⛱ Blockchain: Worldwide Regulations and Case Studies Series #2
Hi friends! 👯♀️ My name is Elif Hilal! I produce content in the fields of blockchain, software, smart contracts, and law. If you are reading my articles for the first time, welcome to my world 🎀 I am sharing the second article of my series with you.
I said that I will continue this series that I started 🙂 Now you are about to read the second article of the series. I hope you’re excited, it’s okay if you’re not, the important thing is to offer you different ideas and perspectives on Blockchain🐝
What does this article contain?
- State of EU Crypto Asset Regulations Before MiCA
- Other legislation on crypto assets
- MiCA!
- Content and purpose of the MiCA draft
- CASP approval
Let’s get started 💥
What Was EU Crypto Asset Regulations Before MiCA?
Before the MiCA was adopted in the EU, a few key points in the DRAFT text were as follows:
- The regulation will directly apply to all 27 existing EU Member States.
- It will not need to be enforced in national law.
- It will also affect any firm, company, or start-up that wishes to do business in the EU; Customer research from anywhere outside the EU (including, for example, the US, UK, and Singapore) will be considered a regulated activity.
The provisions of MiFID II provide requirements and regulatory obligations for “investment firms” that provide financial instrument-related services.
— Legal Entities Qualified as Investment Firms
In fact, to qualify as an investment firm under MiFID II, a business will be involved in certain investment activities related to financial instruments. Therefore, it is crucial to evaluate on a case-by-case basis whether a crypto asset qualifies as a financial instrument.
If a particular crypto-asset is found to qualify as a financial instrument, the issuer (and any entity involved in the provision of services or activities related to that crypto-asset) will likely be subject to a number of regulatory requirements and obligations.
— Evaluation of a Crypto Asset as a Financial Instrument
When assessing whether a crypto-asset qualifies as a MiFID II financial instrument, the recommendation issued by ESMA is to consider “the precise facts and circumstances of the crypto-asset (nature, rights attached to it, negotiability in the capital market, etc.) and national law.”
Also, in January 2019, ESMA published a study on how and when EU regulators interpret crypto assets as categorized as financial instruments. The research explained what the functionality of a particular crypto asset looks like. For example, this research includes explanations such as how the key factor is taken into account of a particular coin looks. Additionally, while certain crypto assets may not begin as MiFID II financial instruments, they may qualify as such later in time as a result of their use or function.
In light of this, the assessment of when a crypto-asset becomes a financial instrument may be different at the beginning and different at the end. The fact that there are also different categories of financial instruments (for example, dozens of different tokens) complicates such assessments 😉
— Financial Instrument Categories
While a comprehensive list of those classified as financial instruments under MiFID II can be found in Annex 1, Part C of the Financial Instrument Markets Directive 2014/65, common examples of financial instruments covered by MiFID II are as follows:
1. transferable securities (such as shares, bonds, and other securities giving the right to buy or sell such transferable securities)
2. money market instruments;
3. units in collective investment undertakings
4. Options, futures, swaps, and other derivative contracts
If a crypto-asset qualifies as a financial instrument, any person or entity providing investment services related to that crypto-asset would likely need to be authorized under MiFID II and regulated by its provisions.
— Interpretation Difficulties Between Member States
As explained, there are several categories of financial instruments that a particular crypto-asset can fall into (most likely unintentionally). Complicating this situation is the sheer abundance of more than 17,000 crypto assets, according to a recent publication (March 2022) by the European Supervisory Authorities.
In particular, it is possible for a crypto-asset to display components of hybrid, multi-purpose, and simultaneously different categories of crypto-assets. For this reason, it is very difficult to classify crypto assets.
BUT THESE WERE TALKED BEFORE THE MICA DRAFT WAS ACCEPTED, MICA CHANGED MANY THINGS.
The definition of a crypto-asset as a financial instrument or a transferable security depends on how the concept of a ‘transferable security’ is applied in the Member State concerned.
Therefore, it is possible for the same crypto-asset to be considered ‘transferable security or other financial instruments in one jurisdiction and another. Such a situation manifests itself as market fragmentation in the so-called EU single market. Aiming to harmonize crypto-asset regulation across the EU, the MiCA regulation is a great method and resource for solving these problems.
Regulating Securities Tokens Under Proposed MiCA Regulations (remember Howey test was also trying to find the security token)
MiCA’s assessment (published by the Commission in conjunction with MiCA) explains the definition of ‘security tokens’, defined as crypto assets that qualify as financial instruments under MiFID II. This assessment states that crypto assets that qualify as financial instruments will continue to be regulated under current Union legislation, regardless of the technology used for their issuance or transfer after the MiCA comes into force.
What Are Other Existing Legislation Related to Crypto Assets?
📌 Crypto Assets Covered by the Electronic Money Directive II (EMD2)
MiFID II is not the only piece of legislation that can fall within the scope of crypto assets. Some crypto-assets, so-called stablecoins, may qualify as electronic money under EMD2 if they meet all the elements of the definition in the directive (especially if they offer users a product directly on the reserve that supports the ‘stable coin’). In such a case, launching these crypto assets in the EU requires an e-money license.
📌 Crypto Assets under the Second Payment Services Directive (PSD2)
The other current legislation crypto service providers should be aware of is the Second Payment Services Directive (PSD2). A crypto-asset service provider operating regulated payment services may require authorization as a payment institution under PSD2 (or as an EMD2 electronic money institution, depending on its business model), unless there is an exemption from regulation.
📌 U.S. Valuation of Crypto Assets as Securities
We talked about it in the first article. In the US, the SEC has previously issued warnings that many crypto assets can qualify as securities and be regulated as such. However, the SEC has decided that Bitcoin and Ethereum are not securities, partly because of their decentralized nature and because no individual/company is in control of each respective crypto asset. But we also know that many tokens and projects are penalized 🙂
Howey Test
Similar to an assessment of whether a crypto-asset qualifies as a MiFID II financial instrument, when determining whether a digital asset qualifies as a security in the United States, the SEC evaluates whether the asset constitutes an “investment contract.” The test to make such a determination is called the Howey Test. The test assesses whether certain transactions qualify as “investment contracts,” and the Supreme Court’s SEC v. WJ Howey Co. (1946) case.
According to the Howey Test, a transaction is an investment contract if:
1. is an investment of money;
2. there is a profit expectation from the investment;
3. money investment is in a joint venture;
4. any profit comes from the efforts of an organizer or third party
As I mentioned in my previous article, the SEC aims to find security tokens using the Howey test.
EXPECTED REGULATION!! MiCA (European Union Crypto-Asset Markets Regulation — Markets in Crypto-assets Regulation)✌🏻
Dear readers, MiCA stands for Markets Regulation in Crypto Assets. This regulation is a recommendation by the EU Commission, largely in response to calls from the crypto world for a regulatory framework.
As part of the EU Commission’s “Digital Finance Strategy”, MiCA proposes a comprehensive and harmonized framework for digital assets. There has been a draft for MiCA for years and finally, MiCA has published a magnificent Regulation recently 💥💥💥💥💥 So what did they say, what was their content, and what do we need to understand.. here we are stepping into these immediately.
This Regulation is by no means a simple thing. Because the EU has already implemented it, with 27 member states, this is the most common and in-use legislation we’ve seen in crypto to date. Not only does it help reduce regulatory arbitrage in the region, it also paves the way globally. Both the USA and Eastern countries are currently examining MiCA for crypto legislation and taking steps accordingly. 🪄
On June 30, 2022, after two years of debate and arguments, EU officials announced that they had reached an agreement on landmark Crypto Asset Markets (MiCA) regulations!
This legislation focuses on regulating crypto-assets such as stablecoins and crypto-asset service providers called CASPs (crypto-asset service provider SO here actually includes Exchanges). Meanwhile, the Financial Action Task Force calls CASPs VASPs, preferring to use them as virtual asset service providers. Let me share an incredibly useful document about VASPs and FATF right away.
MiCA defines CASPs as “any person whose profession or business is to professionally provide one or more crypto-asset services to third parties.”
MiCA’s definition of CASP has some similarities with FATF’s definition of VASP. however it has been broadened to allow it to encompass more entities, yet know that they are still trying to explain the same concept in different ways. 🙂
We see that MiCA has 4 broad goals in the accepted draft:
1- To draw legal clarity and demarcation for crypto assets not covered by current EU financial services legislation
2- Establishing uniform rules for crypto asset service providers and issuers at the EU level
3- Changing existing national frameworks applied to crypto assets that are not covered by current EU financial services legislation
4- Establishing special rules for so-called ‘stablecoins’, including when e-money
BACK TO FIRST ARTICLE: MiCA has defined three Crypto asset types.
In my first article, I shared a picture with you and wrote:
1- Entity-based tokens: These are tokens that aim to maintain a stable value “referring to several currencies that are legal tender, one or more commodities, one or more crypto assets, or a basket of such assets.” These tokens can be used as a means of payment to purchase goods and services and as a store of value!
2- E-money tokens: This is another name for single-fiat stablecoins. These are crypto-assets of stable value based on a single fiat currency that aims to operate similarly to electronic money. Stablecoins, for example, are meant to be integrated into gold, dollars, or other assets.
3- Utility/service tokens: These are issued for non-financial purposes to provide access to an application, services, or resources digitally and are accepted only by the issuer of this token. These tokens have a non-financial purpose related to the operation of a digital platform and digital services. NO FINANCIAL SERVICES HERE, NO FINANCIAL PURPOSE!
THE PRESENT STATUS OF THE MICA DRAFT 🍀
While MiCA broadly covers cryptocurrencies along with stablecoins, it does not apply to central bank digital currencies (CBDCs) and does not issue security tokens that could qualify as securities or other financial instruments!!
While there are discussions about emerging technologies such as decentralized finance (DeFi) and immutable tokens (NFTs), both are excluded from this version of MiCA.
The most important things we need to know:
- Global standards are set with MiCA. Understanding the state of crypto-assets has brought transparency and clarity to the industry regarding the scope of regulations.
- The final adopted version of the law is aimed to enter into force in 2023! In addition to this situation, it is also said that additions and subtractions will be made with innovations.
- Agreed that any asset-backed stablecoin issuer should write WHITEPAPER, publish it, notify the authorities of the situation and KEEP RESERVES AT INSTITUTIONS LIKE BANK.
- The most important result, in my opinion, is the whitepaper here!
Also, after local authorities approve a crypto business according to EU regulations, this CASP (exchanges) will be able to expand their operations to other EU countries without having to obtain additional licenses, a process called passports 📌📌
CASP Approval
CASPs, aka global crypto exchanges, will face capital requirements and will need to establish policies and procedures to allow the trading of crypto assets on its platform. (Let’s think about it this way, it is aimed to prevent the increase of cases such as fraud in the stock market and to protect investors/customers)
According to the announcement, “According to the interim agreement reached today, crypto asset service providers (CASPs) will need the authorization to operate within the EU. National authorities will need to issue permits within a three-month timeframe”. Therefore, the expectations are that the CASP approval and registration process will not be a long and difficult process.
— MiCA also relies heavily on the guidance of the Financial Action Task Force (FATF). (I added the FATF link above)
Also, one of the most controversial points came when Ernest Urtasun, a member of the European Parliament, tweeted that the agreement would impose a strict limit on the use of stablecoins 👉🏻
According to Urtasun’s tweet, “large” stablecoins will be limited to €200 million in daily trading volume. The exact nature of this remains unclear, but regardless of how exactly it is implemented, such a cap would drastically change the way stablecoins are used and could have a negative impact as well. To put this in perspective, as of July 1, 2022, Tether’s global 24-hour trade volume was $53.5 billion. So there are doubts about its applicability.
In my other article, I talked about SEC decisions, ICO cases, and important regulations regarding blockchain. I look forward to sharing. Have fun 🤍🤍
By the way, you can sign up for my Meetup page, join my Telegram group, and follow me on Twitter to be informed about the events I organize in the Blockchain ecosystem! You know how to reach me! see you soon ❀🎀
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