisation is received, the Service Provider can to passport their license across the EU subject to a notification procedure. MiCA sets out general requirements that Service Providers would need to comply with, such as requirements relating to outsourcing, the safeguarding of crypto-assets and organisational requirements. In addition, specific requirements will apply, e.g. in relation to the custody and administration of crypto-assets on behalf of third parties and the exchange of crypto-assets into either cryptocurrency or fiat currency.

There will be eight categories of crypto-asset services¹⁴ which will require a license for the Service Provider. The types of services will be a) the custody and administration of crypto-assets on behalf of third parties, b) the operation of a trading platform for crypto-assets, c) the exchange of crypto-assets for fiat currency that is legal tender, d) the exchange of crypto-assets for other crypto-assets, e) the execution of orders for crypto-assets on behalf of third parties, f) the placing of crypto-assets, g) the reception and transmission of orders for cryp-to-assets on behalf of third parties, and h) providing advice on crypto-assets.

Key takeaways

The possibility of clear allocation of crypto-assets to certain categories under MiCA will undoubtedly remove much of the regulatory uncertainty that is at hand today. Given that MiCA will be in the form of an EU Regulation, it will also provide for a fully harmonized regulatory landscape in the EU for crypto-assets.
The new regulatory burden for Issuers and Service Providers that MiCA entails, may to some extent impede innovation relating to crypto-assets, especially from smaller actors in the market. Hence, it is not unlikely that fewer and larger actors, capable of fulfilling internal governance requirements and setting of sufficient compliance resources, will remain. On the other hand, the regulatory certainty for the entire EU market will likely attract more actors yet.
 

¹   https://www.fi.se/sv/publicerat/nyheter/2021/se-upp-for-riskabla-produkt…
²   https://www.reuters.com/technology/dogecoin-spotlight-cryptocurrency-bac…
³   Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU
⁴   ESMA, Advice – Initial coin offerings and Crypto-Assets, 9 January 2019, ESMA50-157-1391, p. 18
⁵   Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions amending Directives 2005/60/EC and 2006/48/EC and repealing Directive 2000/46/EC
⁶    EBA, Report with advice to the European Commission on crypto-assets, 9 January 2019, p.14.
⁷    Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC
⁸    Proposal for a regulation of the European Parliament and of the Council on Markets in Crypto-Assets, and amending Directive (EU) 2019/1937.
⁹    https://ec.europa.eu/info/publications/200924-digital-finance-proposals_en
¹⁰  MiCA, p. 2-3
¹¹  https://law.stanford.edu/2021/01/12/new-crypto-rules-in-the-eu-gateway-f…
¹²  See Article 3.6 MiCA.
¹³  See Article 3.8 MiCA.
¹⁴    See Artile 3.9 MiCA.