The European Commission has presented the so-called MiCA regulation. As a result, this creates a far-reaching and harmonized regulation on the European level for crypto assets, including many related services. What can be potentially challenging for startups also contains enormous opportunities in terms of professionalization and growth for the entire crypto ecosystem. — Authors: Philipp Sandner, Johannes Blassl
In September 2020, the European Commission presented a draft for a comprehensive regulation of “crypto assets” (digital, blockchain-based assets), which is expected to come into force at the end of 2022. The regulation “Markets in Crypto-assets” (“MiCA”), which is directly applicable in all Member States, describes the most extensive regulation of digital assets to date.
Various crypto assets: From Bitcoin over Libra to the blockchain-based Euro
Crypto assets such as Bitcoin and Ethereum are just as much in the focus of the new regulation as Facebook’s project Libra and the “utility tokens” that have gained awareness through initial coin offerings (ICOs). Bitcoin was the first crypto asset and still remains the most important up until today. Further crypto assets have been launched and the sector continues to expand. Also, numerous “utility tokens” were created through ICOs. A utility token can be considered as a means of exchange or operating resource, which provides certain functionalities, voting rights or access rights.
With so-called “stablecoins”, another important category of crypto assets has been created during the last years: For example, Tether, a stablecoin linked to the US dollar, exceeded PayPal based on daily transaction volume, for the first time in July 2020. Stablecoins are crypto assets that are supposed to provide a high degree of price stability. Their issuers intend stablecoins to be used as a means of payment. The Libra project initiated by Facebook also falls into this category.
The MiCA regulation attempts to capture this entire spectrum of crypto assets and provides differentiated and detailed rules, which are in no way inferior to the existing complex financial market regulation. Figure 1 provides a high-level overview of the various types of crypto assets the MiCA regulation includes.
It can be assumed that Libra back in 2019 provided the trigger to accelerate and systematize regulation. And yet it is remarkable that the sector of crypto assets, which is still of little importance when compared to other asset classes in total, is to be regulated in such a comprehensive and detailed manner.
A possible scenario for the European Commission could be that a rapidly growing crypto sector is expected in the coming years. If so, it should be comprehensively regulated at an early stage. For one of the largest economic areas in the world, the MiCA regulation seeks to constitute substantial investor protection for the entire crypto sector.
Prevention of a regulatory patchwork for crypto assets through individual national rules
With this new regulation, the EU Commission also aims to halt the legal fragmentation already happening in several of the EU Member States. In some cases, Member States have already issued national regulations for crypto assets. For some time now, a few EU states have started to introduce “nationally tailored” regulations with regard to services involving crypto assets. In other EU countries, however, service providers related to crypto assets are still completely unregulated.
For example in Germany, custody and management of crypto assets or private cryptographic keys used to keep, store or transfer crypto assets became a financial service requiring financial market authorization at the beginning of this year. Therefore, as the temporary custody of third-party crypto values is relevant in many blockchain-related business models, many crypto-asset-related business models in Germany require a BaFin license since the beginning of this year.
Currently, and until the MiCA regulation comes into force, companies often have to adapt their international business model to each European Member State individually, which can result in high costs.
A regulation that is directly applicable throughout Europe, such as the MiCA regulation, can reduce the complexity and uncertainty for service providers in the diverse field of crypto assets. Also, a uniform European regulatory framework will create a level playing field for market participants by avoiding national – and therefore local – disadvantages resulting from a higher density of regulation.
Integration into existing financial market regulations
The new regulation covers issuers and service providers who issue crypto assets or offer services in this field. However, the applicability of the regulation is limited to those crypto assets that are not already subject to the current financial market regulations. This means that classic financial market instruments such as bonds, shares or funds are generally not covered by the MiCA regulation, even if they are blockchain-based. Put differently, the European legislator recognizes that a new category of blockchain-based crypto assets is emerging alongside the classic financial market instruments.
For issuers of crypto assets, it is intended to create the requirement of a prospectus “light”. This requires issuers to publish certain information sheets, commonly referred to as “white papers”. It is also worth noting that the exchange trading of crypto assets is to be aligned with existing capital market regulations. Consequently, insider trading and market manipulation concerning crypto assets could then also be punished. This will strengthen both investors’ confidence and the general public’s trust in the integrity of trading with crypto assets. Therefore, the MiCA regulation might provide the basis for institutional investors, e.g. larger funds, to invest in crypto assets such as Bitcoin.
Tough times for stablecoins and startups
However, it should not be denied that with the planned comprehensive regulation, all companies that are active in the field of crypto assets will be facing considerable challenges. Especially for FinTech startups, this is significantly demanding, as more regulation is always associated with costs and effort. Established FinTech startups should find it easier to cope with the new regulatory requirements. Smaller FinTech startups, however, face high regulatory hurdles in the future. Companies that offer or intend to provide related services should, therefore, possibly already now examine how they can continue to offer their services under the new regulatory framework.
Furthermore, the draft regulation clearly shows the scepticism of politicians towards so-called stablecoins. By tying to “stable” assets or values, such as a currency, stablecoins try to reduce the high volatility of existing crypto assets to a minimum. In case such stablecoins become successful, they could become private substitute money that could also be used as a means of payment on a broader scale. The MiCA regulation clearly distinguishes between Euro-based stablecoins and other stablecoins that try to achieve their stability with different means. Potentially, non-Euro stablecoins could seriously compete with national currencies, especially the Euro. Therefore, the new regulation seeks to impose very far-reaching requirements on such stablecoins. For stablecoins that can achieve systemic relevance, the already high regulatory requirements will be increased even further.
Looking at the MiCA regulation in its entirety, a very far-reaching regulation for all kinds of crypto assets, including many services and issuances in this area, is emerging on the European level.
What may initially seem intimidating to FinTech startups, also contains enormous opportunities with regard to the professionalization of the entire crypto ecosystem. Those who believe that the upcoming regulation should be some kind of “stop sign” for Bitcoin, Ethereum, stablecoins and ICOs might be wrong. Instead, a sophisticated regulatory foundation is being built for all these approaches, which could soon place crypto assets on the same level as existing financial products.
Prof. Dr. Philipp Sandner is Head of the Frankfurt School Blockchain Center (FSBC) at the Frankfurt School of Finance & Management. The expertise of Prof. Sandner includes blockchain technology in general, crypto assets, distributed ledger technology (DLT), Euro-on-Ledger, security tokens (STOs), digital transformation and entrepreneurship.
Dr. Johannes Blassl works as a lawyer in Frankfurt in the field of banking and capital markets law. He advises companies and banks on the use of blockchain technology in the financial sector. In addition to his work as a lawyer, Dr. Johannes Blassl is a lecturer at the EBS Law School in Wiesbaden and the Universities of Applied Sciences in Fulda and Mainz.