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It’s often said that financial regulators are always fighting the last war. The European Union’s soon-to-be-ratified package of cryptocurrency regulations offers a telling example.
The Markets in Crypto-Assets (MiCA) framework devotes a full 26 of its 168 pages to a subcategory it calls “asset-referenced tokens.” These are a type of stablecoin, or cryptocurrency designed to hold its value, but unlike dollar-pegged stablecoins such as USD coin (USDC) or tether (USDT), asset-referenced tokens are backed by a basket of different fiat currencies, commodities or crypto assets. The most famous example has not been issued, and likely won’t be anytime soon.
That coin, of course, is the original vision of libra, Facebook’s proposed digital currency that provoked a global government backlash after its unveiling in 2019. The project was later renamed diem, and the consortium behind it watered down the design to a simple dollar-backed stablecoin.
“It’s quite obvious and apparent that the whole proposal was drafted with the libra project in mind,” said Patrick Hansen, a contributor for RegTrax, Stanford University’s working database on fintech policy.
Meanwhile, MiCA is mum about the torrid decentralized finance (DeFi) market, where global investment has swelled 360% since September 2020 (the month the European Commission introduced the proposed framework) to $96 billion as of Oct. 18 of this year.
Despite being dated on arrival, the proposed framework would dramatically simplify expansion for crypto businesses throughout the 27-nation EU. Once a crypto firm is licensed in one EU member state, under MiCA, that license would become “passportable,” meaning the firm could set up in another EU nation without having to obtain approval or additional licenses from the local government.
For many market participants, that’s good enough.
“If there would be an overarching regulation from the EU, that would help a lot. Because then you would have one license to rule them all,” said Eric Demuth, co-founder and CEO of Bitpanda, a Vienna-based cryptocurrency startup which was recently valued at $4.1 billion.
Introduced in September 2020 by the European Commission, the EU executive branch responsible for proposing and enforcing laws, the MiCA framework is one part of a larger Digital Finance strategy that aims to adapt Europe for the digital age.
And it’s notably different from the regulatory efforts undertaken by other jurisdictions.
For instance, the U.S. has introduced numerous bills in the last few years that directly affect the crypto space, from tax requirements to securities law, while different states may have their own regulatory requirements. However, the country has no real comprehensive equivalent to the EU’s MiCA. Its most comprehensive bill on crypto regulation was proposed in August. Meanwhile, China banned crypto trading and mining outright earlier this year, while working on its own government-issued digital currency.
Eva Kaili, a member of the European Parliament since 2014, and a proponent for innovation-friendly regulation of blockchain applications, said that the EU is trying something different with MiCA during an interview with CoinDesk.
“The nature of the European Union is different. We have 27 different member states with different legal and tax systems that are not harmonized. So we are trying to adopt a unique approach to policy making with this file,” she said.
MiCA encompasses cryptocurrencies like bitcoin and ether broadly, along with stablecoins. But as it is, the proposed framework would not apply to digital currencies issued by central banks (CBDCs) nor crypto assets such as security tokens that might qualify as financial instruments like securities, deposits, treasury bills or derivatives.
Even though the promise of a passportable license for crypto asset service providers sounds exciting for established crypto firms looking to set up in the region, industry players are also concerned about how MiCA will influence the digital asset market in the EU in other ways.
For instance, Martin Erhold, regulatory specialist at Bitpanda, said that even though legal certainty will likely attract institutional investment, overregulation could crowd out innovation and entrepreneurs. In addition to strict rules for crypto issuers, under MiCA, firms will have to register in the EU and bear the compliance costs or be banned, he said.
“Successful service providers will reap benefits of the larger EU single market and the market consolidation is expected. However, too high barriers to EU market entry may deter third-country service providers and issuers from entering the EU, risking decoupling EU from other innovative markets,” Erhold said in an email.
Then, there is the disproportionately heavy emphasis placed on stablecoin regulation in the proposal.
“Almost a third of the whole proposal is basically covering stablecoins and e-money tokens,” said Hansen, former head of blockchain at German technology trade association Bitkom and current lead of strategy and growth at Unstoppable Finance.
Hansen explained that the MiCA rules for stablecoin issuers might be particularly harsh, and that he is optimistic that the framework will be modified to make these rules less strict.
“Maybe regulators are probably more open to less stricter rules in the stablecoin market, but it remains to be seen,” Hansen said.
The MiCA proposal is slowly making its way through the bloc’s complex legislative process. The European Central Bank (ECB) and the European Economic and Social Committee have already published their opinions on the proposal. Currently, the European Council Working Party on Financial Services is reviewing the document.
Kaili said lawmakers expect EU parliament and council deliberations to wrap by early 2022, without any major changes to the current version of the file. She added that from that point onwards, the EU typically gives countries two years to implement new regulations.
At the moment, EU countries have to issue their own regulatory requirements for crypto assets in accordance with some overarching guidelines.
According to Yana Afanasieva, head of regulatory affairs at bitFlyer Europe, the local arm of the Japanese crypto exchange, there were two forces of regulatory initiatives that compelled European countries in the last few years to implement regulations at the local level. One was the guidance for virtual asset service providers (VASP) published by the intergovernmental Financial Action Task Force (FATF) in 2019. The second was AMLD5, an anti-money laundering directive issued by the European Union which required VASPs to register with their local government. AMLD5 came into effect in 2020, and as with all EU directives, it laid out a goal that EU countries had to achieve, but left it up to individual countries to create and implement their own laws.
Given the freedom to go their own way, different countries took different approaches to regulating crypto. While Gibraltar and Malta created regimes for licensing or registration for VASPs, and turned it into an opportunity to attract new businesses, other countries did the bare minimum, Afanasieva said.
“So there is a range right now, and it creates, at this point of time, a lot of confusion for operators. They have to ask themselves, does this mean, if I want to operate in the EU, that I need to go and apply for 30 different registrations or can I still benefit from the EU treaty that introduced the free movement of goods and services?” Afanasieva said.
According to Erhold, despite having a substantial market size compared to the U.S. and East Asia, VASPs have to operate at a local level.
“And when this is fragmented to the extent that it is fragmented right now, it just does not help scale, and we’re a digital market, which is inherently cross-border,” Erhold said.
Bitpanda, which operates in 37 countries worldwide, has had to obtain some kind of government approval or licenses at the national level within the EU, including in Italy and France.
According to Dr. Simon Grieser, partner at the law firm of Reed Smith LLP, the main objective of MiCA is to level the playing field for crypto service providers so it’s clear who needs to be registered or licensed, and all market participants have to comply with the same framework.
“The other reason, of course, is that cryptocurrencies are a growing and very important econometric topic. And so, my understanding from discussions with regulators and other market participants is there is a need to protect customers, and make sure investments in such kinds of assets are protected under the supervision of competent authorities,” Grieser said.
MiCA broadly applies to crypto-assets which are defined as “digital representations of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology.”
The framework also defines three subcategories of crypto assets, starting with the asset-referenced token. An example of this is libra, the stablecoin proposed by Facebook in 2019: Libra was designed to be backed by a basket of currencies and facilitate global payments (though it has since been renamed diem and will be a dollar-backed stablecoin only.)
The second type of crypto-asset covered is the “e-money token,” which is a stablecoin pegged to the value of a fiat currency like the U.S. dollar. Examples of these include dollar-backed USDC and USDT. The third, is the “utility token,” which is intended to provide digital access to a good or service, and is only accepted by the issuer of that token, like the basic attention token (BAT) issued by privacy-focused web browser Brave.
“Issuers of these crypto-asset categories in the EU must, in the future, publish a white paper (if no exception applies) and send it in advance (20 days prior to the emission) for notification to their respective national financial supervisory authority, such as the BaFin in Germany. The supervisory authority can then prohibit the issuance of those tokens,” Hansen wrote in RegTrax.
Meanwhile, firms that provide any service related to the defined crypto assets, including and not limited to custody services, trading and currency exchange (between crypto-assets and to fiat currencies), must obtain approval from regulatory authorities in an EU country. Once local authorities have approved the firms according to EU regulations, they would then be able to extend operations to other EU countries without having to obtain additional licenses.
“The national bespoke regimes on crypto assets would no longer be applicable,” the MiCA document said.
According to Hansen, MiCA indicates nations that already have a robust licensing regime for VASPs will have an easier time meeting the new EU-wide requirements.
But compliance won’t be cheap.
An impact assessment by the EU Commission on MiCA estimated it would cost issuers between $4,500 to $87,000 per white paper depending on the “complexity of the regime” and how much legal advice is required. In crypto, a white paper is an investment prospectus and a roadmap, published well before a project releases any code. Usually it costs around $4,500 or more just to hire a writer to ink the white paper.
“The compliance costs on crypto-asset service providers is expected to be higher and will crucially depend on the type of services for which authorization is sought respectively,” the impact assessment said.
The application of the envisaged regime is estimated to give rise to one-off compliance costs between $3.2 million and $19 million, while ongoing compliance costs might cost up to $28 million, according to the assessment.
Hansen said there is a chance that high compliance costs for token issuers and entrepreneurs might force businesses looking to set up in Europe to consider going elsewhere.
“I guess not all the projects and teams out there want to bear those regulatory costs … So I could imagine a future where even projects and teams that are based in the EU, when it comes to the official launch, they might like to do that out of another jurisdiction,” Hansen said.
Although Afanasieva agrees that the costs might create some friction, consume time and resources, there is a greater concern.
“So the biggest fear for companies is not so much cost, but fear of losing customers because most crypto companies, they really want to grow… And when you have this environment where somebody will publish an article saying ‘everybody should leave Germany unless you have German custody’ or ‘everybody should do X, Y, Z,’ the biggest fear is that customers will get scared,” Afanasieva said.
But MiCA compliance rules are particularly harsh on stablecoin issuers.
The MiCA document explicitly states that it intends to govern stablecoin issuance in the EU, as confirmed by the fact that not one but two categories of crypto assets covered by the framework are different types of stablecoins.
In June 2019, social media giant Facebook revealed it was building its own multi-platform stablecoin libra. U.S. lawmakers swiftly ordered a stop to the project so they could examine the implications of the initiative. The Group of Seven (G7) nations also announced it was investigating the project. By July, Facebook admitted libra as envisioned may not become a reality and the plan was watered down. Last year, the project was rebranded as the Diem Association.
As proposed, MiCA lays out some standard requirements for both prospective and established stablecoin issuers. For instance, all stablecoin issuers are required to own and maintain capital funds equivalent to either €350,000 (around $400,000) or 2% of their total reserve assets – whichever is the larger sum.
But not all stablecoin issuers are created equal. The framework also lays out additional requirements for what it categorizes as ‘significant’ issuers: any issuer that passes a number of thresholds, including a market capitalization of at least €1 billion, and records at least 500,000 transactions per day, will be considered significant.
Significant stablecoin issuers, which include major global stablecoins like USDC and USDT, have a number of additional requirements to fulfill under MiCA, including maintaining capital funds equivalent to 3% of their reserve assets.
“Tether, for example, with currently approximately 25 billion US dollars backing its stablecoins, would have to hold at least 750 million(!) of [its] own funds,” Hansen wrote in RegTrax back in January. As of Oct. 18, the total supply of USDT is almost $72 billion, and it claims around 75% of its reserve assets are cash and cash equivalents.
Hansen says the requirements for significant stablecoin issuers seem harsh. MiCA kind of agrees. The framework says that a restriction on stablecoin issuance could potentially be justified given the risks to financial stability, monetary policy and sovereignty, but cautions against this option as it “would not be consistent with the objectives set at EU level to promote innovation in the financial sector.”
With the current developments in the stablecoin space, it is unlikely that the framework will change much in its approach to regulating these currencies. Earlier this year, USDT issuer Tether came under heavy scrutiny from regulators in the U.S. and the EU after it revealed that around half of its reserves were made up of unspecified commercial paper. In September, the U.S. Securities and Exchange Commission (SEC) subpoenaed USDC issuer Circle as part of an ongoing investigation.
Hansen pointed out that 26 out of the 30 trading pairs with the highest trading volumes on leading crypto exchange Binance include a stablecoin, and the heavy restrictions MiCA might place on these assets could cripple EU competitiveness. But for Erhold, the benefit of clear rules of the road would trump immediate concerns over stablecoins.
“I mean, there’s a big ticket item that they’re discussing about the whole treatment of stablecoins and whatnot. But from our perspective, as intermediaries, as part of the already existing system, irrespective of any bigger stablecoins coming out, the most important thing is legal certainty,” Erhold said.
Demuth pointed out that MiCA will probably not come into effect before the end of 2023.
“So until then, everybody will make their own law. And that time period of two years, is not a long time for politics and laws. But for the fintech space, it is a decade. Until then, we have to keep the same system and talk to every regulator and get licenses individually everywhere,” Demuth said.