A first look on MiCA, the EU’s comprehensive regulatory framework for crypto-assets

On June 30, 2022, the last day of the French Presidency, the Council announced a commitment the Regulation of the European Markets in Cryptoassets (MiCA) had been reached with the European Parliament. The final text has not yet been published. This blog explores the negotiations and the likely final form of the MiCA. With the MiCA commitment, the EU will establish a comprehensive set of rules that fills a regulatory gap and aims to end the legal fragmentation of crypto regulation in the EU.

The compromise resolves a period of almost two years of interinstitutional and intrainstitutional negotiations, which began with the approval of the Commission proposal in September 2020 and was followed by the Council negotiating mandate in November 2021 and Parliament’s Committee on Economic and Social Affairs (ECON) negotiating mandate in March 2022, setting the starting point for so-called ‘trilogue’ discussions.

The negotiations were accompanied by an unprecedented growth in investor appetite, but also the recent collapse of the TerraLuna stablecoin ecosystem, which set off a chain reaction that undermined broader confidence in crypto asset markets. Supervisory authorities have become increasingly critical of crypto assets lately, with the ECB concluding that crypto assets are creating instability and insecurity and a “new wild west”.

NFTs excluded from MiCA

The co-legislators took different views on whether non-fungible tokens (NFTs) should be regulated under MiCA. NFTs can serve as digital collectibles, tokenized works of art, or other unique physical or virtual items. Unlike other tokens, NFTs are not interchangeable with other tokens of a similar class. This makes them functionally different from a typical payment token or investment token, even though they are both based on the same distributed ledger technology (DLT). The final commitment generally excludes NFTs from the scope of the MiCA. They may be subject to separate legislation specifically for NFTs if deemed necessary by the Commission within the next 18 months.

However, some tokens designated as “NFTs” may still be subject to MiCA “if they fall under existing crypto asset categories.” Supervisory authorities such as BaFin already take this “substance over form” approach when determining whether a specific crypto asset qualifies as a tradable security and falls within the scope of MiFID as a financial instrument. This also makes it clear that each token will need to be evaluated on a case-by-case basis and that the nomenclature chosen by the issuer will not be decisive for the regulatory evaluation. However, the supervisory authorities must establish transparent and feasible criteria that allow distinguishing between regulated and unregulated crypto assets. For example, unless the final text of the MiCA provides clarification, it remains to be determined whether fractional NFTs will be subject to the MiCA. Without further guidance, there still seems to be room for different interpretations by national regulators and regulatory arbitrage, as well as uncertainty about the scope of the new regulation.

Sustainability yes, but no Bitcoin ban (yet)

Cryptocurrencies that rely on “proof of work” as a consensus mechanism have been identified as a means of over-consuming power. In this context, some members of the European Parliament spoke out in favor of phasing out “proof of work”, with the potential result of a ban on Bitcoin in Europe.

Facing backlash from market participants, the ECON proposal has already abandoned this phase-out proposal. The final MiCA text now appears to follow the EU’s general stance on environmental sustainability: comprehensive disclosure, including major adverse environmental and climate-related impacts. However, the Commission is asked to consider “minimum sustainability standards for consensus mechanisms, including proof of work” in a report. So a future “proof-of-work” ban is not entirely ruled out, but it is at least delayed.

A comprehensive stablecoin regime

The Commission’s proposal was intended to provide a response to the “potential risks to financial stability and orderly monetary policy” posed by stablecoins, such as the proposed “Libra/Diem” currency. A stablecoin (called an “electronic money token” or “asset-referenced token” in the terms of the MiCA) will be subject to various requirements, for example, maintaining a liquid reserve, offering the holder a right to redeem the stablecoin at any moment and for free. free of charge, and that the issuer must be established in the EU. According to some observers, MiCA will include limits for large stablecoins (eg €200 million per day).

The “Crypto Travel Rule” and other AML regulation

MiCA is adopted in conjunction with certain amendments to AML regulations that address the money laundering risk inherent in crypto assets. As stated in the provisional agreement reached on June 29 on AML regulation, crypto asset service providers under MiCA must also comply with AML obligations. The EU also implemented FATF recommendations 15 and 16 (the so-called “Travel Rule”) by extending the Funds Transfer Regulation to transfers of crypto assets.

As a result, certain information about the originator and beneficiary of a crypto asset transfer must be exchanged between crypto asset service providers and recorded for monitoring purposes. The Funds Transfer Regulations will also cover transactions between non-hosted wallets and wallets hosted by service providers (but not transactions between non-hosted wallets). The Parlament prevailed with its proposal not to impose any de minimis threshold for obligations under the Extended Funds Transfer Regulation.

According to the Press release, a crypto-asset service provider will need to verify whether a non-hosted wallet is “owned” by a client if this client sends or receives €1,000 or more to or from their own non-hosted wallet. How this is reflected in the final text remains to be seen, but it appears to be a significant step away from the EU Parliament’s initial proposal to notify similar transactions to competent AML authorities.

A long way until MiCA applies

Mica it will have to be formally adopted, translated into all the languages ​​of the EU member states and published in the Official Gazette. Stablecoin issuer provisions aside, it is expected to be another 18 months until the MiCA comes into force. The Commission will use these additional months to prepare delegated legislation setting out the technical details implementing MiCA, for example on the investment of reserve assets by stablecoin issuers or the content of their license applications. The landscape of crypto assets in the EU will persist until 2024.

According to press coverage, the ECB has already raised concerns about this lack of a level playing field and raised an imminent need for harmonization with EU member states until MiCA arrives. It remains to be seen whether member states that do not have a regulatory framework for cryptocurrencies will catch up with the more developed regulations of countries like Germany.