The year 2022 will not be remembered fondly in the cryptocurrency market. The progressive decline in the value of coins, the problems of the FTX exchange and the collapse of trust are all raising questions about the future of crypto. Can regulating the crypto-asset market be a panacea for the market’s ills?
The very public demise of FTX
The declaration of bankruptcy by FTX – the third largest cryptocurrency exchange, has triggered an seismic shift within the industry.
According to Changpeng Zhao, the CEO of Binance, the world’s largest cryptocurrency exchange, the collapse of FTX marks the beginning of a crypto crisis, comparable to the days which saw the collapse of Lehman Brothers in 2008 and the ensuing financial crash.
He adds that consumer confidence could be shaken enough to set the crypto market back many years. The gravity of the situation is also indicated by the Bitcoin exchange rate, the world’s most popular virtual currency, which has already fallen to around $16,500 from its previous value of approximately $20,000 – which does not seem like such a huge decrease, until you consider that at the end of 2021 it was as high as $60,000.
Many including Stefan Berger, member of the European Parliament, argues that the FTX crash would not have happened if the market had been regulated. Changpeng Zhao also believes that proper regulation could have mitigated the impact of such events.
Industry calls for regulation of the cryptocurrency market
The lesson to be learnt from recent events is, first and foremost, that there is a need for greater financial transparency for cryptocurrency service providers.
The answer to this need lies within market regulation, and in connection with this, it is worth discussing legislation currently being worked on by European Union, i.e. the Markets in Crypto Assets (MiCA).
MiCA aims, among other things, to create a uniform legal framework for the cryptocurrency market in the EU, to introduce a uniform rule for crypto issuers and crypto service providers (including exchange operators), while protecting investors from risk.
What MiCA regulates
Crypto-actives covered by this regulation include:
utility tokens, i.e. assets not treated as money but as a right to a future product or service, which by definition act as digital vouchers;
- asset-linked tokens (stablecoins), i.e. cryptocurrencies that should, by definition, maintain a stable value by reference to another asset (e.g. to another crypto-asset or to the dollar exchange rate) – according to the EU legislator, such cryptocurrencies generate the highest risks, as they aspire to act as a means of payment;
- tokens which are e-money, used as a medium of exchange and whose value is maintained by reference to the value of fiat currency.
Crypto-actives excluded from the MiCA regulation include:
- DeFi, or decentralised finance
- CBDCs, or central bank digital currencies, i.e. the equivalent of FIAT currencies issued by central banks based on blockchain infrastructure
- NFTs, i.e. non-fungible tokens (except those offered in large series, which may be considered exchangeable)
- Cryptocurrencies that can be categorised as financial instruments.
Who is covered by the MiCA regulation:
MiCA covers two categories of entities – crypto-asset issuers and crypto-asset service providers.
The initial obligation for asset issuers (with the exception of, inter alia, crypto assets offered for free or crypto assets ‘created’ automatically as a reward for maintaining a DLT or approving a transaction) is to publish a so-called white paper, a simplified equivalent of a prospectus.
MiCA also establishes a regulatory framework for crypto-asset service providers (CASPs). Entities providing such services must be authorised by a Member State, and be established and have their management in the EU.
It is worth noting that CASPs, like other EU-regulated financial institutions, once authorised in a Member State, will be able to provide such services throughout the European Union under the single passport mechanism.
MiCA will protect cryptocurrency investors
MiCA is also aimed at ensuring the safety of investors, which is an important issue in the light of recent events.
MiCA imposes requirements for CASPs to maintain a minimum capital. In addition, these entities are required to secure their clients’ ownership rights in cryptocurrencies, in particular against their insolvency, and to prevent the use of cryptocurrencies for their own account. All funds received from clients must in turn be held at a credit institution or central bank.
MiCA also provides for retail token holders to withdraw their offer to purchase a cryptocurrency within 14 calendar days from the date of the initial agreement and without incurring additional costs or having to provide any justification.
MiCA also incorporates several environmental factors that are increasingly popular today, including that CASPs are required to publish online information related to the main adverse environmental and climate impacts of the consensus mechanism of their specific cryptocurrency, with ESMA and EBA mandated to develop regulatory technical standards on the specific information that CASPs will need to provide.
MiCA is part of the European Union’s larger digital finance package.
Other documents contained in this package include:
- The Regulation of the European Parliament and of the Council on operational digital resilience for the financial sector (DORA)
- The Regulation of the European Parliament and of the Council on a pilot regime for market infrastructures based on distributed ledger technology (DLT)
- The Communication on a Retail Payments Strategy for the EU.
MiCA will create a harmonised European crypto-asset market that will provide legal certainty across the EU through clear asset classification and transparent guidelines for service providers and issuers. If the regulations meet with widespread acceptance, it is likely that more institutional investors and assets will enter the market, which should stimulate its further development.
In addition, MiCA, due to the scale of the European single market, could follow in the footsteps of the General Data Protection Regulation (GDPR) and also contribute to shaping similar regulations in other parts of the world.
The regulation is expected to enter into force in 2024.
By Maciej Kuranc, Associate, Kochanski & Partners