Crypto, Crypto, Who Will Regulate You After All?
A conversation with Web3 specialist lawyer Luiza Castro
It’s one of the key challenges in the discussion around Web3: how will we ensure financial stability, a more equitable accessibility to participating and benefiting, and at the same time not forget about environmental sustainability?
Here’s where we are currently: 300 million people in the world own crypto — of which some might be you! This space is no longer a niche: Silicon Valley VCs and leading banks from the traditional financial sector like Goldman Sachs and Barclay’s have entered the game, and most recently, with inflation and interest rates rising, the most popular cryptocurrencies are experiencing heavy loss — i.e. people are losing a ton of money. E.g. Bitcoin has lost around 58% of its value in the second quarter of 2022, its worst quarterly loss in more than a decade.
So yes, regulatory frameworks are more than needed, on both a national and global level.
To explore the current state further, we had the pleasure to talk with Luiza Castro, a Web3 specialist lawyer who runs her own law firm in Portugal. Her work is also associated with KillB — as in “kill bureaucracy” helping with legal and financial setup for crypto businesses.
Monika Jiang: Hello, and welcome to week seven of our asynchronous conference, Web3 in Beautiful Business. I’m here with lawyer Luiza Castro, who’s based in Portugal and works across matters in real estate, immigration, labor, tax, corporate, and Web3. Luiza, where do we stand currently with present and anticipated crypto regulations?
Luiza Castro: Thank you, Monika, happy to be here speaking to everyone today. Indeed, the market has been undergoing a turbulent phase. However, from a legal perspective, we now see an accelerated boost towards regulation. So different national governments are trying to regulate different areas, or at least to start voting and discussing the limits of regulation — while we can regulate the markets. They’ve been doing their best to stay ahead of the curve, but as we all know, the Web3 world is moving incredibly fast, and legal institutions, as we historically know, are not the fastest moving parts of our system.
So instead of trying to fix and come up with a framework for each case as soon as it gains attention they should try to stick to a topic that they know, that has been relevant for a period of time, and try to fully regulate that. What we’re seeing now are legislators trying to regulate hot topics that lose relevance in a couple of months — so that the legislators lose interest in regulating them, as well. That’s how we start having half regulations being passed, because at the moment when they were being drafted it all made sense, but very quickly it doesn’t anymore, so they don’t get differentiated.
Monika Jiang: What about larger attempts, like MiCA (Market in Crypto Asset) Regulation, a framework proposed by the European Union, which is scheduled to be implemented by the end of 2023? Could you help us make sense of the main points of this approach?
Luiza Castro: The first important point is that MiCA sets a standard for requesting the entire set of documents whenever a project is put out on the market, which is an effective first filter.
Then, it’s crucial to note that this regulation will not cover tokens that qualify as financial instruments. Those will be regulated by the MiFID (Markets in Financial Instruments Directive), another European Union directive that aims for the whole harmonization of the financial markets within the European market, and for the improvement of investor protection and transparency in those markets.
About the types of crypto assets:
- There is the value reference token: this will refer to a crypto value where pretty much different nominal currencies that are legal tender, or one or more commodities, or a combination of those, are linked to achieve a value of stability. So value reference tokens are also called stablecoins.
- The second token category that they cover is the e-money token, a crypto-value the main purpose of which is to serve as a means of exchange and that purports to maintain a stable value by referring to the value of a fiat currency that is legal tender.
- So the EU consequently subdivides the common term stablecoin between the e-money token and the value reference token. Now we have the utility token that is intended to provide digital assets to a good or a service that’s available via DLT (Decentralize Ledger Technology). This is one of the most common ones, especially when we are talking about gaming. This utility token fulfills a non-financial purpose in relation to a digital platform or service.
- The two last ones — what they call “the special case of the NFT” — the subdivision of the fungible tokens, the significant and nonsignificant e-money tokens, which are still being discussed. Legislators are still putting the size of factors on it, especially for the assessment of e-money tokens.
This is the main point of MiCA: they’re starting to categorize these tokens to assess the legal consequences respectively. A concrete example is gaming. In crypto gaming — a play-to-earn game — you first have to understand if gaming demands that the player has skills or not. Why is that important? Because if it demands skills, that will be a normal wage earning game: you have your utility token that you can use in the environment. But if it does not demand skills, then, according to the MiCA and other European regulations, it is considered gambling. So if it’s gambling, you enter six different regulations — and most countries already have a gambling regulation, so we don’t need to create one just for crypto. In the same game, if you can exchange those tokens that you earn in the game, for any other kind of currency, crypto, fiat, we have to evaluate if that’s a financial instrument.
So we now have some play-to-earn games where you can create staking. You pick the tokens that you receive, you put in the gaming account, and that generates interest. And if you multiply that, it’s called staking. Staking is a kind of security. Not all countries allow security, and in a lot of countries that allow it you need to have a license for that. So in order to have this feature in your game you need to get that license.
Also, sometimes blockchain is not inside the game. So in order to make the exchange trading possible, the game normally puts the tokens straight to the gamers account, and then the gamer can trade in any sort of crypto exchange, which might have Binance, FTX, or whatever. But in some other games creators want to have this exchange happen inside the blockchain. So you can do this whole exchange in the gaming environment, which means that the game also needs to have a crypto license for exchanges, because it’s making this whole transaction sector. That’s where MiCA comes in to regulate — or any other governmental frameworks in progress, i.e. the Responsible Financial and Innovation Act in the United States.
Monika Jiang: What about other regions, like the Middle East, Asia-Pacific, Latin America, where the adoption of crypto seems to be much faster? Are there lessons learned that could inform the current work with, for example, the European framework, MiCA, and others?
Luiza Castro: For sure, for example Dubai has been proven to be a really good market for crypto, created not so long ago, one they call “the free zone.” The free zone has specific crypto regulations that for now have been very beneficial. There are some limitations, but all in all, it’s a really beneficial place for you to put your crypto business. And they have regulations about it. But keep in mind that it’s not in all of Dubai, it’s in the free zones. So Dubai itself, the UAE, it’s not a friendly place for crypto, but the free zones are.
Latin America has overall been good for gaming. And some places for token issuing, like Panama, have an OK regulation for token issuance. So in a big structure, once you have a company dealing with token issues, that could be a really good place for you to put your company.
The most classical ones in the U.S. are Delaware and Wyoming. Delaware has been present not just in crypto but in the global startup world for a while now. They have a very flexible regulation in regards to corporations, and they are good for a lot of crypto payment business, NFT, DeFis, asset backed and play-to-earn games, with the exception of security and utility tokens. Once we’re talking about skills, they are not good for gambling. And they have good taxation rates for foreign entities. For example, they don’t have VAT.
The other point of the U.S., especially of Wyoming, is that they have DAO regulation, and DAO has been one of the hot topics. Their DAO regulation isn’t nearly ideal, in my opinion, but it’s something. When I have clients who want to incorporate a DAO, or something like a DAO, I personally don’t recommend opening it in Wyoming, even though they have a regulation. And why is that? Because the regulation is rather wrong. So you still have a lot of flaws, and the way that they’re putting the structure itself, it’s not really what we in the Web3 world see as a DAO. I don’t think you would protect the client as much as other regulations that don’t have a DAO legislation, but they have traditional corporate laws with instruments that may assimilate, or at least come close to what we see as a DAO, which is the case of foundations. Once we have foundations in some countries, it’s what comes closer to a DAO, as we know, in the corporate world. So for example, Switzerland’s a great place for you to have a DAO foundation, just as Malta, Liechtenstein, Gibraltar. So, depending on the business, sometimes it’s better to take a closer look at traditional corporate law than to jump head-first into just any law that passed, just because of the hype.
Monika Jiang: I want to ask a final, broader question: originally, the idea for the crypto market had always been to remain a self-regulating, autonomous, decentralized market as an alternative to the traditional financial sector. But now it seems like there are some main players in place that could develop in monopolistic patterns, that hold power. So how much is the current crypto market really different from the traditional sector? And how much should governments be actually involved in regulations?
Luiza Castro: I think that’s one of the biggest and most polemic topics when we talk about crypto regulation. So there are now more and more big players involved in the game, and we have different communities trying to have more homogeneous, more smooth and similar regulations all across the world. Here in Discord you have a lot of groups that are trying to propose what regulation should look like, to then try to see in Europe with Brussels, and in the US with the Parliament. That effort is quite scattered. Lawyers all over the world are starting to create communities to discuss all of that. There’s Discord, there’s Twitter; different groups. So you’re starting to have more and more of a community trying to discuss that in unison instead of in separate voices. And then the question arises: but should the market actually be that regulated? Do we need that amount of regulation? For a lot of people that goes against the Web3 purpose that is actually going as further as possible from the banks and governments, and being a worldwide decentralized structure, network, market, or any of the faces of the Web3 that you want to name it. But at the same time, you want to be somewhat protected, so that the government can’t tax, seize, or interfere in your business at any point. That’s the balance that everyone is actually discussing and trying to reach, because you want to be as far as possible from traditional structures and traditional regulations, and you don’t want the government taxing and meddling in every aspect of your business. That’s why you joined Web3.
My feeling is that the balance that we want will not be as achieved. I think that the regulations for Web3 will be different from the regulations of traditional markets, because there is no way, at least not today, maybe in a few years, that the governments can actually regulate a crypto market. There is no way they can actually see how much you have in all of your wallets, how many wallets you have, where they are — there is simply no way to do that. So they will have to adapt. But I think they will try to control as much as they can, especially because they see that this is a growing market, and there is money involved, too. And whenever there is money involved, there are people willing to take advantage of it.
So I don’t think that it’s going to be as unregulated as we all wished. But I also think that the regulation will be a bit softer than traditional markets, and it will also take time. So the market will evolve, and maybe in a couple of years we’ll have a much more unanimous opinion amongst experts on how to proceed or how to go forward. And maybe once we reach that, we’ll then be able to actually enter the discussion with the parliament on how to better regulate, or, even, how to better not regulate the market itself.
This conversation was edited for clarity.
Now over to you, what do you think?
Drop a message on our Houseverse on Discord!
How much shall the government intervene in forming crypto regulations?
Which exemplary frameworks / approaches are you aware of in your country that we could discuss here?
What should be the key goals for an overall regulatory framework:
- financial stability
- financial inclusion
- environmental sustainability
- other ______