By Camilla Tagliabue
This blog post was submitted as a contribution to the Tabula project, an international and comparative research collaboration carried out over the summer of 2021.
Anyone who has spent any significant amount of time online recently, whether reading a newspaper, listening to a podcast, participating in a Clubhouse Room, or simply hanging out with friends, has almost certainly heard the term “crypto asset.”
But what is a crypto asset?
Even though there is not a globally harmonized definition, a crypto asset can be broadly defined as a type of digital asset based on cryptography and on a new technology called Distributed Ledger Technology (DLT). DLT represents records of all electronic transactions and is maintained by a decentralized user-based network, which has the responsibility to process, validate, or authenticate electronic transactions and data exchanges.
From the European Union’s legal and regulatory standpoint, some crypto assets could be identified as “financial instruments” as defined under MiFID II and so would be regulated by those provisions. Others might fall within the definition of “electronic money” and be regulated by EMD2. Such classifications depend on the type of crypto asset considered and on a specific case-by-case analysis. Most of the crypto assets present in the market, however, fall outside the scope of EU legislation and end up being unregulated. Indeed, as of today, there is not an EU-wide regulatory framework that properly addresses all types of crypto asset, and only a few member states within the European Union (Germany, France, and Malta) have even adopted their own specific national regulations.
Moreover, in the last couple of years, and especially during the pandemic, there has been an exponential increase in the buying, selling, trading, and overall use of crypto assets. Certainly, the social and economic impact of the pandemic has underlined the importance of digital finance and the use of innovative digital technologies. This, in combination with a lack of an appropriate regulatory framework, has left consumers and investors with limited access to appropriate information, and increased their exposure to loss of investments and high risk of fraud and deceptive behaviors. In addition, the market has been challenged with financial instability, absence of transparency, and the ability to use crypto assets to conduct illicit and criminal activities.
Given this, the European Commission understood the necessity to intervene. After several public consultations, on September 24, 2020, the European Commission announced the adoption of a new Digital Finance Package. The Digital Finance Package, among other elements, includes a new legislative proposal regarding crypto assets and the implementation of a pilot regime for DLT market infrastructures. The adoption of the new Digital Finance Package aims to provide legal clarity and homogeneity across the EU regulatory framework concerning crypto assets, while promoting innovation and the deployment of pioneering technologies, modern investment solutions, and new payment instruments. In addition, the package underlines the importance of enhancing fair competition, ensuring the safety and stability of the financial and monetary markets, and developing mechanisms to better manage the risk related to the use of crypto assets.
Regulation on the Markets in Crypto-Assets (MiCA)
As mentioned, the Digital Finance Package includes a comprehensive legislative proposal: the Regulation on Markets in Crypto-Assets (MiCA). If enacted, MiCA would be the first European regulation focused only on crypto assets.
First and foremost, MiCA pursues homogeneity and legal certainty for all types of crypto asset. In this regard, the new legislative proposal would regulate (at a European level) all crypto assets, markets, and service providers that are out of the scope of the current EU financial services legislation. As set forth in Article 2 of MiCA (“Scope”), the Regulation would not apply, for example, to those crypto assets that qualify as either “financial instruments” or “electronic money.” Moreover, MiCA would replace the existing applicable national legal frameworks concerning crypto assets.
Second, MiCA has the objective of ensuring uniformity and harmonization of the rules regulating service providers and issuers of the crypto assets that fall within the scope of the same. In this regard, MiCA would provide the establishment of a licensing regime (the so-called EU passport) and specific transparency and disclosure requirements related to all the activities of issuers and services providers, such as issuance, operation, offer, and marketing of crypto assets and their organization and governance.
Third, MiCA would provide consumer protection rules and the establishment and implementation of appropriate requirements and measures to prevent market abuse, market manipulation, and fraudulent behaviors. Moreover, MiCA also would establish specific rules for “stablecoins” (even when those are considered e-money pursuant to EMD2). “Stablecoins” are not defined by MiCA. Nonetheless, they can be identified as a newly developed class of digital currency that is not as volatile as other cryptocurrencies, such as bitcoins. To attempt to offer price stability, a stablecoin’s value is tied to a reserve asset, such as a national currency (e.g., the U.S. dollar) or a commodity like gold.
Lastly, if approved and enacted, MiCA would be directly applicable to all EU member states and all consumers, service providers, issuers, and companies doing business across the European Union, without each member state needing to enact laws at the national level to incorporate MiCA’s provisions.
The Sandbox Approach—A New Pilot Regime for DLT Infrastructures
In addition to the MiCA proposal, the Digital Finance Package includes a proposal for the implementation of a pilot regime for DLT infrastructures, a so-called sandbox. The sandbox would create a new union status for DLT market infrastructures, which would be defined as either DLT multilateral trading facilities or DLT securities settlement systems operated by the central security depositary (CSD). In addition, the only crypto assets that could be traded within the DLT market infrastructures would be non-liquid transferable securities (as defined pursuant to EU applicable law).
As indicated by the European Commission, because the existing rules may inhibit and restrict the use of new technologies and innovative solutions, a pilot regime is the most suitable instrument to test new proposals and the tokenization of traditional financial assets, allow the deployment of new technologies (such as the distributed ledger technology and crypto assets), and verify the implications. Indeed, on the one hand, the pilot regime would allow investors, consumers, issuers, and service providers to test innovative solutions and promote innovative products based on DLT while being exempted from certain existing EU rules applicable to financial instruments; on the other hand, it would permit regulators and competent supervisory authorities (such as the European Securities and Markets Authority) to observe the market and see the consequences, challenges, benefits, and risks related to the use of DLT and the trading and settlement of transactions related to crypto assets used as financial instruments.
If implemented, the sandbox would last approximately five years, starting from the entry into application of the regulation implementing the pilot regime (as provided pursuant to Article 10 of such regulation). After five years, the European Securities and Markets Authority would provide a report to the European Commission. Based on that report and the data collected, the European Union would be able to determine the feasibility of the development of a sustainable and reliable secondary market for crypto assets that qualify as financial instruments, and would be in a position to consider the enactment of a permanent EU regulatory regime.
Since the announcement of the Digital Finance Package by the European Commission, several European authorities, including the European Central Bank, the European Economic and Social Committee, and the European Data Protection Supervisor (EDPS), have issued opinions regarding MiCA and the pilot regime for DLT infrastructures. It appears, therefore, that the implementation and enactment of the Digital Finance Package is one of the top priorities on the European Union’s agenda.
If implemented, MiCA could establish legal certainty and a uniform legal framework with respect to crypto assets and their issuers, consumers, investors, and service providers, while ensuring the safety and stability of the financial market and promoting innovation. Nonetheless, some critics fear that MiCA’s implementation might lead to the imposition of too many restrictions and constraints, which could exclude some operators, especially startups, or even inhibit innovation and the development of crypto assets. These fears and criticisms might be true, but it is necessary to wait for several years after the implementation of the regulation to understand the real effects, benefits, and disadvantages of such a regime.
Furthermore, the deployment of the pilot regime with respect to the trade of crypto assets qualified as financial instruments would be the perfect opportunity for regulators, investors, service providers, and innovators to test the trading and settlement mechanisms regarding crypto assets. The data collected in connection with that program would be critical to determine whether a reliable and sustainable secondary market for crypto assets can be established.
With the adoption of the Digital Finance Package, the European Union has put itself at the forefront of the crypto industry, potentially influencing global standards regarding the usage, regulation, and supervision of crypto assets and leading to dramatic change in the industry.