Is Europe’s MiCA a template for global crypto regulation?

Today, the European Parliament approved the EU’s framework for crypto-assets, the Markets in Crypto-Assets Regulation (MiCA).

It was a non-event, in that the result of the vote was expected. Still, it’s important because it brings the EU’s 27 members closer to being the first in the world to have a comprehensive crypto law. With only a couple of final administrative steps outstanding, the enforcement clock will start ticking in June this year, leaving 12 to 18 months before the rules start.

Dea Markova is CEO and Head of Digital Assets at Forefront Advisers.

For the avoidance of doubt, the rules were adopted last summer. It took that long to clear the 571-page law through the EU’s legal and translation services. That was all there was to the delay, despite conspiracy theories and rumors that something darker was afoot.

Legal and compliance teams should study the final text to ensure that the details they captured last year when the text was politically adopted did not change under the scrutiny of legal services – but changes will be marginal.

The market is as positive as a market can be about regulation. Through booms, US enforcement madness and layoffs, the centralized crypto market has fallen in love with MiCA. It offers a license tailored to crypto-asset services and stablecoin issuers that can be matched across 27 EU member states and 450 million people.

It deliberately refrains from regulating decentralized finance (DeFi) or non-fungible token (NFT) activities. It borrows from capital markets regulation – the 2014 Markets in Financial Instruments Directive (MiFID) – but does not copy it. For example, there are no aptitude tests to divide between savvy and non-savvy crypto investors. Rules for stablecoin issuers will give consumers confidence that their tokens are properly reserved and always redeemable.

While banks, custodians and asset managers are currently weary of the reputational risk of dealing with crypto, MiCA stands to build institutional comfort with crypto as an asset class.

MiCA is legislation written by competent technocrats who serendipitously timed the negotiations with the bull market and thus captured political interest and optimism that has since disappeared in the EU.

In my opinion, MiCA is a politically acceptable and workable compromise based on existing regulations. It was important to get it done now that the market is mature enough and the profitability pressure is putting governance and risk management to the test. It gives entrepreneurs security, and it stops politicians from falling to their knees on an industry issue.

By choosing to rely on available regulatory frameworks, the Commission set MiCA to regulate token issuers as entities, not token exchanges as activities. That is, the requirements are on the issuer, regardless of how its token is used. I think this limits how future-proof MiCA is.

Regulatory professionals will recognize these terms; they have a history. Over the past decade, the mantra for governments from Europe to Asia has been to adapt to the fragmentation of financial services by creating activity-based, not entity-based, regulation. For example, we now focus on buy-now-pay-later activity specifically, rather than just on banks as a type of entity.

Issuing tokens as bearer instruments makes this impossible – the issuer is not responsible for, or not yet responsible for, determining whether their token is used to pay or to invest.

The EU squared this circle by focusing on probabilities. It said a token linked to a currency is more likely to be used for payments than anything else, so it should follow the regulatory framework. In EU parlance, this is an e-money token (EMT), a token that floats more like an investment, and is regulated as such.

Much political energy was spent on tokens linked to a basket of currencies, commodities or other assets. This was Europe chasing the ghost of Facebook’s libra stablecoin experiment, while the market was busy moving on. The rules for these assets are complicated and opaque in their attempts to address both payments and investment uses.

This points to how crypto complicates the distinction between payment and investment. MiCA Level 2 technical rules will seek to draw a clearer line, but it will be difficult. There are 20 technical standards to be written for MiCA, and this may be one of the more complex.

Perhaps by setting its legal framework, the EU can create the market behavior expected in the legislation – i.e. which token will be used for payments, and which will be used for investment.

Finally, while the market function of EMTs can be compared to e-money, their technology is like other tokens. So far, the EU has reversed technology neutrality. To combat money laundering, due to their underlying technology, EMTs are treated differently than e-money. But in June, the commission will propose that EMTs should offer the same consumer protections as e-money, including reversible payments, despite their underlying technology.

For international companies, the key question is when and how the global crypto order will be established.

The supervisory authorities are asking themselves the same thing. For a market as digitally accessible as crypto, there are very few rules in Europe that can protect EU citizens from inferior services offered from abroad. This will be especially true if a non-European exchange chooses to offer a hyped token (eg Terras luna, which collapsed spectacularly last summer) and Europeans flock to it unsolicited.

The international framework is established by the Financial Stability Board, and will have to be rolled out by the G-20 members. Because MiCA came first, the EU is very keen for the FSB to adjust. Learning a lesson from the FTX scandal, the FSB can take a tougher stance on the commingling of activities and funds. In parallel, the UK, now outside the EU, sets its own rules for stablecoin and crypto-asset services, similar to MiCA.

In short, Europe has a good chance to export MiCA, albeit with a time lag. But the combination of this time lag and the bear market in the meantime can expose companies to erratic regulators, and consumers to unstable businesses.