MiCA: A Guide to the EU's Proposed Markets in Crypto-Assets Regulation

Summary

A detailed new digital finance package (DFP) was introduced by the European Commission (EC) on 24 September 2020 which, if it is implemented in its current form, would change the European economy over the coming decades. It is known as Markets in Crypto-Assets Regulation (MiCA).

MiCA was “leaked” in the middle of September to encourage the crypto industry to prepare itself for official implementation in EU legislation for up to four years.

Despite this long timeframe, it is possible that MiCA would permanently transform Europe’s digital asset environment and its stringent business regulatory criteria, which would result in changes impacting many of those in the digital world, including more niche markets such as Decentralized Finance (DeFi).

MiCA focuses extensively on the guidelines for governing, out-of-scope crypto-asset types and the providers of services for these assets, known as Crypto-asset Service Providers (CASPs). It seeks to increase the competitiveness of Fintech and technology in the continent while reducing uncertainties and maintaining the European economy’s financial stability.

Most notably, the current regulatory structure also provides a detailed new statutory initiative on crypto assets, intended to help standardize Distributed Ledger Technology (DLT) and European Union (EU) virtual assets rules, while defending investors and consumers.

In this publication, we will discuss what MiCA is, its specifications, and its anticipated influence on the cryptography sector in the coming years.

What is the thinking and history behind the publication of MiCA?

The EU has long wanted to create an environment that would give EU customers access to advanced and secure crypto-asset without undermining market stability. The safety of crypto consumers is undoubtedly its key priority, with this weighed against the need for more sophisticated investment offerings and the regulatory and financial uncertainties involved with the broader use of potentially risky assets, such as stable coins.

MiCA is the result of a phase that began in early 2018 after the Bitcoin Bull Run in 2017. This surge of public investment and interest in cryptocurrencies prompted European regulators to notice the threats of uncontrolled virtual assets to consumers and economies, like terrorism funding and money laundering threats.

The FinTech Action Plan of the EC, released in March 2018, required a review of the relevant and applicable regulatory system for EU financial services and for crypto assets by the European Securities and Markets Authority (ESMA) as well as the European Banking Authority (EBA).

Many crypto-assets are independent of EU regulation on financial services and are thus not subject to investor and customer protection and business integrity clauses. As a result, European authorities began collaborating under the DFP on a new regulatory crypto-asset structure that became MiCA. They aim for it to allay a number of fears, including the potential damage that may be caused to investors by the potential creation of a shadow financial system.

What is MiCA?

MiCA is a regulatory mechanism established to govern currently off-scale crypto-assets and their EU providers and to provide all Member States with a common licensing system by 2024.

MiCA seeks to “unify the European framework for the trading and issuance, as part of Europe ‘s digital finance policy, of different forms of crypto-token”

Its full, official title is a proposal for a regulation of the European Parliament and of the Council on Markets in amending Directive (EU) and Crypto-assets 2019/1937.

Where will MiCA apply?

Once accepted, MiCA will apply as a directive throughout the European Union (EU) to all member countries and will provide a legal structure for markets, assets, and service providers to enable licensed services in the EU to be offered.

It would also impact third countries trying to do business in the EU; consumer prospecting from outside the EU is regulated, say, for instance, from Singapore and, post-Brexit, potentially the UK.

What are MiCA’s regulatory objectives?

The strategy for crypto-assets markets has four broad objectives:

1. To provide legal clarity for non-existent EU financial services regulation crypto assets
2. To create unified rules on issuers and providers of crypto assets services at the EU level
3. To substitute the current national crypto-asset systems not covered by existing EU regulations on Financial Services; and
4. To specify clear guidelines for so-called ‘stable coins,’ even when it is e-money.

The MiCA proposal incorporates 28 definitions. They define crypto-assets as “a digital representation of rights or values that can be electronically exchanged and processed using distributed ledger technology or related technology.”

Also important is the definition of a crypto-asset service, which is defined as the following programmers and operations related to any crypto-asset:

1. The execution on behalf of third parties of crypto-asset orders
2. Crypto-asset interchange for other crypto-assets
3. Administration and custody on behalf of third parties of crypto-assets
4. Recommendations on crypto assets
5. The trading of crypto-assets for the lawfully bidding fiat currency
6. The operation of a crypto-asset exchange platform
7. Crypto-asset placement
8. Transmission and reception on behalf of third parties of crypto-asset orders

Importantly and in relation to these definitions, MiCA provides a definition for a “crypto-asset service provider” (CASP) as “anyone whose business or occupation is to provide one or more crypto-asset services professionally for third parties.” This concept is broader than the definition of a Virtual Asset Provider (VASP) as defined by the Financial Action Task Force which means that MiCA is accessible to most cryptographic companies and potentially industry niches that do not currently exist.

Which crypto-assets does MiCA regulate?

MiCA seeks to control any rights representation or digital value that can be stored or shared electronically using distributed ledger technology (DLT) or related schemes.

MiCA does not regulate Crypto-assets that have already been established as e-money or financial instruments under the Second Financial Instrument Directive on Markets (MiFID II) or the Electronic Money Directive (EMD) but will cover crypto-asset systems which are not regulated by current EU regulations on financial services, looking at the material of an instrument and not the technology used to issue it (so substance over form).

Consequently, MICA will regulate the following three crypto-asset sub-categories:

1. E-Money token, being a form of crypto-asset, which have a stable value based on only one electronic money currency. The intention of E-money tokens it to work similarly to electronic money in the sense that they can be used as payment in the place of a fiat currency.
2. Asset-Referenced tokens, which are tokens that have the aim of maintaining a value that is stable by referencing multiple assets, i.e., currencies that represent legal tender, one or more commodities, one or more crypto assets, or a basket of these kinds of assets. The tokens will then be used as a payment mechanism for the purchasing of services and goods, as a value store; and
3. Utility tokens are issued for non-financial reasons to provide digital connectivity on DLT networks to resources, applications, or services available.

Which activities does MiCA regulate?

MiCA will regulate the activities of crypto-asset selling and promotion

Just as conventional financial partners must issue a prospectus for public shares, issuers of all MiCA crypto-assets must publish a white paper (official language in English or the official EU State), which must contain key material on features, obligations and rights, and the underlying project and technologies.

The whitepaper must be circulated with authorities at least 20 days before publication.

However, as with prospectuses for other types of assets, there are certain exemptions. With respect to the public offer of crypto-assets, other than asset-referenced tokens or e-money tokens, the MiCA requirements will not apply if:

• The crypto-assets are offered for free
• The crypto-assets are automatically created through mining as a reward for the maintenance of or validation of transactions on a or similar technology
• The crypto-asset is unique and not fungible with other crypto-assets
• The offering of crypto-assets is addressed to fewer than 150 natural or legal persons per Member State acting on their own account
• The total consideration of such an offering in the Union does not exceed €1,000,000, or the corresponding equivalent in another currency or in crypto-assets, over a period of 12 months
• The offering of crypto-assets is solely addressed to qualified investors and the crypto-assets can only be held by such qualified investors.

With respect to the public offer of asset-referenced tokens or e-money tokens, the MiCA requirements will not apply if:

• The asset-referenced tokens/e-money tokens are marketed and distributed exclusively to qualified investors and can only be held by qualified investors.
• The average outstanding amount of asset-referenced tokens/e-money tokens does not exceed €5,000,000, or the corresponding equivalent in another currency, over a period of 12 months, calculated at the end of each calendar day.

It should be noted that when issuers of asset-referenced tokens or e-money tokens rely on these exemptions, they must still produce a white paper conforming to the prescribed form and content requirements, and submit that white paper to their home member state regulator at least 20 working days before the publication of the white paper to the public.

The Member States must ensure that issuers of crypto-assets are responsible for whitepaper information under their national regulations

Finally, because of the complexities of DLT safety and threats, issuers need to maintain good cybersecurity to safeguard the funds of investors. The national authorities can suspend their offer if they do not.

CASP authorization

Providers of crypto-asset services (CASPs) will require prior authorization from the competent governments of the Member States.

If the EU country has already set up a specialized CASP licensing system, regulators can refer to the transfer of firms from a national license into a MiCA CASP license that is applicable in the European Union by applying a simpler authorization procedure.

As with MiFID II, CASPs will be subject to additional requirements relating to their capital needs, staff training, governance model, insurance coverage, and more (based on their size and relevant risk).

The EU is at pains to note that investor security is at the core of its philosophy and that additional commitments relating to appropriate asset differentiation, business structure, fund protections, and management skills must also be fulfilled.

CASPs delivering cross-border facilities will not have to be physically present in all the Member States, other than in their home Member States, where they would like to offer services.

Those planning to offer crypto-asset services must apply to the competent authority of the Member States in which they have a registered office for authorization as a service provider.

What does MiCA say about the FATF Standards and Crypto Crime?

MiCA doesn’t directly address the challenge of terrorist financing and money laundering as the matter is already covered by EU anti-money laundering legislation since the 5th Anti-Money Laundering Directive (AMLD 5) became applicable on 10 January 2020. However, the proposal succinctly phrases the overarching objective of the law with regards to money laundering and terrorist financing in Consideration 8 of the draft:

“This Regulation should include definitions of ‘crypto-asset’ and of ‘distributed ledger technology’ which are as wide as possible to capture all types of crypto-assets which currently fall outside the scope of EU financial services legislation. This should ensure that the Regulation is future-proof and keep pace with innovation and technology developments in the sector. While the purpose of this Regulation is not to address antimoney laundering and combatting issues raised by crypto-assets, this Regulation should contribute to this objective. Therefore, the definition of ‘crypto-assets’ set out in this Regulation should correspond to the definition of ‘virtual assets’, set out in the recommendations of the Financial Action Task Force. The list of crypto-asset services in the scope of this Regulation should also encompass the virtual asset services likely to raise money laundering concerns and identified by the Financial Action Task Force.” [Source: Politico. eu]

With Consideration 8, MiCA further attempts to harmonize EU legislation with the FATF’s recommendations on dealing with crypto crime by aligning its terminology and scope of service to that of FATF’s.

Further in Consideration 64 of the draft, MiCA has further talked about other types of cryptocurrency crimes, such as insider dealings, unlawful disclosure of inside information, and market manipulation related to crypto-assets (also know as Wash Trading). For example, crypto-asset service providers would be required to put in place surveillance and enforcement mechanisms to deter potential market abuse.

“To ensure users’ confidence in the crypto-asset market and market integrity, cryptoassets that are admitted to trading on a trading platform for crypto-assets should be subject to provisions to deter market abuse. However, as the issuers of crypto-assets and crypto-asset service providers are very often small and medium-sized enterprises, it could be disproportionate to apply all the provisions of the Regulation (EU) No 596/2014 (Market Abuse Regulation) to them. Therefore, this Regulation should include some bespoke provisions on market abuse that would prohibit some behaviors, such as insider dealings, unlawful disclosure of inside information and market manipulation related to crypto-assets, as these behaviors are likely to undermine users’ confidence in the integrity of crypto-asset markets. These bespoke rules on market abuse committed in relation to crypto-assets should be applied, where crypto-assets are admitted to trading on a trading platform for crypto-assets. The provisions on market abuse should be applied taking into account the specificities of the DLT market structure on which crypto-assets are traded as well as the role of different actors in the cryptoasset market which may enable them to commit market abuse.”

When will MiCA come into force?

Although there is a proper timeframe for getting any new legislation into the complicated EU mechanism until it becomes law, the adoption of MiCA is not precisely timed, although the EC anticipates it will be in the next four years.

By 2024, a detailed mechanism should be in place by the EU to allow the uptake in the financial sector of crypto assets and distributed ledger technology (DLT). It should also discuss the risks correlated with any of these technologies.

It should however be noted that not all EU legislative proposals have run to timetable

What are the proposed benefits to the crypto-asset industry?

The EC draws attention to fact that crypto-asset firms are not able to benefit from Europe’s internal financial services industry because of “a lack of both legal clarities about regulatory processing of crypto-asset as well as the absence of a committed and consistent supervisory and regulatory system at EU level”. It says that this is demonstrated by the recent reluctance of crypto corporations to ‘passport’ their licenses in the EU.

It also notes that CASPs are outside the regulatory frameworks of most Member States, which prompts those governments to control these businesses by establishing customized national frameworks.

The EU believes that the growth of these businesses is hindered by being subject to different regulations, definitions, and frameworks of both crypto-currency assets and their service providers, adding that this has impeded their ability to expand operations at the EU level, citing legal complexity, high costs, and regulatory ambiguity.

All this leads to an ‘uneven playing field’ for CASPs and affects the internal sector’s efficiency. As both CASPs and their customers do not have a standard EU system, the EU believes they both are in danger when working with crypto assets. The EC hopes that MiCA will fix this situation.

Next steps

While the EU Commission has not yet published the legislative roadmap for MiCA, under the EU legislative process the proposal will be transferred to the European Parliament (EP) and then the European Council (the Council) for review at first reading under the Ordinary Legislative Procedure. There is no time limit at the first reading stage.

Conclusion

It is, therefore, possible for MiCA’s official enforcement to put an end to all the national crypto-policies of all EU Member States by 2024, in favor of a single, oriented regulatory system, which could allow EU crypto-asset service providers to function more efficiently across all EU markets, but under stronger restrictions.

Then who knows how the crypto-asset market will look like in 2024?

Speedy development in both DLT as well as crypto-asset technologies, which contributed in 2020 to the introduction of new areas such as decentralized exchanges and decentralized finance (DeFI), has led to a greater global discourse.

With extensive regulatory crypto changes set to take place among all Financial Action Task Force members in reaction to their revised requirements, MiCA could be very mild when it eventually joins the European Union in a few years.

How Merkle Science Can Help

Merkle Science provides blockchain transaction monitoring and intelligence solutions for cryptoasset service providers and financial institutions to address their risk exposure to virtual currency-related crime in accordance with MiCA AML compliance requirements.

Our Blockchain Monitor enables compliance teams to go beyond using a database of bad addresses and configure custom risk rules to identify and detect high-risk transactions or addresses. The following are a few ways through which compliance teams can customize risk parameters:

• Detect direct or indirect interactions with high-risk entities (such as coin-mixers, darknet marketplaces), ransomware addresses, scam addresses, theft and hack addresses, the US OFAC list, and other sanctioned or criminal addresses
• Set specific parameters related to frequency, size of transactions, and custom patterns to flag otherwise concealed criminal activity on the blockchain. (See FATF’s Virtual Asset Red Flag Indicators of Money Laundering and Terrorist Financing for more information)
• Test and optimize risk rules within a “sandbox” environment before implementation to avoid false positives and too many/few relevant risk alerts.

For more information about how Merkle Science could help your firm comply with MiCA and EU virtual currency requirements reach us at contact@merklescience.com.

About the author

Claire Cummings is a solicitor who has over 20 years’ experience in financial services for alternative investments, with particular expertise in crypto-assets and the digital asset arena, and is currently the Managing Partner at Cummings Pepperdine.

As a solicitor, Claire has acted as alternative funds and fund managers, brokers, and distributors and has spent time as in-house counsel, director, and compliance officer of a CTA advising on a wide range of transactions. Claire’s work includes advising on FCA’s rules on marketing crypto-assets, MiCA, AIFMD, MiFID II, and EMIR issues, and also guiding organizations on cryptocurrencies, token issues/ICOs, setting up funds, and drafting fund documentation.

Claire draws on her experience as a solicitor, managing partner, and director of a fund management company to work with her clients as they establish and build their businesses.