European regulation has huge impact on crypto-assets

MiCA: Markets in Crypto Assets

The European Parliament and European Council have reached a provisional agreement on a first draft of the long-awaited Markets in Crypto Assets (MiCA) regulation. MiCA is expected to have a huge impact on providers of crypto asset services in the European Union (EU) - as well as providers based outside the EU - and financial institutions due to the opportunities it will create for banks, investment firms and insurance companies. Parties will have to comply with certain legal obligations and may need a licence. Crypto service providers for example will be required to declare information on their environmental and climate footprint. The final text with practical details will be available soon. This article highlights the key takeaways we can expect.

Scope of the regulation

MiCA is part of the ‘EU digital finance package’ that aims to support the future potential of digital finance in terms of innovation and competition while mitigating the risks entailed. It will apply to crypto assets that are not currently regulated by existing financial services legislation, such as the Markets in Financial Instruments Directive (MiFID). The European Securities and Markets Authority (ESMA) will provide further guidance. Specifically, MiCA will apply to issuers of crypto assets and 'stablecoins', as well as providers of crypto asset related services (CASPs) in the EU.

Crypto issuers

Issuers of certain types of crypto assets are required to disclose all relevant information relating to specific crypto assets and publish this information in a white paper. In addition, issuers must explain to competent authorities why they cannot consider certain crypto assets to be a financial instrument under MiFID II. Subsequently, national competent authorities (NCAs) are tasked with approving the white paper.

Crypto asset service providers

In order to operate in the EU, CASPs - such as brokers, exchanges and 'custodian wallet providers' - must be licensed, a so-called 'EU passport', issued by NCAs. Although requirements may vary depending on the specific CASP, MiCA imposes prudential requirements and governance standards on all CASPs, which are overseen by NCAs. The European Banking Authority (EBA) will develop guidelines and issue binding decisions. ESMA will be tasked with maintaining a public register of non-compliant crypto asset service providers.

Legal framework for 'stablecoins'

Stablecoins, which are primarily issued for payment purposes, have been the focus of policymakers for some time. In particular, the rapid growth, increasing global use and critical role of stablecoins in the broader crypto asset ecosystem increase the potential implications for the crypto market should a large stablecoin fail.

European regulators are therefore imposing strict requirements to mitigate the increased risks to consumer protection and market integrity. In order to obtain a MiCA licence, issuers of stablecoins are required to meet the following conditions:

Have a registered office in the EU
Build up a sufficiently liquid reserve, with a 1/1 ratio and partly in the form of deposits;
Offer every stablecoin holder a claim at any time and free of charge, with the rules governing this reserve also providing adequate minimum liquidity.

The EBA will supervise issuers of stablecoins.

ESG considerations

Actors in the crypto asset market will also have to provide information on their environmental and climate footprint. ESMA will develop draft regulatory technical standards on content, methodologies and presentation of information on key negative environmental and climate impacts.

Although Proof-of-Work cryptocurrencies (PoW) - such as 'Bitcoin' - are notorious for their huge energy consumption, MiCA is not issuing a ban on crypto currencies that use the PoW algorithm. Instead, it instructs the European Commission to prepare a report on the environmental impact of crypto assets and to introduce a mandatory minimum sustainability standard for such consensus mechanisms as PoW.

No impact (yet) on NFTs and DeFi

Non fungible tokens (NFTs: digital objects held by an internet user) will be exempt from MiCA. However, a reclassification for NFTs is always possible if they qualify as a financial instrument or a crypto-asset.

Decentralised financing (DeFi) and crypto lending are not (yet) addressed in MiCA. A report with possible new legislative proposals will be submitted no later than 18 months after the entry into force of the regulation.

Finally, MiCA provides for a public register of non-compliant CASPs, which can be used to curb their activities, if there is unfair competition or unfair commercial practices.

Introduction of MiCA

Now that the main aspects of MiCA have been agreed, the regulation still needs to be finally approved by the Commission and the European Parliament.

MiCA will come into effect 18 months after the approval date - likely late 2022, early 2023. The revised texts will therefore not apply before 2024. Until then, crypto service providers have the opportunity to prepare for this new crypto legislation.