Untangling Crypto Regulations: A European Journey
In 2018, the US Securities and Exchange Commission (SEC) enforced punitive measures in eighteen crypto related cases, as opposed to five instances the year before and just one case in 2016. Comparatively, the EU crypto scene has seen lesser legal action in individual circumstances and more action related to the bigger picture.
Napoleon Ta, a partner at Founders Fund, notes that capital formation is the next big thing in blockchain. Consequently, STOs (Security Token Offerings) have gained momentum in 2019 and will continue to grow in the near future. EU nations have already started to build the regulatory landscape and infrastructure in anticipation.
To briefly delve into STOs, tokens are broadly classified as utility and security tokens by the US SEC and Swiss FINMA (Financial Market Supervisory Authority).
Utility tokens enable their holder to use products or services offered by the token issuing company. Possession of utility tokens does not represent a stake in the company.
Security tokens, on the other hand, carry with them the expectation of profits and represent ownership of an external asset. Moreover, traditional investments can be digitized in the form of security tokens. As a result, they are considered to be securities and are subject to federal security regulations.
Amid European Banking Authority (EBA) and European Securities and Markets Authority’s (ESMA) calls for pan-EU crypto rules, there has already been traction to make crypto regulations seamless across EU. Security tokens are regulated as per MiFID II rules.
On 3rd Jan 2018, the EU instituted MiFID II — Financial Instruments Directive (2014/65/EU). The directive deals with the regulatory framework associated with the trading of financial assets. Under this law, security tokens are classified as “transferable securities”.
The main objectives of MiFID II include providing uniform regulation across the EU’s financial markets and ensuring proper levels of investor protection. With this law in place, offering and trading securities over the entire EU should be much easier now.
Another important piece of EU legislation in this context is the Prospectus Directive (2003/71/EC). This directive is positioned under the Financial Services Action Plan that lays down the framework for any project that wants to issue or offer transferable securities within the EU. It states that these projects must have a prospectus approved by the national financial regulator of the respective member country.
The Prospectus Directive streamlines this process. If the prospectus is approved in one member country, then it is usually not necessary to submit it for approval in another member nation; just informing the regulator is enough. In fact, in some member nations, if the enterprise meets specific criteria, even the prospectus might not be required. This process makes it uber convenient for any enterprise looking to offer security tokens in several EU nations.
EU regulations also list out the steps needed to acquire a license to trade security tokens on an exchange. MTF (Multilateral Trading Facility) license is one such option. MTFs provide retail investors and investment firms with an alternative to traditional exchanges.
They have become quite popular in Europe over the last few years, thanks to fast transaction speeds, low costs and trading incentives. Similar to the Prospectus Directive, if a license is obtained in one of the EU nations, then all the exchange operator usually needs to do to conduct business in another member nation is to notify the regulatory body in that jurisdiction.
On an individual country-level, here are some examples of how crypto regulations have developed so far:
Malta: Malta is possibly the forerunner when it comes to crypto friendly regulations, even among the European nations. Christened the Blockchain Island, a host of crypto projects have shifted base to Malta, the most notable being Binance and OKEx. In July 2018, the Maltese government passed legislation to set up the first regulatory framework for blockchain, Distributed Ledger Technology (DLT) and cryptocurrencies.
Three significant laws were passed in this legislation:
1) Malta Digital Innovation Authority Act (MDIA Act), which establishes an official body to certify DLT platforms.
2) Innovative Technology Arrangement and Services Act (ITAS Act), which deals with the registration of technology providers and companies working in the cryptocurrency space.
3) Virtual Financial Assets Act (VFA Act), which establishes regulations for ICOs, exchanges and trading.
The VFA Act also defines 3 categories for tokens: utility, security, and VFA (Virtual Financial Asset).
Tokens that are classified as VFA are not securities. Projects consequently used this scope to classify their tokens as VFA, allowing a much wider audience to purchase them.
Switzerland: The town of Zug in Switzerland is home to a crypto and blockchain development hub dubbed as the Crypto Valley. It has been ranked as the fastest-growing tech community in Europe. The Swiss FINMA is the government body responsible for financial regulation, including STOs.
In 2018, FINMA published guidelines categorizing tokens into four categories — payment, utility, asset and hybrid. Out of these, only asset tokens are treated as securities. Enterprises which offer STOs have to comply with all regulations which other securities like stocks, bonds and derivatives are subject to. Moreover, STOs are also subject to the ‘Big 5’ Swiss financial regulations — Stock Exchange Regulation, Anti Money Laundering Regulation, Banking Regulation, Financial Market Infrastructure Regulation, and Collective Investment Scheme Regulation.
France: The French financial regulator Authorité des Marchés Financiers (AMF) released guidelines in 2018 that stipulate that ICOs should provide full transparency and ensure specific guarantees for investors. Companies will also have to disclose to the authorities details such as what type of tokens they are planning to issue.
The purpose of these regulations is to ensure that potential buyers can make an informed decision. Interestingly, the requirement of full disclosure has reduced the number of ICOs operating out of France, while making STOs more favourable.
Germany: In Germany, the financial regulator BaFin (The Federal Financial Supervisory Authority), has classified Bitcoin and Ethereum as units of account and financial instruments. In the past, it had raised concerns over ICOs and maintained that ICOs should be subject to strict scrutiny. It had also been turning down proposals of token offerings raised by several companies, citing non-competence.
In Jan 2019, however, BaFin approved the token offering proposal of a Berlin-based start-up called Bitbond. This approval is being considered to be a precedent-setting judgement and paves the way for future STOs in Germany.
Estonia: Estonia has been using its own blockchain technology, called Keyless Signature Infrastructure (KSI), since 2012. It comes as no surprise that Estonia was among the first nations of the EU to legalize activities related to crypto. The Estonian Financial Supervisory Authority (EFSA) stated that every ICO is unique, and each one should be assessed independently based on its own merits.
Taxation on both cryptocurrency and ICO investments is low. The government’s encouragement towards blockchain technology and cryptocurrencies, coupled with the openness of the market, has made Estonia one of the most crypto friendly nations in the world today.
Across the EU, we are seeing increasing regulatory clarity and growing trends in favour of STOs. As a familiar security class, they are easier to govern and hence easier to create legislation for. Moreover, framework directives like MiFID II are narrowing cross border crypto regulatory gaps. While Malta continues to make landmark regulations for cryptocurrencies, the rest of the EU is following closely on its heels.
About the Authors:
Rohit Chatterjee is an Analog Design Engineer working at Texas Instruments. Abhijoy Sarkar is a banker-turned-entrepreneur. They are high school friends who lost contact years ago. They reunited over crypto in early 2018 and have been investing through mutual research and shared knowledge. Rohit and Abhijoy wrote this article as freelancers for aXpire via MatchBX.io