The story so far: The European Parliament, the legislative body of the 27-nation EU bloc, has approved the world’s first comprehensive set of rules to bring largely unregulated cryptocurrency markets under the purview of government regulation. The regulation, called Markets in Crypto Assets (MiCA), will enter into force after formal approval by the member states.
Why regulation?
According to Chainalysis, around 22% of the global crypto industry was concentrated in Central, Northern and Western Europe, which received $1.3 trillion in crypto assets. Having a comprehensive framework like MiCA for 27 countries in Europe not only harmonizes the crypto industry, but also gives the EU a competitive edge in its growth compared to the US or the UK which lack regulatory clarity. More importantly, 2022 saw some of the biggest failures and wipeouts in the crypto industry involving bankruptcies and fraud scandals, be it the collapse of crypto exchange FTX and its spat with Binance or the failure of Terra LUNA cryptocurrency and its associated stablecoin. The lack of liquidity caused by these shocks led other crypto lending platforms to halt customer transfers and withdrawals before filing for bankruptcy.
As the investment and size of the crypto industry grows, European and other regulators have felt the need to bring governance practices in crypto firms to ensure stability and financial sector-like route and contagion. MEP Stefan Berger, who is leading the MiCA regulation, explained that the law will protect consumers from deception and fraud and “the sector that was damaged by the FTX collapse can regain confidence”.
What kind of assets will MiCA cover?
The MiCA legislation will apply to ‘cryptoassets’, which are broadly defined in the text as “a digital representation of a value or a right that uses cryptography for security and is in the form of a coin or token or other transferable digital medium and stored electronically using distributed ledger technology or similar technology”. This definition implies that it will not only apply to traditional cryptocurrencies such as Bitcoin and Ethereum, but also to newer ones such as stablecoins.
Stablecoins are digital tokens that aim to remain tied in value to a more stable asset – a fiat currency such as the US dollar or other stable cryptocurrencies. MiCA will establish new rules for three types of stablecoins – asset-referenced tokens, which are linked to multiple currencies, commodities or cryptocurrencies, e-money tokens, which are linked to a single currency and utility tokens, which are intended to provide access to a commodity or service that will be provided by the issuer of that token.
As for the assets that will be outside MiCA’s scope, it will not regulate digital assets that will qualify as negotiable securities and function as shares or equivalents and other crypto-assets that already qualify as financial instruments under existing regulation. It will also, for the most part, exclude non-fungible tokens (NFT). MiCA will also not regulate central bank digital currencies issued by the European Central Bank and digital assets issued by national central banks of EU member states when acting in their capacity as monetary authorities, along with crypto-asset-related services offered by them.
What are the new rules?
MiCA will impose compliance on issuers of cryptoassets, which are defined as the “legal entity that offers to the public any form of cryptoasset”. It will apply to crypto-active service providers (CASPs) that offer one or more of these services – the operation of a trading platform such as CoinBase, custody and management of crypto-assets on behalf of third parties (customers), exchange of crypto-assets for funds/other crypto-assets, execution of orders for crypto-assets, placement of crypto-assets, providing transfer services for crypto-assets to third parties, providing advice on crypto-assets and crypto-portfolio management.
The regulation prescribes different sets of requirements for CASPs depending on the type of crypto-asset. The basic regime will require each CASP to be incorporated as a legal entity in the EU. They can be authorized in any member state and will be allowed to perform their services across the 27 countries. They will then be monitored by regulators such as the European Banking Authority and the European Securities and Markets Authority, who will ensure that the companies have the necessary risk management and corporate governance practices in place. CASPs will need to demonstrate their stability and soundness, ability to keep the funds’ users safe, implementation of controls to ensure they do not engage in proprietary trading; avoidance of conflicts of interest, and their ability to defend themselves against market abuse and manipulation.
In addition to authorization, stablecoin service providers must also provide key information in the form of a white paper that mentions the details of the crypto product and the main participants of the company, the terms of the offering to the public, the type of blockchain verification mechanism they use, the rights related to the crypto assets in question, the main risks involved for the investors and a summary to help potential buyers make an informed decision regarding their investment. Issuers of stablecoins will also be required to maintain sufficient reserves equal to their value to avoid liquidity crises. These stablecoin companies linked to non-euro currencies will have to limit their transactions to a daily volume of €200 million ($220 million) in a specified region.
Another piece of legislation passed with MiCA requires crypto companies to submit information about senders and receivers of crypto assets to their local anti-money laundering authorities, to prevent money laundering and terrorist financing activities.
What has been the reaction?
Executives at some of the biggest cryptocurrency firms have taken exception to some aspects of MiCA, but the broad view is that having a regulatory framework is better than having no rules at all and attracting regulatory action on a case-by-case basis without clarity.
Meanwhile, since it has been three years since MiCA has been in development, some experts feel that the regulation is already lagging behind in covering newer vulnerabilities in the crypto industry. For example, it does not cover practices such as crypto betting and lending, which led to some of the industry’s biggest failures last year. A Bloomberg analysis notes that MiCA also does not cover NFTs, or decentralized finance, which is vulnerable to hacks and fraud because it is managed by code rather than humans.
How is crypto regulated in India?
India does not yet have a comprehensive regulatory framework for cryptoassets. A bill on the same is reportedly in the works.
Full-fledged regulation aside, the Indian government has taken certain steps to bring cryptocurrencies under specific government and fiscal frameworks. In the Union Budget 2022, the finance ministry said cryptocurrency trading in India has seen a “phenomenal rise” and imposed a 30% tax on income from “transfer of virtual digital assets”. In March this year, the government placed all transactions involving virtual digital assets under the Prevention of Money Laundering Act (PMLA).
However, statements by ministers and bureaucrats after the budget seem to suggest that the legality of cryptocurrencies in the country remains a gray area. India is now calling for consensus in the G20 group, where it currently holds the presidency, to have a globally coordinated policy response to crypto-assets that takes into account the full range of risks, including those specific to emerging markets and developing economies.
