Tracking Key Crypto Regulatory Updates in the European Union

Last month, the EU Parliament Economic and Monetary Affairs Committee (ECON) voted in favor of a new draft of the Markets in Crypto Assets (MiCA) framework. Further, recently the EU Parliament agreed to start negotiations with the EU member countries on rules that would allow the tracing and identification of transfers of crypto-assets

One of the previous drafts of the MiCA framework contained a provision that sought to restrict the use of proof-of-work (PoW) cryptocurrencies such as Bitcoin due to objections over their energy usage. The PoW is a decentralized consensus mechanism. The new MiCA draft, which was introduced in March 2022, strikes down the POW provision. Under the POW mechanism, miners use alphanumeric codes called hashes to validate a blockchain’s transaction and add the next block to the blockchain. The process of creating alphanumeric codes requires a lot of computing power leading to increased use of energy. Few EU lawmakers wanted to ban POW mining as they consider it to be an environmentally unsustainable consensus mechanism as it enables extensive energy consumption. The regulators increased their focus on POW-related energy concerns following an open letter from Swedish authorities in November 2021, which called for the EU to ban POW mining in order to meet Paris Climate Agreement.

Back in November 24, 2021, the European Council adopted the proposed MiCA framework as a part of the Digital Finance Package. The package aimed to create a unified approach for crypto in the EU and ensure consumer and investor protection throughout member states, rather than allowing a fragmented approach in which standards differ from nation to nation. 

First introduced in September 2020, the purpose of MiCA is to create a regulatory framework for the crypto-assets market that supports innovation and draws on the potential of crypto in a way that preserves financial stability and protects investors. The MiCA draft legislation establishes a licensing regime and streamlines a uniform set of rules for member states including transparency and disclosure requirements for the issuance of digital assets, the authorization and supervision of crypto service providers, consumer protection rules, and measures to prevent market abuse. Merkle Science published a guide to EU’s crypto regulation, read insights from MiCA here.

Key provisions from the new MiCA draft that was introduced in March 2022

On March 14, the ECON agreed upon its negotiating position related to the new MiCA draft rules, with 31-4 votes in favor and 23 abstentions.

Environmental threats: The members of the European Parliament (MEPs) scrapped the POW provision. However, in an effort to reduce the high carbon footprint of cryptocurrencies — in particular, the mechanisms used to validate transactions — the MEPs have asked the EU Commission to present a legislative proposal by January 25, 2025. Under the legislative proposal, the EU Commission has to add those crypto mining activities in the  EU taxonomy that contribute substantially to climate change. For instance, POW mining activities may be included in the EU taxonomy as opposed to Proof-of-Stake mining activities, which consume comparatively less energy.

The EU taxonomy is a classification system that establishes a list of environmentally sustainable economic activities. The EU taxonomy is a tool, which helps companies, investors, and policymakers understand whether an economic activity can be considered environmentally sustainable or not.

Crypto Oversight: Under this new version of the MiCA draft, European Securities and Markets Authority (ESMA) will supervise the issuance of asset-referenced tokens, whereas the European Banking Authority (EBA) will govern the electronic money tokens (E-money tokens).

MiCA defines asset-referenced tokens as “tokens that maintain a stable value by referring to any value or right, or combination thereof, including one or several official currencies.” Essentially, asset-referenced tokens are those that can be pegged against baskets of goods, including fiat currencies, securities, commodities, and even other crypto assets. E-money tokens, on the other hand, can only be pegged against the official currency of a country. The function of E-money tokens will be very similar to the functions of electronic money as they will be used for making payments or as a store for value.

Reportedly, on March 31, 2022, during the first round of talks to finalize the MiCA framework, the EU Parliament and the EU member states discussed the possibility of shortening the two-year implementation period of MiCA. To pass the MiCA framework within the EU, the EU Parliament, which represents the EU citizens, and the EU Council, which represents the governments of the 27 EU member states, have to reach an agreement on the identical text of MiCA. Basically, they have to agree on the same MiCA draft.

The EU establishes a pilot regime for market infrastructure based on DLT technology

On March 24, 2022, The EU Parliament adopted the EU Commission’s proposal of a pilot regime for market infrastructures based on distributed ledger technology (DLT). The EU Commission had already adopted the proposed regulation in September 2020 as part of its Digital Finance Package. To efficiently test the implementation, the proposal adopts the ‘sandbox’ approach, under which ESMA will receive feedback from stakeholders and assess whether or not regulatory technical standards need to be amended in line with the proposal. According to the MEPs, such an approach avoids regulatory arbitrage and loopholes.

The DLT pilot regime establishes operating conditions for DLT market infrastructures and supervises coordination and cooperation between ESMA and other relevant authorities. Additionally, it also sets out limitations regarding DLT transferable securities that can be traded going forward.

The EU Parliament wants to introduce new rules to trace and identify transfers of crypto assets

On March 31, 2022, the ECON and Committee on Civil Liberties (LIBE) adopted their position on draft legislation strengthening EU AML/CFT rules. These rules aim to ensure crypto can be traced in the same way as traditional money transfers. In April 2022, session of the EU Parliamentary Plenary, the MEPS, without a vote, confirmed the ECON and LIBE’s mandate. This means that the EU Parliament is now going to start negotiations with EU member states regarding these rules.

Under the new requirements, all transfers of crypto assets will have to include information on the source of the asset and its beneficiary. This information has to be made available to the competent authorities. These rules will also cover transactions from unhosted wallets. The rules will not apply to person-to-person transfers conducted without the help of service providers such as crypto exchanges and over-the-counter crypto trading platforms.

Unlike other jurisdictions, the EU plans on removing the minimum threshold and exemptions for low-value transfers. Under the new measures, rules that apply to fiat payments and transfers over €1,000 ($1,114) would be applied to crypto – except without any threshold, meaning even the smallest movements of crypto funds will have to be compliant with the AML/KYC regulations. Further, MEPs also want the EBA to create a public register of crypto asset businesses and services that involve high AML/CFT risks.

The crypto sector has been very sharp in its criticism of the new EU proposal. Coinbase CEO Brian Armstrong called the proposal “anti-innovation, anti-privacy, and anti-law enforcement.” Coinbase Chief Policy Officer Faryar Shirzad warned it could mean recording and reporting transactions through self-hosted wallets “even if there is no reason to suspect wrongdoing.”

How can Merkle Science help?

With the EU Council strengthening the crypto regulatory regime and gearing up to ensure strict implementation of its guidelines, crypto-asset service providers and token issuers should proactively put robust compliance frameworks in place. Merkle Science’s highly customizable and easy-to-use platform provides near real-time detection of blockchain transactional risks. Our predictive cryptocurrency risk and intelligence platform set the standard for the next generation of financial safeguards and criminal detection. Merkle Science's proprietary Behavioral Rule Engine allows crypto businesses to tailor the tool according to their risk policies based on the recent changes so that businesses may stay ahead of emerging illicit activities and fulfill their local compliance obligations.