After years of instability, the European Parliament last month finalised a set of rules designed to bring greater certainty and visibility to the European crypto market. The Regulation on Markets in Crypto Assets (Markets in Crypto Assets - MiCA) is the world's most comprehensive regulatory framework created to date for the crypto universe. Its adoption, which will allow it to come into force gradually from now until 2025, will provide a better regulatory environment for the European market for these assets and help reduce regulatory arbitrage between Member States.
Is this proactive approach to crypto regulation a stroke of political genius?
Some observers have suggested that by approving this new regulatory framework ahead of the US and UK, European officials have prepared the EU to attract more investment and new entrepreneurs. Only time will tell if this is true, but even if some aspects of the regulation can be improved (see below), we believe that in the short term, the full MiCA framework gives the EU an advantage over the US and UK for crypto businesses.
What is MiCA?
MiCA was proposed in 2020 as a way to ensure that crypto businesses, market participants and investors in the EU have clear rules. The European Parliament overwhelmingly approved the new regulation on 20 April 2023 with a vote of 529 in favour and 29 against. MiCA covers both issuers of crypto assets and service providers;its intention is to protect consumers without disrupting innovation.
MiCA classifies crypto assets into a number of different groups, including asset referenced tokens (Asset Referenced Tokens , ART), electronic money tokens (E-Money Tokens - EMT) and utility tokens (Utility Tokens - UT). Under the regulations, stablecoin issuers must be authorised by the Central Bank and meet certain requirements. Crypto Asset Service Providers (Crypto Asset Service Providers - CASP) must also be authorised and subject to governance and liquidity rules. MiCA does not apply to security tokens or non-fungible unique tokens (NFTs).
MiCA brings many positive elements...
Our positive feeling about MiCA is shared by most industry players, who have been very pleased that the regulation is more constructive than initially expected and avoids misconceptions such as banning bitcoin mining or requiring wallets to be registered.
There are five areas where we think MiCA will really shine.
Firstly, MiCA will bring much more regulatory clarity. The EU's unified approach to crypto regulation across all member states will, in theory, allow firms to operate transparently across the EU.
Second, MiCA brings more transparency. Any entity wishing to offer a crypto asset must have a detailed white paper disclosing information about the asset, its use, the rights associated with it and the risks.
Thirdly, MiCA will make digital assets more attractive to institutional investors and large companies that have avoided this universe until now due to regulatory uncertainty.
Fourth, oversight will be improved, as CASPs will be subject to liquidity and other requirements and stablecoins will have to keep reserves separate from their own assets.
Finally, the new regulation will be a normative initiative that will have a "Brussels effect", enabling other countries and regions of the world to adopt similar approaches to crypto-asset regulation.
Beyond these five points, it is also important to note how, with MiCA, the EU differs from the US, and the UK in particular. In the US, the SEC has taken a regulation-by-application approach, even for the largest, regulated and generally conservative firms in the sector (e.g. Coinbase).
While over 10% of UK citizens have invested in crypto assets, the UK government has been slow to put in place real rules for the sector (despite recent positive initiatives). Now the EU has provided a model that can be replicated elsewhere. Hopefully this will stimulate legislative and regulatory activity in the US and UK.
...but has some limitations in our view.
While MiCA has cleaned house, it has left out some key topics in this sector that we believe need to be addressed.
For example, it does not provide guidance on decentralised finance (DeFi), staking and lending/borrowing. Decentralised finance is one of the most promising areas of this technological universe, as it has the potential to disrupt existing banking and financial services by offering more customer-focused products, ensuring transparency of fees and risks borne by investors and being accessible to a wider audience.
DeFi is one of the obvious crypto verticals where banks, financial institutions and service providers will leverage these assets, particularly through the tokenisation of traditional financial assets, with JPMorgan stating that "tokenization is a killer app for traditional finance" ; and by connecting them to DeFi protocols.
SPACs could find themselves having to deal with uncertainty in these areas, so some regulatory clarity for DeFi would have been very helpful. This is something we have seen in Brazil, where the Central Bank has taken the brave and forward-looking view that DeFi is here to stay and should be at the heart of the regulatory effort. It has built the regulatory framework for crypto-assets with the understanding that it should build on DeFi and live with it in the future.
In France, the Central Bank, recognising that "the regulation of disintermediated finance cannot simply replicate the systems that currently govern traditional finance", is currently considering an approach that could be instructive ; drawing on non-financial regulations, such as those governing product safety, it would place the burden of regulatory compliance on DeFi's product directly, so that only those "safe products and services" would be manufactured or distributed in the region.
Europe has done well in terms of ETP (Exchange Traded Products ) offerings on crypto assets and has one of the most dynamic collateralised product environments. However, there is a lack of guidance in MiCA for ETFs/ETPs, which will make it more difficult for product providers and investment funds to navigate the regulatory landscape.
We also believe that MiCA does not go far enough to help connect the current financial infrastructure with crypto. If Europe is to win in the tech and blockchain wars, it should be because of its strong financial sector, not in spite of it. Creating a pathway in MiCA to allow crypto investment managers to operate under existing UCITS (UCITS ) rules would have been an interesting signal.
Finally, there is a lot of talk around all the "bad" crypto investment products that retail investors can access online, but unfortunately these cover very little of the difficulty for these same investors to access regulated financial products in trusted channels through their brokers, banks or asset managers. The latter are missing the opportunity to create business for their clients - a 2022 BCG report found that around 95% of retail investment in crypto assets bypasses traditional wealth management channels.
MiCA has failed to end the de facto two-tier regimes where investors can easily access all sorts of tokens on exchange platforms, but nothing in the regulated and trusted channels of banks and investment platforms.
MiCA, a harbinger?
We believe MiCA is helping to drive regulatory activity on this front. We are already seeing policymakers outside the EU moving to create their own frameworks for crypto assets.
A week after MiCA was approved, the chairman of the US House Financial Services Committee said that comprehensive cryptoasset legislation would be introduced this summer and the UK government has just closed the consultation period on its flagship regulatory framework for crypto-assets .
For now, the EU is in pole position and ready to benefit from its regulatory leadership. However, if the region wants to win the war to become the preferred geography and standard-setter for crypto assets, we believe it needs to act and iterate faster.
The EU's advantage is significant, but it is only one battle in a battle that is not limited by geography. In other words, governments around the world are competing to give the crypto sector the regulatory clarity it needs to thrive. The EU cannot afford to stand idly by if it wants to stay one step ahead.
