The Block Perspective - March 2023
European Crypto Regulatory Climate and its Impact on Crypto Ecosystem
Welcome to the first edition of The Block Perspective, Shyft’s monthly thematic overview! Here, we will be diving deep into some of the most pressing issues and trends in the industry, offering fresh insights and analysis from our team of experts. From the latest regulatory developments to real-world use cases and market trends, we will give you a comprehensive view of the blockchain landscape and the opportunities it presents.
Today, we are excited to delve into the European crypto regulatory landscape and explore its current state and future implications for the industry. We will examine the specifics of these regulations, from the EU’s MiCA proposal to 5AMLD, and explore how they shape the broader crypto market. Let’s not wait for any further and dive straight into this complex and ever-changing landscape and gain a better understanding of the future of digital assets in Europe.
The Delicate Balance: Europe's Crypto Conundrum
Europe faces a pivotal task in crafting crypto regulations that protect privacy, autonomy, and innovation while preserving user experience. The contentious MiCA proposal presents a significant challenge, sparking debate and potentially jeopardizing blockchain's foundational principles.
Achieving the optimal balance is vital to prevent hindering innovation, talent growth, and user privacy. Privacy-enhancing technologies and DeFi platforms offer viable solutions, necessitating strong collaboration between policymakers and industry stakeholders to ensure a seamless user experience.
Ultimately, Europe must champion cooperation and bolster cutting-edge solutions to effectively navigate this regulatory terrain. By doing so, Europe can unlock the full potential of cryptocurrencies, uphold their distinctive values, and maintain a user-centric approach that respects privacy. This will create a win-win situation for users, regulators, and industry stakeholders, fostering a thriving crypto ecosystem.
Dynamics of the World’s Largest Crypto Market
A year ago, Europe was proclaimed the world's largest cryptocurrency market. The Central, Northern, and Western Europe regions, in particular, had become responsible for one-fourth of all global cryptocurrency activity, amounting to more than US$1 trillion in digital assets.
Large crypto transactions by institutional investors rose from US$1.4 billion in July 2020 to more than US$46 billion in June 2021. Much of this phenomenal volume stemmed from transactions worth more than US$10 million.
One way to decipher the popularity of digital currencies in European countries is through the percentage of the invested population. For instance, as high as 10-20% of the population in several European countries invested in crypto assets, including Slovenia, Croatia, Luxembourg, Bulgaria, Cyprus, Slovakia, Austria, Portugal, Czech Republic, Estonia, Netherlands, Lithuania, and Ireland.
Realizing the growing market of cryptocurrencies in Europe, a long list of digital asset exchanges is making a b-line to enter the lucrative European market. In fact, according to a report published in January 2023, Coinbase, one of the most well-known crypto exchanges at a global level, was looking forward to "leveraging its status as the lone public crypto exchange in a do-or-die play to increase market share across Europe."
With renowned crypto businesses and investors looking forward to augmenting their positions in major European markets, it is high time we take a closer look at the European crypto regulatory climate.
Existing regulations and legislations play a key role in shaping an industry ecosystem. And crypto assets are no exception. We will now look at the prevailing crypto regulatory ecosystem in some of the major European economies.
Considered one of the world's most crypto-friendly countries, Germany started treating cryptocurrencies as financial instruments in 2011. And although this isn't equal to making cryptocurrencies legal tender, Germany did greenlight crypto's use for payment purposes, even before most of the world started taking digital assets seriously.
Any German crypto company, whether it wants to offer its services to German residents or not, must obtain a license from BaFin or the Federal Financial Supervisory Authority. However, when it comes to companies located outside Germany, they only have to obtain a BaFin license when actively soliciting German residents. And in case German residents register on their platforms voluntarily, they aren't required to seek a license from BaFin.
Having implemented 5AMLD in 2020, crypto businesses are also required to enforce strict KYC/AML controls and report all suspicious transactions to BaFin as and when they come across one.
The French crypto regulations want companies to register with the Financial Markets Authority to demonstrate their compliance with basic money laundering and governance norms. However, reports published in mid-February 2023 show that no operator has yet received such a license, hinting at procedural burdens associated with the system.
Despite this, sixty companies have opted for simpler registration under the country's prevailing two-tier system. Reportedly, these companies will not be affected by the new compliance requirements coming into effect.
The prevailing two-tier system seeks crypto businesses to apply for a simple registration with local financial regulator L'Autorité des marchés financiers (AMF) to operate and could also opt for full licensing with more disclosures. However, it is also a fact that none of the French companies has yet opted for a full licensing process.
To explain this briefly, the regulation of Digital Asset Service Providers - known as DASPs or PSANs in French - is a two-tiered regime. The first tier seeks mandatory registration of providers of services in crypto custody and crypto-fiat exchanges. The second tier, known as the optional license, is for any digital asset service provider that requests such licenses and meets underlying requirements.
Essentially, crypto-custodians and crypto-fiat exchanges in France must register with the Authority. However, full licensing isn't a must, at least for now.
The Prevention of Money Laundering and Terrorist Financing is one of the most crucial regulations for crypto start-ups in Spain, which also requires virtual asset service providers to register with the Spanish Central Bank.
The second pertinent legislation in this matter has to do with the recent circular of the National Securities Market Commission (CNMV). The circular - aimed at protecting potential investors - requires companies that advertise crypto as an investment object in Spain to comply with several requirements.
The Netherlands is a European country, with 12% of its total population invested in crypto. The country's crypto-fiat exchanges and custodian wallet providers fall under the supervision of De Nederlandsche Bank or the Dutch National Bank. Initial Coin Offerings in the Netherlands come under financial supervision only if they qualify as securities or units in an investment fund.
The Money Laundering and Terrorist Financing Prevention Act (WWFT) is the key crypto regulation in the Netherlands, which mandates all crypto-related entities to register with the DNB. In 2020, the WWFT was amended to incorporate rules that stemmed from European law, the 5th Anti-Money Laundering Directive (AMLD5).
Keeping up with its image of being one of the most crypto-friendly jurisdictions globally, Slovenia has simplified the licensing mechanism for VASPs. Instead of going through a tiresome and intensive licensing process, crypto companies can enter their data into the register created and administered by Slovenia's National Bank.
Although, in general, Slovenia accords a six-month deadline for crypto-related businesses to register with Slovenia's Central Bank, the provided time is comparatively lesser for crypto exchanges and custodian wallet providers, as they have been given only three months.
The penalizing provisions for non-compliance may lead to fines from 6,000 Euros to 120,000 Euros for both private individuals and companies.
While, so far, we've seen what some of the European nations are doing in the crypto regulatory space, we must remember that the European Union has plans to introduce an EU-wide crypto regulatory mechanism. Expectedly, this regulatory framework, known as MiCA, would take away the regional aberrations and make the crypto ecosystem homogeneous.
Adoption of the Draft MiCA Regulation by the European Parliament
On Monday, March 14th, the Economic and Monetary Affairs Committee adopted its mandate to negotiate new rules relating to crypto-assets. The key provisions in the draft included the overarching themes of transparency in the ecosystem, communication, authorization, and control of operations.
To understand the impact that MiCA could bring to the European Crypto Regulatory Climate and the continent's crypto ecosystem, we must look at the regulation in detail.
What Does MiCA Recommend?
The European Commission, the European Parliament, and the Council of the European Union agreed on MiCA on June 30th, 2022. MiCA stands for Markets in Crypto-Assets Regulation, which is seen as the first comprehensive regulatory regime made specifically for crypto assets.
Since the regulation is yet to come into effect, we would concentrate on the procedural document, which serves as the basis for the three institutions to negotiate among themselves.
How MiCA Defines Crypto Assets and What it Means for the Crypto Ecosystem?
Crypto assets - according to MiCA - are digital representations of value or rights that could be transferred and stored electronically. The tool to accomplish the transfer and storage is Distributed Ledger Technology.
This definition covers a lot more ground than what we generally understand from the term crypto assets. It is because the term crypto asset, defined in MiCA, does not refer to cryptography.
However, this definition was adopted by the Council of the EU without changes. The opinion of the contradicting experts and bodies was that digital asset could be a more appropriate term if the Council went by their definition.
Many cited the UK Crypto Assets Task Force's definition of the crypto-asset to be more appropriate - "a cryptographically secured digital representation of value or contractual rights that uses some type of DLT and can be transferred, stored, or traded electronically."
Asset Categories according to MiCA
The Markets in Crypto Assets regulation has put crypto-assets into four categories: Asset-Referenced Token, e-Money tokens, Utility Token, and a category for all other crypto-assets that do not fall within the above three.
Asset-Referenced Tokens are essentially stablecoins. However, these tokens could use assets other than fiat currencies for stabilization.
E-Money tokens are stablecoins that use one single fiat currency for value referencing.
A Utility token - as evident from the name - provides access to a good or service that the token issuer has up for offer.
The fourth category of tokens may include all other types of assets that do not fall into the above-mentioned categories. These could be exchange tokens or security tokens, or something else.
The crypto industry players must understand the categories they fall into and how the regulations would work in shaping their categories.
What Would MiCA Mean for Asset-Referenced Tokens?
The issuer of any asset-referenced token would have to establish themselves in the European Union and obtain mandatory authorization to offer such tokens to the public in the EU or admit them for trading on a crypto-asset exchange.
One of the benefits of MiCA being a bloc-wide regulation is that authorization - once granted - would stay valid throughout the EU. The prerequisites of authorization for asset-referenced tokens include specified capital requirements: the higher of 350,000 Euros, 2% of the daily average of the reserve over the preceding six months, and a quarter of the fixed overheads of the preceding year.
What Would MiCA Mean for E-Money Tokens?
MiCA suggests that for any institution to become the issuer of an e-money token, it must have authorization as an electronic money institution or credit institution.
The European Banking Authority will not be the lead regulator if at least 80% of the token holders and transaction volume are concentrated in the home state. Instead, the home regulator will stay as the supervisory authority.
What Would MiCA Mean for Non-Stablecoins?
Tokens, not asset-referenced or e-money, are expected to face a relatively lighter regime. However, the issuer of such non-stablecoin crypto assets must obtain relevant regulatory approval of a white paper with specified content and form requirements.
However, certain non-stablecoin crypto-assets must not obligatorily fulfill white paper requirements. These non-stablecoins include crypto assets offered for free, automatically created as a reward during the validation process, a utility token for goods/services already in existence or operation, can be used for goods and services in a limited network for merchants, etc.
5AML - Fifth Anti-money Laundering Directive
The Fifth Anti-Money Laundering Directive, or 5AMLD, has expanded the anti-money laundering obligations beyond what its predecessor (4AMLD) did.
Before 5AMLD, there was no set of AML and CFT-related requirements for crypto companies operating in the European Union or serving residents of its member states, but that changed with its introduction in 2018. However, the member states were given sufficient time to implement the directive, with January 2020 being the deadline.
Since then, all crypto businesses within the European Union, including those operating a crypto exchange, custodian e-wallets, or more, must register with the local regulatory authority where they operate or plan to offer their services. They must also monitor and report all suspicious transactions to relevant authorities.
Shocking U-Turn: EU Parliament Reintroduces Crypto Payment Restrictions
The European Parliament has reached a consensus on the final text of an anti-money laundering bill set for a vote on March 28, which, to much dismay of the broader crypto community, brings back restrictions on crypto payments involving self-hosted wallets. The updated bill caps commercial cash transactions at €7,000 and imposes a €1,000 limit for crypto transactions involving self-hosted wallets, with the cap applying only if the customer or beneficial owner cannot be identified.
MEPs have further tasked the European Commission with evaluating the commercial payment rule in three years to ensure alignment with the European Union's digital identity framework and the requirements of the newly proposed Anti-Money Laundering Authority.
The Overall Ramifications: What it Was & What it Could Become?
Before MiCA was conceived, crypto-assets were not imagined as part of monolithic European legislation.
Establishing a harmonized regulation across the continent would help market players diversify their businesses through definitive crypto asset strategies. It will offer healthy protection mechanisms to non-regulated crypto assets, related service providers, and consumers. However, the web of compliance requisites will become more intricate for the service providers.
The businesses would have to improve their operational efficiency to keep the public informed about their pricing process and trading volumes in real time and settle all trades within the same day trades have happened. Exchanges would have to keep their funds separate from that of their clients.
The registration might become yet more complicated if the MiCA authorities ask crypto businesses to get their businesses insured. It could mean enhanced levels of operational hassle and increased involvement of traditional finance organizations like banks and insurance agencies.
To conclude, any regulatory framework in any industry may end up doing two things. First, it could make the industry more efficient and fair by enabling a variety of participants to expand and diversify in an organized manner.
On the other hand, it may disrupt the existing equilibrium and pace of growth. It may turn the process unnecessarily complicated and inherently inefficient. However, only time will tell how the European crypto regulations will steer the market.
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