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PRIMER: Markets in Crypto-Assets Regulation (MICA)

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The Markets in Crypto-Assets Regulation (MICA) is being brought in to complement anti-money laundering (AML) rules and enhance financial stability and investor protection in Europe.

The proposals include parts of the EU’s MiFID, Market Abuse and Prospectus regulations, and apply them to the cryptoasset space.

“There’s a sense of urgency in the EU to get this done,” said Teunis Brosens, head economist for digital finance and regulation at ING. “Decisionmakers can see the popularity of crypto and growing importance of stablecoin.”

Under the proposed regime, someone issuing certain cryptoassets must also issue a whitepaper. Cryptoasset service providers such as brokers, exchanges and wallet providers, will need a license.

These licenses will come with a lot of ongoing requirements surrounding onboard screening, organization, capital and transparency, according to Marian Scheele, senior counsel at Clifford Chance. “It’s a big burden for smaller players in the market,” she said.

MICA was first proposed in 2018. A politically-agreed text is expected later in the year, while implementation should kick in in 2023-2024.

“Before this proposal, there was, to some extent, a regulatory vacuum at an EU level,” said Sophia Le Vesconte, senior associate at Linklaters. “This has raised various concerns around unregulated risks, for example in relation to consumer protection or financial stability. But at the same time, there are also concerns that an unregulated environment is not conducive to healthy innovation. You can end up with a bit of a Wild West, where standards vary significantly and it is not easy to differentiate the good actors from the bad ones, which can undermine confidence in the market as a whole.”

As well as plugging the gaps with new regulation, other opportunities are expected to come out of the regulation.

“This common regime and a passporting approach to licensing will be very significant game changers,” said Caroline Malcolm, head of international public policy and research at Chainalysis. “It will open up services across Europe and allow new entrants to scale, which wasn’t really viable before.”

See also: EU open banking regulation is tip of the iceberg

The final text, however, has not been agreed on, and market participants have some concerns on the existing proposals.

Custodians

A key criticism is that the proposals are heavily based on laws for traditional financial institutions, which does not make them easily applicable to cryptoassets.

The focus has been placed on licensing and regulating the underlying entity, such as a bank. In some instances, this works well and the custodian or exchange can be relied upon, but in others – for decentralized assets, for example – this creates issues.

“The biggest concern from our point of view is on the liability of crypto custodians,” said ING’s Brosens.

In the proposals, the liability of crypto custodians is very broad, Brosens explained. “This boosts the investor protection perspective, but it also means the custodian is liable for events that it can neither address nor control, such as a bug in a smart contract, or an exploit elsewhere on a blockchain that it has no influence on,” he said. “That creates liability risks that the custodians cannot manage.”

This could lead to a scenario where there are no custodians in the EU, or they offer the services at a very high price and EU investors look to non-EU custodians.

“Regulators will have to find the right balance between a liability that protects investors properly and limited liability to make sure that a custodian is still able to run a viable business model,” said Brosens.

Evolving tech

Other issues are the innovative and evolving nature of crypto as a currency and asset-class, which has meant the industry has changed substantially in the few years since the regulation was initially proposed.

“Non-fungible tokens (NFTs) are a demonstration of how quickly the market is moving,” said Simon Treacy, senior associate at Linklaters. “When the draft legislation was originally published in 2020, no one really was talking about NFTs and yet 18 months later, it’s front and center of conversations in this area.”

This raises concerns about innovation that could occur in the next 18 months, before the regulation is implemented.

“The technology platforms used to deliver such tokenized products will no doubt evolve fast,” agreed Ben Regnard-Weinrabe, partner at Allen & Overy. “It’s very likely that whatever definitions are included in this proposal will quickly become redundant because the technology moves at breakneck speed.”

Amendments to the proposal surrounding the definitions of cryptoassets and distributed ledger technology are a prime example of the need to shift terminology.

“This creates the difficult question of – how do you cope with the rapid diversification of products and technology within a piece of legislation?” said Regnard-Weinrabe. “At a certain point, you cannot, and you just have to say – ‘this is what we have now, and we’ll have to revisit it soon.’ But that option inevitably comes with a time lag.”

See also: Opinion: blanket ban on ads will dampen Singapore’s crypto hub status

Wider requirements

Other market participants are worried about how MICA would fit in with other regulatory pressures on companies looking to work more in the financial regulation space.

“The interplay between this proposed regulation and existing regulation that cryptoasset companies must adhere to is a concern,” said Brosens.

One example is AML regulation that follows a national regime rather than the European-wide one. This means that even if a company gets a passport to operate throughout Europe under MICA, it will still need to apply for separate AML licenses in each country.

“It would make sense if the AML regime was tied into the crypto regime, but it’s not clear yet whether that’s going to happen,” Brosens added.

Global reach

Despite being an EU regulation, MiCA is expected to have far-reaching consequences outside the EU due to the borderless nature of cryptoassets.

“The nature of crypto is that these products, wherever they’re developed, can be marketed online worldwide,” said Linklaters’ Treacy. “There’s potential for the restrictions in the regulation to apply to companies based around the world.”

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However, this poses questions around enforceability.

“The regulations could potentially have broad extra-territorial effect,” said Linklaters’ Le Vesconte. “There are questions as to whether the EU has tried to be too ambitious in its approach, and whether this is going to be enforceable in practice.”

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