Two years after draft text was first published, the EU’s main cryptocurrency asset market regulation is set to be finalized and become law. This rule will affect cryptocurrency issuers and service providers not only in the EU but globally due to its extraterritorial effects. Some important aspects begin to apply only after the transition period. That means it may be several years before the full impact of MiCAR is felt.
vision
In September 2020, the European Commission first submitted a draft bill to harmonize EU regulation of cryptocurrencies. Now, after two years of negotiations between the European Parliament, Council and Commission, an agreed EU compromise on MiCAR has been reached.
MiCAR aims to establish a single pan-European cryptocurrency market, replacing the national frameworks that are starting to emerge and increasing consumer trust in compliant cryptocurrencies. The passport scheme allows approved crypto service providers to conduct business across the EU as part of the single market for digital finance. It also seeks to mitigate risks arising from market abuse and control cryptocurrencies that may have detrimental effects on financial stability or monetary sovereignty.
This regulation, together with the EU’s Digital Operational Resilience Act (DORA) and the DLT Pilot Scheme, is at the core of the EU’s digital finance strategy and reflects broader trends as the EU overhauls its regulations for the digital economy. Its arrival comes as the International Financial Stability Board begins consultations on what an effective cryptocurrency regulatory framework should look like.
Many market participants will welcome the greater level of legal clarity despite the additional regulatory burden brought by MiCAR. There is also hope that bringing more legitimacy to the cryptocurrency market will lead to more institutional investment and growth. However, some important legal issues remain unresolved and much of the legal framework in the form of detailed technical standards is still in the development stage.
Now, two years later, what has changed?
Scope – What?
The definition of “crypto-asset” is still very broad. Cryptocurrencies that have the characteristics of financial products and are already regulated under the existing securities regulatory system are excluded from the scope.
Since MiCAR was first launched, interest in non-fungible tokens has grown, leading to suggestions that MiCAR could be included in the regime. Ultimately, true “non-fungible” tokens fall outside the scope of the MiCAR framework in that they are generally not interchangeable and not subject to liquid markets. However, no part of an NFT is considered “non-fungible,” nor is issuing NFTs in large series or collections.
Under MiCAR, in-scope cryptoassets are classified as one of the following depending on their perceived risk:
- emergency medical technician: Electronic money tokens, usually stablecoins, pegged to one official currency
- arts: Asset-referenced tokens, which are broadly stable coins pegged to one or more official currencies or other assets.
- different: It is a crypto asset subject to lighter touch requirements as it is not an EMT or ART.
Previously, the definition of ART referred to specific asset classes (commodities, cryptocurrencies and currency baskets). The concept of ART has now been expanded to encompass all cryptocurrencies other than EMT, which aim to maintain stable value by reference to any value or right.
Another area of interest is DeFi. Services provided in a “fully decentralized manner” should not be in the scope of MiCAR (avoiding the difficult question of how to actually regulate DeFi systems). However, MiCAR applies to intermediaries that perform services as part of broader DeFi contracts. For example, if a cryptocurrency is issued to the public in a decentralized manner, the trading platform operator must write a white paper for that cryptocurrency. Exactly how MiCAR applies to a particular decentralized contract must be considered on a case-by-case basis.
Scope – Who?
The final version of MiCAR will apply to both crypto-asset issuers and crypto-asset service providers (CASPs) offering products to the EU. CASPs must be authorized to provide services in the EU. Having a cryptocurrency license means applying rules for conduct, capital, protection, as well as service-specific requirements, etc.
The list of cryptocurrency services has been expanded since the original draft. Along with activities such as cryptocurrency storage and cryptocurrency exchange (see previous blog post), the following are also regulated under MiCAR:
- Transfer service provided Cryptocurrency on behalf of a third party
- Provides portfolio management To cryptocurrency.
In particular, all CASPs must now have an “effective place of management” in the EU (i.e. the place where key management and commercial decisions necessary for conducting business are made) and at least one of the directors must be resident. In the EU.
The revision of MiCAR also includes a new concept called “Critical CASP.” CASPs must monitor user counts. CASPs with more than 15 million active users in the EU are considered “critical” and are required to notify regulators and provide certain information.
Enhanced Requirements for Issuers and Service Providers
Negotiations over MiCAR have strengthened a variety of requirements for both issuers and service providers.
Most importantly, new volume limits have been introduced for ART and EMT used as mediums of exchange to address currency sovereignty issues. If these tokens are used as a means of exchange (e.g. as opposed to an investment purpose) and the trading volume reaches a certain threshold (more than one million transactions per day worth at least EUR200 million), the issuer must cease issuance. We present a plan to ensure that the number and value of tokens remain below the limit. This has raised particular concerns that certain popular USD-denominated stablecoins could become effectively banned in the EU.
Additionally, MiCAR now requires ART issuers to provide holders with redemption rights that can be exercised at any time. Previously, this redemption right only applied to EMT. As expected (see blog post: European Parliament pushes for sustainability disclosures in cryptocurrency markets), the final version of MiCAR introduces ESG disclosure obligations. This is included to encourage a move away from energy-intensive proof-of-work consensus mechanisms. ESG disclosure is required in white papers and on the CASP website, and European supervisory authorities are responsible for developing additional standards.
Other Changes – Custodians and Directors
There have been significant developments for cryptocurrency custodians. The original draft proposed that custodians could be held liable for the loss of cryptocurrencies or means of access to cryptocurrencies, even if they occurred on-chain and outside the custodian’s control. MiCAR now limits this to incidents attributable to the custodian, but the burden of proof is on the custodian to prove that the loss occurred independently of services and operations. Their liability is limited to the market value of the cryptocurrency lost at the time the loss occurred.
The European Central Bank and central banks will gain additional powers to supervise and intervene in cryptocurrency markets. For example, the ECB may require regulators to refuse, withdraw or limit their authorization to issue ART.
What happens next?
This text is expected to be formally adopted in the coming months. It is expected to come into effect in early 2023, but application will not begin until 2024. Typically, MiCAR will take effect 18 months after entry into force, while rules for stablecoins (e.g. ART and EMT) will begin to apply after 12 months.
The transition regime may further delay the impact on existing cryptocurrency businesses. For example, CASPs that were operating before MiCAR came into effect may continue to provide services under national law for an additional 18 months after the rules begin to apply. If necessary, you will have time to apply for a license under MiCAR’s approval regime.
Additionally, over the next few years, several sets of technical rules and guidance will be developed by European supervisory authorities. For example, the European Securities and Markets Association will develop guidance on the criteria and conditions for cryptocurrencies (including NFTs) to qualify as financial instruments.
Finally, MiCAR also requires certain EU authorities to provide an interim review of MiCAR applications within two years and a full report within four years. This includes assessing whether regulatory measures for NFTs and DeFi are appropriate. Given the pace of change in the field, this paper will likely lay the foundation for MiCAR 2.0.
While the EU is implementing MiCAR, other jurisdictions around the world are looking to introduce or strengthen their own frameworks for cryptocurrency regulation. To promote consistency between these regimes, the FSB has proposed recommendations on the regulation of cryptocurrency activities. The consultation ends on 15 December 2022.