Key Contacts: Andrew Tzialli – Partner
‘MiCA’ the European Union’s proposed Regulation of Markets in Crypto-Assets has now entered its next stage of discussions. In the coming weeks EU officials from the European Commission, Council and Parliament will further debate the regulatory framework that is set to dramatically change the crypto landscape across the 27 member states.
Importantly, the latest draft bill has removed a provision that was set to prohibit crypto assets that rely on ‘proof of work’ (one of the mechanisms used to mine new currency and maintain crypto networks) because of its links to high energy consumption. If incorporated, it would have essentially resulted in a de facto ban on the biggest mining-based cryptocurrencies such as Bitcoin, Ethereum (though this is in the process of converting to a ‘proof of stake’ consensus mechanism) and Litecoin and would also have impacted crypto services acting as custodians for these coins.
Whilst this update to the MiCA package was welcomed by the crypto community, any settling of tensions with EU lawmakers were short lived with the early April announcement of further EU proposals to extend KYC/AML measures to outlaw anonymous crypto transactions.
MiCA – a reminder of its objectives
MiCA will enact a single licensing regime across the European union for crypto assets that are not currently caught by existing financial regulation. Whilst not completely devoid of legislation in this jurisdiction (see our article ‘Is cryptocurrency’s legislation-free run over?’ from last year) MiCA will harmonise the European framework and provide a tailored suite of laws for this ever developing sector.
As noted in the explanatory memorandum to the regulation, MiCA has four broad objectives:
- Instil appropriate levels of consumer and investor protection and market integrity.
- Provide legal certainty for crypto assets not covered by existing EU financial services legislation.
- Support innovation by promoting the development of crypto-assets and the wider use of DLT (distributed ledger technology).
- Ensure financial stability with specific rules for so-called ‘stablecoins’, including when these are e-money.
Who will be caught by the legislation?
Crypto-Asset Service Providers (“CASPs”) are defined in MiCA as “any person whose occupation or business is the provision of one or more crypto-asset services to third parties on a professional basis.” The European legislators have opted for the term ‘Crypto’ as opposed to ‘Virtual’ which is used both in Ireland and internationally by the Financial Action Task Force (“FATF”).
Under MiCa, the definition of crypto-asset services is such that a business providing at least one of the following activities, may be classed as a CASP:
- exchanging crypto assets and fiat currency (e.g. using Euro to buy Bitcoin);
- exchanging one class of crypto assets for another (e.g. using Bitcoin to buy Ethereum);
- the custody and administration of crypto-assets on behalf of third parties;
- the operation of a trading platform for crypto-assets;
- the execution of orders for crypto-assets on behalf of third parties;
- the placing of crypto-assets;
- the reception and transmission of orders for crypto assets on behalf of third parties; and
- providing advice on crypto-assets.
The final category encapsulates the broad nature of MiCA as ‘providing advice’ and could be construed as a catch all for any operator in this space. These categories also go a lot further than the existing definition of a Virtual Asset Service Provider (“VASP”) under the Irish Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Act 2021.
Still time to ‘get the house in order’
Despite different regulatory regimes applying to whatever category of ‘CASP’ crypto businesses fall in to, the common theme throughout is that firms operating in this space must get used to the obligations that come with being a regulated entity. Depending on the type of services being offered, this could include minimum capital requirements, liability cover (if lost in result of a hack etc.) and adherence to market abuse rules, to name but a few.
Importantly, crypto service providers, whether established or new market entrants, must factor risk and compliance into every decision being made. Given the impending legislative landscape, companies in the sector can get ahead of the competition by implementing policies and procedures to try and minimise a future culture shock – the process will be a lot smoother if such businesses “act” like a regulated firm before becoming a regulated firm (see our podcast for more discussion in this regard).
NFTs, MiCA & FATF recommendations
The removal of language that would limit proof-of-work coins is a welcome development, but it certainly won’t be the last change before we see a finalised version of MiCA. Since the introduction of the draft legislation in 2020, we have seen rapid growth in other uses of blockchain, with a boom in popularity of decentralised finance (DeFi) and non-fungible tokens (NFTs).
NFTs continue to generate considerable debate as to whether they can be classified as a security, a crypto/virtual asset or whether they escape classification as a financial instrument at all. The FATF has stated that NFTs are “generally not considered virtual assets” in its report from October 2021, but that regulators need to treat this on a case-by-case basis and “consider the nature of the NFT and its function in practice, not the terminology or marketing terms used.” The FATF recommends that if an NFT is used for “payment or investment purposes” then they could be classified as a virtual asset.
As it stands, there is no specific mention of NFTs in the MiCA package, in fact the requirement of publishing a white paper for the issuance of crypto assets does not apply to “crypto-assets that are unique and non-fungible”. However, NFT providers should still be aware that their product may still be caught by existing legislation like MIFID II if deemed either as an alternative investment fund (AIF) (or even MiCA’s “crypto-asset” definition if we drill down and look behind the NFT label).
Recent EU AML/KYC proposals
In a previous post on MiCA, we noted that as soon as you introduce rules and require firms to seek authorisation, you can immediately stifle innovation. Similar sentiments have been expressed by the crypto industry in relation to recent announcements that EU Lawmakers are to extend AML rules to anonymous crypto transactions.
Under the new requirements agreed by MEPs, all transfers of crypto-assets will have to include information on the source of the asset and its beneficiary, information that is to be made available to the competent authorities. The rules would also cover transactions from so-called unhosted wallets (a crypto-asset wallet address that is in the custody of a private user). The rules will not apply to person-to-person transfers conducted without a provider, such as bitcoins trading platforms, or among providers acting on their own behalf.
Recent warnings made by both European supervisory authorities and the Irish Central bank of the ‘highly risky and speculative’ nature of crypto assets highlight an urgency to finalise the MiCA package and, we therefore expect to see the legislative process moving forward without any delays. As it stands, it is anticipated that MiCA will be finalised later this year and will apply to EU member states by 2024.