Over the course of this series of articles about the EU’s upcoming Markets in Crypto Assets Regulation (MiCA), we have looked into what the key terminology is, why the various stakeholders care about it, what exactly the law says, and what the distinction is in law between certain types of tokens. In this final article, we will dive into what the likely effects of MiCA implementation will be, and some things that have been missed out and how these loopholes might be closed. Therefore, in this piece, we will move away from facts and into speculation. Enjoy!
Looking at the wording of the law and the discussion around it, we genuinely believe that the EU is attempting to strike a delicate balance between regulating what is considered to be a ‘Wild West’ market, and keeping Europe a good place in which to innovate. Any rules are going to threaten innovation, as they limit what companies and entrepreneurs can do. However, regulations can also go the other way and create clear guidelines within which new products can be created. The EU is hoping that MiCA pushes harder in the second direction.
We can see the current exasperation of crypto companies based in the US, with certain organizations crying out for a ‘clear set of rules’ - these rules should come in the form of Chapter 12 of the Uniform Commercial Code later on in 2022 or 2023. It is hard to build when living in a state of neverending purgatory, and in common law jurisdictions like the US, there always hangs over every blockchain company the possibility that a judge might reinterpret a law at some point in the future, and the company finds themselves on the wrong side of it. In civil or code law jurisdictions like the EU, regulations create clear instructions as to what is and what isn’t OK, and it is my belief that this will encourage risk-averse industries, like finance, to experiment with DLT and other innovative technologies. Strong rumors have it that most banks in the Netherlands were experimenting with DLT-based product pilots around the time that Facebook announced Libra, and shut them down in the wake of the uncertainty that followed. We believe that MiCA will give them and others the clarity required to start again.
Dusk Network seeks to speed up the transition of the world to a token-backed economy, and to that end, we welcome this potential effect of MiCA. We are happy both that our partners can feel at ease experimenting with our products, and that we also have the guidelines ourselves which will allow us to build compliance in at the ground level, baked into the technology itself. If this is indeed the effect of MiCA, it can open up a whole world of new opportunities and possibilities, and help Europe to compete with the tech-savvy United States, and the fast-growing Asia as a great place to do innovative financial business. This is especially important as Europe seeks to face its twin challenges of an aging population and a stagnant economy.
Compliance creates comfort, but it also creates costs, and sometimes these costs can be prohibitive. The most obvious increased cost and risk within blockchain is around the concept of the whitepaper. MiCA requires the writing of a formal whitepaper explaining many details of a token project before it can be issued or even listed on an exchange. Current whisperings suggest that the length of the whitepaper to be around 10-15 pages, which when compared to an IPO prospectus (around 100 pages), may seem small. The cost does not come from the length however, but the legal liability attached to it. Any issuer of a MiCA-compliant token will be at least civilly liable for everything written in their whitepaper. This means that any company would be wise to spend heavily on lawyers and getting every single word checked and approved before publishing anything. This will add large amounts of money to the issuing process.
This liability doesn’t just add to the costs - it greatly increases the chance of a company being taken to court. While of course we welcome any institution - corporate or otherwise - seeing justice for wrongdoing, we must also acknowledge that we live in a world of frivolous lawsuits. The increased liability coming out of strict whitepapers has the potential to increase these for any crypto asset issuer.
As discussed in the last article, a different piece of EU legislation that will work alongside MiCA, guarantees purchasers of crypto assets a 14-day ‘right of redemption’ - effectively a legal requirement for a customer to be given their money back for any token they purchased within this timeframe. Given how many blockchain companies currently work - raising large amounts of money through a token sale, and then building the product afterwards - this creates much instability. The potential for a large-scale, possibly Twitter-induced, redemption frenzy means that no funds can be considered ‘safe’ until two weeks have passed. The obvious solution to this includes raising more seed capital so that the token money is less required in order to build, so that most or all of the building can be done before the token sale itself. This gives the advantage either to the few entrepreneurs who can raise that much money or to big institutions who already have it.
The 14-day right of redemption, however, does not apply when a token has been listed on an exchange, which means that in a post-MiCA Europe, it will be in the interests of a token issuer to get listed on an exchange as soon as possible. This opens up all sorts of potential for exchanges to make creative deals with tokens to get them up and running quickly. This could be a new revenue stream, but also shifts some of the power in the industry back to the exchanges and away from the issuers. Despite the potential that this offers to exchanges, it will be especially risky for them to rush issuances, considering that they will have to be mindful of their own CASP license under MiCA, and the legal liabilities that that will incur.
It’s not only listing new assets that will cause headaches for European crypto exchanges post-MiCA. We mentioned in the first article that the classification of ‘crypto assets’ as defined by MiCA clearly seems to include Bitcoin and Ethereum. Yet, neither of these seems to fall under any of the specified categories (Electronic Money Tokens, Asset-Referenced Tokens, Utility Tokens), thus meaning that they are covered by MiCA but not by the specific rules applying to these three types. For the purposes of classification, we have used the catch-all term ‘cryptocurrencies’ to refer to tokens such as these. We can ask what specific rules would apply to these coins, seeing as they don’t appear to fit a category. But more importantly: how can a crypto exchange list a token, such as bitcoin, for which there is no ‘issuer’? Well, the June 30 agreement appears to have settled this in a surprising way - exchanges that wish to list assets for which there is no central issuer must write their own whitepapers and go through the same process of issuing them to the National Competent Authority like any issuer would. Critically they would also be liable for what was written in the whitepaper, even though they did not create the crypto asset itself. Within the community, we expect that a ‘grandfather’ rule will be added, meaning that this complex process of writing a Bitcoin or Ethereum whitepaper will not apply to exchanges who came into existence AND had these coins listed before MiCA came into force. But for any new exchanges which emerge post-MiCA, and for any current exchanges who add these types of tokens after it has come into force, this rule will certainly apply and seems to be asking a lot, especially in what will likely be a much more risk-averse climate. Yet it’s hard to imagine an exchange without Bitcoin, or Ethereum for that matter.
Anyone wishing to learn more about this can check out Dusk Network’s Internet of Assets podcast where I interviewed blockchain lawyer Willem-Jan Smits about exactly this (spoiler alert: no, you cannot just use the original Bitcoin whitepaper).
This is a key component of what I have here called ‘the Ugly’ - the parts of MiCA that have not been well put-together. Another prime example of this would be the events surrounding the decoupling of the Transfer of Funds Regulation from the rest of the Anti-Money Laundering Package, agreed the same day as the final draft of MiCA. In short, as MiCA comes into effect which requires exchanges to get licenses as CASPs, the current Anti-Money Laundering Directive 5 will still be in effect. AMLD5 requires providers of crypto-fiat exchange services to get a license within each member state that they operate. The whole point, of course, of the entire Digital Finance Package, was to harmonize things across all 27 member states AND to provide ‘passporting’ rights - the ability to register in one state, and do business in all the others. This huge oversight means that for at least the first 18 months that MiCA is in effect, crypto exchanges will need both national and EU licenses, effectively doubling the amount of work currently required. Very ugly indeed.
Finally we can move to the remaining unopened questions. Much like a startup building a product, eventually there comes a point where you just have to ship something, and in a way government legislation is the same. The EU has been working on MiCA for over two years, and the final agreement on June 30 was intended to end the debate and move towards putting something down on paper. However, just like an app launching with few features, several key elements remain unanswered or unaddressed in the expected final draft. Let’s look at a few of them here.
As mentioned, MiCA began in response to the perceived threat from Facebook Libra and so it follows that a huge amount of the draft legislation is dedicated to stablecoins. The rules for EMTs and ARTs are fairly straightforward and well spelled-out. However, MiCA identifies a third category of crypto assets called ‘utility tokens’, defined as “a type of crypto-asset which is intended to provide digital access to a good or service, available on DLT, and is only accepted by the issuer of that token.” However, in their rush to place regulations on EMTs/ARTs, the EU seems to have left very little in terms of specific rules for utility tokens. We know at present that a license will not be required to issue a utility token, unlike an EMT/ART. But beyond that, MiCA requires issuers of utility tokens to follow many of the same burdensome rules, such as whitepaper writing and issuing to National Competent Authorities. This of course does not mean that additions will not be made later, but what could they be? Will a new set of utility token-specific rules be created? May they eventually also be asked to place capital in reserve? It is not clear and it seems as if this is highly likely to be a source of additional amendments in the near future.
Despite rumors that the final agreement would deal with sustainability issues surrounding Proof-of-Work systems, it did not. Instead the drafters have asked token issuers to include energy usage numbers in their whitepaper AND asked the ESMA to come up with a draft set of sustainability requirements. This means that token issuers will have to declare their sustainability details without knowing whether or not they are breaking any rules. This remains something unlikely to be resolved until 2025.
Non-Fungible Tokens, or NFTs, were another area expected to be addressed in the final draft that was not. Except for some minor rules around using collections of NFTs effectively as securities, the market remains unregulated. Will an amendment be added? Will regulation require different legislation entirely? For now, we don’t know. We also don’t know if the recent NFT market boom is a flash in the pan or here to stay. If it’s temporary, then by the time the EU gets round to regulating NFTs, they may already be yesterday’s news.
There was also no inclusion for privacy requirements such as GDPR in the final draft. While there are the usual confidentiality requirements for CASPs regarding their customers, there appears to be nothing relating to the publication of public addresses and the related metadata, the exact problem that Dusk Network is seeking to solve. We believe this to be a critical piece of blockchain infrastructure, and think that the EU does too, so would expect to see amendments added around this in the future.
Finally, despite the huge amounts of MiCA dedicated to stablecoins, there are big holes in the final agreement. MiCA clearly states that ‘algorithmic stablecoins’ are categorically NOT real stablecoins, since they hold no assets in reserve to back them. That certainly does clash with the ‘right of redemption’ principle, but leaves us with the question: what are they? Based on the wording in front of us, we have to conclude that they fall again into that catch-all category of ‘cryptocurrencies’, meaning that a whitepaper is required but a license is not. Furthermore, they can be handled by CASPs, including getting listed on exchanges. However, since MiCA was promulgated with the specific purpose of regulating stablecoins, leaving an entire subcategory of stablecoins unlicensed and without the restrictions that apply to all others seems…unsustainable. Once again, it could be years before this is resolved, causing much market frustration in the meantime.
MiCA has huge potential to cause great upheaval in the blockchain and crypto markets. On the one hand it imposes a great many limits and restrictions on issuers and providers, potentially taking away some of the revolutionary and decentralized potential of the technology. On the other hand, it may provide exactly the kind of confidence that both innovators and consumers need in order to incorporate blockchain and crypto products into their lists and portfolios. It also has the potential to have impact beyond its borders; just as parts of the world copied huge chunks of the EU’s GDPR directive as they sought to regulate internet privacy, it’s certainly possible that overseas markets may do the same with MiCA. Thus, even if you are not in Europe, it’s hard to overestimate the potential impact of this exciting new piece of regulation. We hope that this series has been useful in helping our readers to understand it, and we welcome anyone to help us to continue the discussion over the coming months and years.
This blog is part of a series on crypto legislation in the EU:
- Who cares about crypto regulation in the EU, and why?
- Everything you need to know about MiCA
- Stablecoins Redefined: EMTs vs ARTs
- MiCA: The Good, the Bad, the Ugly, and the Unknown