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How to build a MiCA compliant business on Tgrade

Photo by Per Lööv on Unsplash

Although MiCA will not be fully implemented until 2023/2024 it is possible to begin planning and organising your business around the regulations.

Before I jump into the how, it is useful to have a recap on what MiCA is and the overview of Tgrade and what is in place to help with the regulations.

What is MiCA?

Regulation on Markets in Crypto Assets (MiCA) is an EU initiative that came about in September 2020 and aims to strike the balance of fostering innovation balanced with protecting investors and preserves financial stability.

The MiCA, and indeed all regulations are controversial to a nascent industry that knows no national boundaries by design and is innovating at high speed, however, the introduction of a standard set of rules across the countries of the EU brings certainty across a large market.

The focus on financial stability is on the stable-coins and asset referenced tokens which in this case refer to stable-coins which are based on tokens or algorithmic digital currencies.

A notable absence is regulations around Decentralised Finance (DeFi) that has emerged in the last 18 months and it was felt that some time was needed to observe how the markets operate in the context of consumer protection and financial stability.

Digital Assets that are securities, such as security tokens, continue to fall under the same regulations as the traditional markets and there is no extra provision within MiCA to cover securities, and securities will fall under MiFID. It is down to the national regulators to consider the existing regulations and how to apply them to the emerging digital markets, although this does get interesting when considering the rules around clearing and how this is interpreted with DLT solutions.

MiCA introduces the concept of a crypto-assets service provider which include the following categories:

  • Custodians of crypto-assets
  • Operators of crypto-asset trading platforms
  • Receiving and sending crypto-assets on behalf of others
  • Crypto-asset advisory services
  • Exchange of crypto-assets for fiat currency
  • Exchange between crypto-assets
  • Execution of orders on behalf of third parties in crypto-assets

Crypto-asset service providers will need to register in one member state and obtain authorisation after which they are granted passporting to the other member countries. It should be noted that the requirements for registration are not as complex as the MiFID rules. Crypto-asset service providers will need to have systems and controls in place including governance and risk management, and have either capital or insurance in place where required. There are specific requirements for the activities of trading, custody or advisory services.

For issuers of crypto-assets the issuance must be through a legal entity and submit the whitepaper which describes what is being issued, the rights of the holders and describe the risks. There are further requirements around the issuance of asset-referenced tokens and e-money tokens which is a focus of MiCA.

The EU council reached agreement on MiCA in November 2021 and it is expected to be brought to the EU parliament in 2022 for debate.

Photo by Greg Rosenke on Unsplash

What is the impact of MiCA?

If we consider the current landscape of crypto and look at the different types of projects, and service providers

E-money and Asset Referenced Token issuers will see the biggest impact, although for licenced e-money providers the only substantive change is the requirement to issue a whitepaper. The Asset Reference Token issuers have significant barriers to offer the tokens to the public in EU, examples of Asset Reference tokens in circulation today are DAI and the Diem project. Note the Asset Reference Tokens in this context are stablecoins and not Asset backed tokens such as Real Estate or Art which fall under securities (MiFID) regulations.

The impact on blockchains issuing utility tokens will be minimal if they have a base in the EU as many will already have a legal structure behind them and produce whitepapers.

The crypto-service providers such as exchanges will already have many processes in place and are likely to be registered and the additional steps will become clear as MiCA goes through the parliamentary process and the guidance notes are produced.

The Decentralised Finance (DeFi) protocols such as lending, Decentralised Exchanges (DEX) do not fall under MiCA, although there is some discussion around whether a DEX would need to have a legal presence and register and that is problematic where a DEX is structured to be fully decentralised. The conflict is between the protocols who have a strong desire not to be centralised or have persons of control and the regulatory view about ensuring Financial stability and consumer protection thus requiring a legal entity and responsible people to regulate. The regulations around DeFi will evolve as the landscape is better understood, particularly in the context of financial stability and the safeguards around consumers.

How does Tgrade work in the context of MiCA?

Tgrade is a public, permissionless blockchain, secured by Proof of Engagement. What makes Tgrade interesting from a MiCA perspective is the self-sovereign governance mechanisms around the creation and management of Trusted Circles.

Anyone can create a Trusted Circle and set the rules around it. In the European context this means a Trusted Circle can be wrapped around a legal entity based in one of the EU member countries. The legal entity can thus apply for a crypto-asset service provider licence when the MiCA laws are in force and gain passporting to the other member countries.

What can you do with a Trusted Circle? With the governance tooling in place, addresses can be added to the Trusted Circle building a whitelisted group. Note the compliance checks are all done off-chain, by design, and the link between the off-chain identity and a blockchain address is established before the governance processes which record the addition or removal of addresses to/from a Trusted Circle. The governance processes demonstrate that there are controls in place and that the members have gone through a compliance procedure, and fills the criteria in context of being crypto-asset service provider.

Finally with a Trusted Circle in place, there is the ability to connect a Digital Asset or Smart Contract to a Trusted Circle meaning that only members of a Trusted Circle may hold, transfer or trade the assets. The permissioning of the assets helps providers comply with client suitability provisions and helps with the reporting requirements as they have the link between a Tgrade blockchain address and the holder’s identity.

Photo by Hello I'm Nik on Unsplash

How do I go about building a MiCA compliant business on Tgrade?

The final version of MiCA is yet to be published and through the passage of parliament may end up being modified, however, taking the starting point that crypto-asset service providers will have responsibilities and a set of rules. The fundamentals are that the crypto-asset service providers need a legal entity in order to be registered and depending on the category there are some specific rules.

Let’s consider a couple of scenarios of businesses that will be impacted by the MiCA regulations, an e-money provider and an exchange specialising in sustainable investments.

The e-money provider

The e-money provider has undertaken the whole registration process and has been granted the licence to be an e-money provider. The e-money provider wants to create a digital Euro for use by all members of the EU and EEA. The e-money provider choses Tgrade as they are able to onboard customers through their existing procedures and policies and they onboard them into an EU Trusted Circle which they created. The e-money customers using the digital Euro may transfer them to anyone in the Trusted Circle or use them in the lending and borrowing platforms in the Trusted Circle who work alongside the e-money provider.

The e-money provider has obligations around the know-your-transaction regulations to combat AML and has built a nice set of tooling that monitors the Trusted Circle participants for suspicious transactions, and indeed they are in discussions with a couple of financial crime units who are interested in the data to help them stem the flow of proceeds of crime.

The set-up is ready for MiCA and when the time is right they publish their whitepaper.

The ethical exchange

The ethical exchange has developed a market making protocol which allows their customers to trade sustainable green loans. The loans are issued by regulated institutions, on behalf of companies, who do the structuring and ensure the regulations are complied with such as ensuring that each instrument has a prospectus, and the risks are disclosed to the investors. The green loans are smart contracts that pay the coupons and redeem in digital Euros.

The ethical exchange has been designed to be a market place for fund managers who construct green portfolios.

The operators of the ethical exchange set up a legal entity in one of the EU member countries and seeks the appropriate regulatory approval.

The ethical exchange builds on Tgrade and begins by creating a Trusted Circle where they can begin adding the addresses of the fund managers and the issuing institutions which have gone through all the necessary compliance checks. The exchange then sets the permissions of the market making protocol to the members of the Trusted Circle.

The loans are issued to the exchange and the funds use the market making protocol to buy and trade them.

The ethical exchange is fully transparent and the automation of the market making shows the price at all times.

The ethical exchange has built some tooling to monitor the Trusted Circle using market surveillance technology to ensure that good practice is being maintained. The ethical exchange has the link of identity to the blockchain addresses and thus can take action in the case of behaviour that breaches the agreements the participants have made.

The ethical exchange will register as a crypto-asset service provider and meet the regulations around operating a crypto-trading platform in addition to the MiFID requirements.

There are many open questions around the trading of securities on blockchain, especially around the regulations on clearing and whether a security traded with a digital Euro meets the rules or whether a further fiat clearance step is required, and whether the blockchain can be considered equivalent to a CSD and this is a topic in its own right. However, to illustrate what is possible with Tgrade in the context of MiCA we can see that the frameworks are in place that make it simple to comply.

Disclaimer

This article is an illustration and a very general approach to MiCA and building a compliant business. You should always seek legal advice as the individual circumstances of each project may vary in what is required. The MiCA legislation is still being formed and this article has been based on the information available at the time of writing the article.

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The foundation of Tgrade is a robust, secure, fully decentralized platform that offers the ability for self-sovereign groups to form and interact with each other.

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Martin Worner

Martin Worner

Building Tgrade, a public blockchain with self-sovereign governance frameworks to help bridge traditional finance.

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