The limitations of the EU’s new cryptocurrency regulations

The final vote on the EU’s much-anticipated set of crypto rules, known as the Markets in Crypto Assets (MiCA) regulation, was recently postponed until April 2023. It wasn’t the first delay — previously the European lawmakers changed the procedure from November 2022 to February 2023 .

However, the setback was solely caused by technical difficulties, and thus MiCA is still on track to become the first comprehensive pan-European crypto framework. But it will happen only in 2024, while during the second half of last year, when the MiCA text was mostly written, the industry was shaken with a series of shocks, which provoked new headaches for regulators. There is little doubt that in such a dynamic industry as crypto, the whole of 2023 will also bring some new hot topics.

Therefore, the question is whether MiCA, with its pre-existing imperfections, can qualify as a truly “comprehensive framework” a year from now. Or, more importantly, will it for an effective set of rules to prevent future failures like TerraUSD or FTX?

These questions have certainly crossed the mind of the President of the European Central Bank, Christine Lagarde. In November 2022, amid the FTX scandal, she argued “there will have to be a MiCA II, which encompasses more broadly what it aims to regulate and supervise, and that is very necessary.”

Cointelegraph reached out to a number of industry stakeholders to get their opinions on whether the Markets in Crypto Assets regulation is still enough to enable the crypto market in Europe to function properly.

EU DeFi regulations are still a long way off

A main blind spot with respect to MiCA is decentralized finance (DeFi). The current draft generally lacks any mention of one of the later organizational and technological forms in the crypto space, and that could certainly become a problem when MiCA arrives. It certainly caught the attention of Jeffrey Blockinger, general counsel at Quadrata. Speaking to Cointelegraph, Blockinger imagined a scenario for a future crisis:

“If DeFi protocols disrupt the large centralized exchanges as a result of a major loss of confidence in their business model, new rules could be proposed to deal with everything from money laundering to customer protection.”

Bittrex Global CEO Oliver Lynch also believes that there is a global problem with DeFi regulation and that MiCA will not make an exception. Linch said that DeFi itself is unregulated and to some extent even a low priority for regulators, as the majority of customers transact crypto mainly through centralized exchanges.

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However, Linch told Cointelegraph that just because regulators can most easily monitor and engage with centralized exchanges doesn’t mean that DeFi doesn’t have an important role to play in the sector.

The lack of a distinct section dedicated to DeFi does not mean that it is impossible to regulate. Speaking to Cointelegraph, Terrance Yang, CEO of Swan Bitcoin, said that DeFi can to some extent be transferred to the language of traditional finance, and therefore can be regulated:

“DeFi is just a bunch of derivatives, bonds, loans and equity financing dressed up as something new and innovative.”

Returns, lending and borrowing of secured crypto products are things that investment and commercial banks are interested in and should be regulated accordingly, Yang believes. In that way, the suitability requirements as formulated in MiCA can actually be useful. For example, DeFi projects could potentially be defined as providing crypto asset services in MiCA’s vocabulary.

Lending and staking

DeFi may be the most notable, but certainly not the only limitation of the upcoming MiCA. The EU framework also fails to address the growing crypto lending and staking sector.

Given the recent failures of lending giants, such as Celsius, and the increasing attention of US regulators to betting operations, EU lawmakers will also have to come up with something.

“The market collapse of the past year was fueled by poor practices in this area such as weak or non-existent risk management and reliance on worthless collateral,” Ernest Lima, partner at XReg Consulting, told Cointelegraph.

Yang noted the particular problem of imbalance in the regulation of lending and investment in the European Union. Ironically, it is currently the crypto market that has an asymmetric advantage in terms of loose regulation compared to the traditional banking system in Europe. Legacy commercial or investment banks and even “traditional” fintech companies are over-regulated compared to the arguably heavily under-regulated crypto exchanges, crypto lending and staking platforms:

“Either let the free market operate without regulation at all, except perhaps for fraud, or make the rules the same for everyone offering the same economic product to Europeans.”

Another issue to watch is the non-fungible tokens (NFT). In August 2022, European Commission advisor Peter Kerstens revealed that despite the absence of the definition in MiCA, it will regulate NFTs as cryptocurrencies in general. In practice, this could mean that NFT issuers will be equated with crypto asset service providers and required to submit regular accounts of their activities to the European Securities and Markets Authority at their local authorities.

Reason for optimism

MiCA was largely met with moderate optimism by the crypto industry. Despite some rigidities in the text, the approach generally seemed sensible and promising in terms of market legitimation.

With all the tumult in 2022, will the next iteration of the EU’s crypto framework, a hypothetical “MiCA-2,” be more restrictive or cryptosceptic? “The further delays MiCA has faced have only highlighted the empty approach the EU has taken to introduce legislation that is needed now more than ever, particularly given recent market events,” Linch said, arguing the need for tighter and faster market controls.

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Lima also expects a closer approach with several issues covered. And it is very important for European legislators to keep up with the regulatory updates:

“I expect that a more robust approach will be taken in some of the technical standards and guidelines that are currently being worked on and that will form part of the MiCA regime. We can also see greater control from regulators in authorisation, approval and supervision, but ‘crypto winter’ will have long since thawed when the legislation is revised.”

Ultimately, one should not get caught up in the stereotypes about the slowness of the EU’s bureaucratic machine.

It is still the EU, and not the US, where there is at least one major legal document that will become law, and the main effect of MiCA was always much more important symbolically, while the pressing problems in crypto could actually be covered by less ambitious legislative or implementing acts . However, it is the mood of these actions that remains crucial – last time we heard from the EU it decided to oblige banks to store a 1250% risk weight on their exposure to digital assets.