Should we be worried about the new report from the European Parliament trying to undo sections of the completed Mica legislation?
EU MICA, the regulatory framework for digital assets, was published in the Official Journal of the European Union on June 9th, 2023, marking the end of a significant chapter in the realm of financial regulations. This regulatory journey can be seen as a regulatory version of the “Game of Thrones” saga which experienced many turns and unexpected discoveries. This regulatory sitcom, which began on December 9th, 2019, with the European Coins and Councils’ Joint statement on stablecoins, has been filled with twists and surprises. Throughout its evolution, EU MICA has sparked intense debates within the Web3 community, as stakeholders strive to strike a delicate balance between progress and the inclusion of crucial components like NFTs. The focus has been on moving forward while avoiding ever-growing complexity of Web3.
While EU MICA represents a notable achievement on a global scale, diverging from the current US-led crackdown on digital assets, it is important to acknowledge its limitations. EU MICA, although a significant step forward, does not fully encompass the vast scope of the Web3 landscape.Some crucial elements have been omitted, leaving room for further developments and adaptations. Adding to the intrigue, the European Parliament Committee on Economic and Monetary Affairs (ECON) recently issued a report containing recommendations for the post-MICA era.
The report, titled “Remaining regulatory challenges in digital finance and cryptoassets after MiCA,” aims to outline the next steps in EU regulatory measures following MiCA, addressing the open questions and challenges in digital finance and crypto assets. The review contained the following fairly shocking remarks
The proposed new solution from ECON essentially argues that the newly released MiCA is set aside (!) and proposes to apply the categories of traditional financial law to every problem concerning crypto-assets and the so-called “decentralized finance” (DeFi), the innovative financial toolings automatically run through smart contracts on public blockchains. This approach has been seen as dysfunctional for both policy makers and members of the ecosystem across the Atlantic for longer than a decade.
In this regard, the influence of the United States authorities’ approaches of SEC and CFTC is clearly recognizable in ECONs report. The report praises interventions of the CFTC concerning exchanges with respect to practices within the field of crypto-assets that are widely accepted within the Union.
Such an approach is highly problematic as it creates legal uncertainty deriving from the practical difficulties (if not the impossibility) of applying rules shaped for traditional finance, which are rarely applicable to crypto-assets and DeFi, due to their technological features. Just because a car and a sailing boat both have an engine and move forward, does not mean that you can apply the same street traffic regulation for both.
At one point the Study argues that, due to the limited scope of MiCA, it would be possible to apply to DeFi the rules on financial instruments provided by the existing financial law legal framework, notably the EU rules on securities encompassed in the European Markets in Financial Instruments Directive (MiFID II) and in the Prospectus Regulation. Such a positioning contrasts the recent history of European law, which tried to exhibit itself to the world with modern rules capable of accompanying and not destroying technological innovation. Moreover, theoretically these rules would be already applicable to DeFi but no competent authority in the EU has started an enforcement proceeding against a DeFi protocol.
The Importance of Crypto-Asset Classification:
One key aspect discussed in the report is how to categorize crypto-assets and decide which regulations apply to them. The United States has struggled to determine whether to treat tokens as securities or commodities.
In contrast, MiCA already proposed a solution by dividing crypto-assets into two categories: non-securities crypto-assets under MiCA and securities crypto-assets governed by existing financial laws like MiFID II. It remains unclear why the study proposes to change this in Europe to a system, which has already proven to not be efficient.
Advantages of MiCA and Potential Challenges:
MiCA provides a clear set of rules for regulating non-securities crypto-assets, ensuring protection for investors and consumers. While there may be some confusion about how to classify assets under MiCA and MiFID II, it shouldn’t be a big issue since MiCA already includes strong safeguards for consumers, in providing strict rules on mandatory information (especially in the white paper) and marketing communications. In comparison, the United States lacks a comprehensive framework for non-securities crypto-assets.
Default Rule Proposal and Its Impact:
The report released by ECON proposes an unexpected approach to token classification, suggesting that all crypto-assets be considered securities by default. This means they wouldn’t fall under MiCA unless they receive an exemption from the National Competent Authorities (NCAs). However, this goes against the EU’s political goals, the legal integration of member states, and the EU’s aim to become a leader in regulating the digital revolution.
Fragmentation and Impeding Innovation:
If the suggested default rule is adopted, it could lead to significant differences within the EU. Since securities laws under MiFID II are not the same across member states, each NCA would make decisions based on their national laws. This lack of consistency contradicts MiCA’s goal of harmonizing regulations for crypto-assets. Additionally, the default rule could hinder innovation, create uncertainty, and slow down the growth of the crypto-assets market in Europe.
Misalignment with Political Decisions and Industry Realities
According to Patti, while the report has been authored by esteemed academics, it can seens as a position paper that diverges from current development within the industry as well as just political confirmation with just released MICA. Moreover, it seems that the academics involved in the study may not be fully aware of the practical implications related to obtaining exemptions from National Competent Authorities (NCAs) in the crypto-assets industry. Such a solution would entail that every offering of crypto-assets within the Union should get an exemption from the NCAs. This is exactly against MiCA’s legislative setting, which provides for a mere duty to notify the white paper to the NCA prior to the offering. The latter choice has been made in order not to burden NCAs with excessive competences and not to slow down the process of token offerings, in the light of the high speed of innovation in the field of blockchain.
Realities:
Within the Study you can feel a kind of pressure towards finding a solution in the fastest possible way to avoid another crypto winter from happening – the study mentions frequently the expression “crypto winter” – as if a new law could really solve all the issues that blockchain has in one month. These statements are misleading. Before the crypto winter there was a summer and an incredible growth compared to other asset classes. The report presents every development in a negative way and mentions the TerraLUNA collapse and the FTX saga without really assessing whether with MiCA things would change.
Probably things would have been different under MiCA, given the new rules on stablecoins and the organizational requirements of Crypto-Assets Service Providers. By the way, as to FTX, they missed that their business operated in Europe in accordance to a EU financial license which has nothing to do with crypto.
The report discusses hacks and outrages without indicating that in many cases the funds were recovered due to the on-chain investigation techniques, using tools from commercial Blockchain analytics firms.
ECON’s report states that crypto-assets’ are more dangerous, because they underperformed compared to traditional stocks, but it does not reflect about price performances of tech stocks on regulated markets “during the crypto winter”, which were overall similar to crypto-assets. This emphasis on prices seems not central in the way of regulating crypto-assets.
It remains crucial to duly inform investors, set standards for solid intermediaries and avoid misbehaviors in the market, but finally the market itself will determine the prices of crypto-assets as it happens also in more traditional markets.
According to MiCA, the white paper should indicate to the prospective investor that “the crypto-asset may lose its value in part or in full”. This is it. It seems redundant and non useful to spread fear through a continuous mention of the “crypto winter”.
Since the initial advice papers of European authorities for banking (EBA) and securities and markets (ESMA) in 2019 it appears clear that the Union has considered crypto-assets, blockchain and fintech as a great opportunity to raise funds and provide innovation in the changing technological environment.
The same approach has been taken in title II of MiCA (Markets in Crypto-Assets Regulation) and remains consistent with existing principles. This section focuses on defining categories for different types of tokens and establishing guidelines for white papers. It highlights that crypto-assets are subject to distinct regulations compared to traditional capital market laws.
However, these regulations do not significantly deviate from the already established financial laws; they simply offer a slightly more lenient approach to strike a suitable equilibrium between safeguarding investors and fostering innovation.
On other matters, the new EU crypto-law remains strict. For so-called stablecoins (named in MiCA Asset referenced tokens “ARTs” and E-money tokens “EMTs”, which pose systemic and financial stability risks,) MiCA provides requirements that will be difficult to meet. Also the Crypto Exchanges so called CASPs will be regulated through strict rules as Anti Money Laundering (AML) and Counter Terrorist Financing (CTF) remains one of the primary goals of the Union.
And CASPs rules seem not apt to regulate decentralized autonomous organizations (DAOs). Here again ECON recommendation goes deliberately against MiCA in assuming the DAOs should in principle undergo the same rules as CASPs.
These organizations may find it difficult or even impossible to meet the requirements set for Crypto-Asset Service Providers (CASPs). Surprisingly, the report seems to focus more on concerns about the crypto winter than on the innovative potential of smart contracts. Additionally, the regulatory framework overlooks the fact that DeFi protocols aim to eliminate intermediaries. This means that the regulations do not fully address the implications of removing middlemen in these protocols.
Conclusion:
The recently released report on regulatory challenges in digital finance and crypto-assets after MiCA, prepared by academics and published by ECON, should be approached cautiously. It contradicts political decisions and proposes a default rule that could potentially undermine the EU’s reputation as a global regulatory leader. This default rule has the potential to fragment the market, stifle innovation, and introduce uncertainty. Instead, it is essential to prioritize MiCA’s goal of harmonization and establish a dedicated EU-level regime that effectively addresses the unique challenges posed by crypto-assets.
Regulating such a complex landscape requires careful management, especially on an international scale. It would be wiser to take the time to develop a clear understanding of how to regulate through extensive consultations and collaborative efforts between academics, policy makers, law enforcement and members of the private sector – potentially in a public-private dialogue.
Copy-pasting and relying on rules that were not originally designed for blockchain projects could lead to undesirable consequences. It is like applying the fax infrastructure to emails. Attempting to regulate blockchain and crypto-assets, which have a global nature, with a narrow set of territorial rules and ignoring their cross-border availability from day one seems problematic.
It is interesting to consider the implications of adopting a one-size-fits-all approach to global challenges. Applying territorial regulations to the dynamic and borderless realm of blockchain may have unintended consequences. While the intent is to foster innovation and harmonization, there is a potential risk of fragmentation and confusion. It is crucial to carefully evaluate the best strategies that balance regulatory effectiveness and the unique characteristics of blockchain technology. Something that might be enhanced and reflected upon in the upcoming ECON reports.
Side notes:
The Role of the ECON Committee and Academic Studies:
It is important to note that the ECON Committee does not hold specific regulatory authority within the EU Consequently, the ideas presented in the study are merely suggestions put forth by a group of academics. While reports like this one serve as a basis for the European Parliament to address regulatory issues and initiate discussions, it is crucial to consider their limitations.
Prof. Francesco Paolo Patti
Francesco Paolo Patti,
This contribution is based on a interview and reflections in discussions with Francesco Paolo Patti, Italian law Professor of the Bocconi University in Milan, Council Member of the European Law Institute (ELI) and co-founder of the Blockchain Lawyers Group association.
Editing: Grace Marshall
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