Which Crypto Services will be affected by MiCA?

Introduction

Markets in Crypto Assets Regulation (MiCA) will be fully implemented on the Cryptocurrency markets in 2024 and is expected to impact most of the DeFi projects around the world. Protocols will have to change if they want to have any users within the European Union (EU) jurisdictions.

In this article, we will provide an overview of the types of projects that will be affected by the MiCA regulations.

A quick recap of MiCA

Enacted on May 31, 2023, MiCA aims to regulate the way crypto assets are classified and what things those classified assets need to comply with to operate in the EU. The MiCA Regulation categorizes crypto assets into three main categories:

• Asset-referenced tokens (including stablecoins backed by commodities, or multiple currencies)
• E-money tokens (stablecoins backed by a single fiat currency)
• Other tokens, including utility tokens

Utility tokens are designed to grant access to goods or services, while the other two categories serve financial purposes, including tokens referencing significant assets and electronic money tokens of notable importance, akin to stablecoins.

There are 3 key objectives MiCA aims to achieve:

• Replace individual regulations found within several EU nations with one unifying and comprehensive framework.
• Set clearer rules for crypto-asset service providers and token issuers.
• Provide more certainty in the regulation of crypto assets, where it is not covered by the existing financial regulations.

While NFTs are technically out of the scope of this legislation, there are some cases where they will be impacted, which we will cover further in this article.

There is some controversy and confusion when we talk about the impact of MiCA on decentralized applications or dApps. This is because some of the financial services that are part of the dApps are impacted, which makes the legislation a bit ambiguous and contradictory, something we will further address in this article.

The umbrella of MiCA

Some parts of MiCA can be clear about what is covered in the business side of cryptocurrency. For example, it is understood that crypto asset providers will be affected.

“At present, there are no rules, other than those in respect of anti-money laundering, for the provision of services related to such unregulated crypto-assets, including for the operation of trading platforms for crypto-assets, the exchange of crypto-assets for funds or other crypto-assets, and providing custody and administration of crypto-assets on behalf of clients. The absence of such rules leaves holders of those crypto-assets exposed to risks, in particular in fields not covered by consumer protection rules. The absence of such rules can also result in substantial risks to market integrity, including in terms of market abuse as well as in terms of financial crime. To address those risks, some Member States have put in place specific rules for all, or a subset of, crypto-assets that fall outside the scope of Union legislative acts on financial services, and other Member States are considering whether to legislate in the field of crypto-assets.”

-MiCA

Custodial Wallets

“Crypto-asset service providers providing custody and administration of crypto-assets on behalf of clients should conclude an agreement with their clients with certain mandatory provisions and should establish and implement a custody policy, which should be made available to clients upon their request in an electronic format”

-MiCA

A custodial wallet is a service where a third party takes custody of the private keys on behalf of the users. Many centralized applications offer custodial wallets as part of their services.

Examples of custodial wallets:

• Gemini Custody
• Coinbase
• Binance

Exchanges

“When a crypto-asset service provider executing orders for crypto-assets on behalf of clients is the client’s counterparty, there might be similarities with the services of exchanging crypto-assets for funds or other crypto-assets. However, in exchanging crypto-assets for funds or other crypto-assets, the price for such exchanges is freely determined by the crypto-asset service provider as a currency exchange. Yet in the execution of orders for crypto-assets on behalf of clients, the crypto-asset service provider should always ensure that it obtains the best possible result for its client, including when it acts as the client’s counterparty, in line with its best execution policy.”

-MiCA

A cryptocurrency exchange is a platform that enables users to buy, sell, and trade cryptocurrencies (Ethereum, BTC, Stablecoins, etc.). They may also facilitate margin trading, lending, futures, and options trading.

There are three types of exchanges in the cryptocurrency exchange realm:

1. Centralized Exchanges (CEX): These are regulated by a single authority and oversee all accounts and transactions. They offer high liquidity and fast transactions but are more susceptible to hacks and cyber theft.
2. Decentralized Exchanges (DEX): These operate on distributed ledger technology and allow users to trade cryptocurrencies without any central authority. They provide more privacy and security but have lower liquidity.
3. Hybrid Exchanges: Combining features of both CEX and DEX, these aim to offer the advantages of both centralized and decentralized exchanges.

Here we find one of the problems and controversies of MiCA, a DEX, while being an exchange, can also be classified as a dApp. As the legislation goes into effect, it will further explore how these situations will be or can be resolved.

“Decentralized exchanges (DEXs), such as Uniswap, are dapps offering non-custodial exchange functionality so that users can swap tokens. DEX dapps rely on complex smart contracts called Automated Market Makers to maintain token prices according to the supply and demand of liquidity in pools of tokens.”

-BitStamp

“Exchanges (DEXs): DEXs “were born from the desire to address the vulnerabilities of centralized platforms”, so they aim to provide an exchange between one or more crypto-assets with non-custodial solutions. As a result, users are under complete control of their assets and do not need to transfer and store crypto-assets on an exchange. Based on the mechanism for price discovery, there may be different variants.”

- Pereira Coutinho, Martinho Lucas Pires and Bernardo Barradas

Examples of Exchanges:

• Coinbase
• Eidoo
• Uniswap

Brokers

“To ensure the orderly functioning of markets in crypto-assets, crypto-asset service providers operating a trading platform for crypto-assets should have detailed operating rules, should ensure that their systems and procedures are sufficiently resilient, should be subject to pre-trade and post-trade transparency requirements adapted to the markets in crypto-assets, and should set transparent and non-discriminatory rules, based on objective criteria, governing access to their platforms. Crypto-asset service providers operating a trading platform for crypto-assets should also have a transparent fee structure for the services provided to avoid the placing of orders that could contribute to market abuse or disorderly trading conditions. Crypto-asset service providers operating a trading platform for crypto-assets should be able to settle transactions executed on trading platforms on-chain and off-chain, and should ensure a timely settlement.”

-MiCA

Much like the traditional role of a broker, a crypto broker acts as a trusted intermediary, facilitating seamless transactions between parties. It’s worth noting that in recent times, many brokers have opted not to hold their cryptocurrency reserves. Instead, they diligently seek out the best sellers tailored to your specific needs.

Similar to a DEX, Brokers also fall under the umbrella of MiCA.

Examples of Brokers:

• EToro
• CEX.io
• AvaTrade

Crypto-asset advising firms and crypto-portfolio managers

“To ensure consumer protection, crypto-asset service providers that provide advice on crypto-assets, either at the request of a client or on their own initiative, or that provide portfolio management of crypto-assets, should make an assessment whether those crypto-asset services or crypto-assets are suitable for the clients, having regard to their clients’ experience, knowledge, objectives and ability to bear losses. Where the clients do not provide information to the crypto-asset service providers on their experience, knowledge, objectives and ability to bear losses, or it is clear that the crypto-assets are not suitable for the clients, the crypto-asset service providers should not recommend such crypto-asset services or crypto-assets to those clients, nor begin providing portfolio management of crypto-assets. When providing advice on crypto-assets, crypto-asset service providers should provide clients with a report, which should include the suitability assessment specifying the advice given and how it meets the preferences and objectives of clients. When providing portfolio management of crypto-assets, crypto-asset service providers should provide periodic statements to their clients, which should include a review of their activities and of the performance of the portfolio as well as an updated statement on the suitability assessment.”

-MiCA

Crypto advising firms are entities or individuals that offer specialized advice and recommendations about cryptocurrency investments. They analyze market trends, evaluate various cryptocurrencies, and provide insights on potential investment opportunities.

Crypto-portfolio managers are professionals entrusted with the responsibility of actively managing and overseeing a client’s cryptocurrency portfolio. They make investment decisions on behalf of their clients, aiming to optimize returns and manage risk.

Examples of advising firms and portfolio managers:

• Pantera
• Grayscale
• Multicoin Capital

NFTs

“This Regulation should not apply to crypto-assets that are unique and not fungible with other crypto-assets, including digital art and collectibles. The value of such unique and non-fungible crypto-assets is attributable to each crypto-asset’s unique characteristics and the utility it gives to the holder of the token. Nor should this Regulation apply to crypto-assets representing services or physical assets that are unique and non-fungible, such as product guarantees or real estate. While unique and non-fungible crypto-assets might be traded on the marketplace and be accumulated speculatively, they are not readily interchangeable and the relative value of one such crypto-asset in relation to another, each being unique, cannot be ascertained by means of comparison to an existing market or equivalent asset. Such features limit the extent to which those crypto-assets can have a financial use, thus limiting risks to holders and the financial system and justifying their exclusion from the scope of this Regulation.”

-MiCA

NFTs are technically not considered part of the scope of the regulation. However, some NFTs that share characteristics with some of the previously mentioned assets could get NFTs back into the scope of MiCA. Also, the amount of repetition on a series or collection can be considered when thinking about it as fungible or non-fungible.

“The issuance of crypto-assets as non-fungible tokens in a large series or collection should be considered an indicator of their fungibility. The mere attribution of a unique identifier to a crypto-asset is not, in and of itself, sufficient to classify it as unique and non-fungible. The assets or rights represented should also be unique and non-fungible in order for the crypto-asset to be considered unique and non-fungible. The exclusion of crypto-assets that are unique and non-fungible from the scope of this Regulation is without prejudice to the qualification of such crypto-assets as financial instruments.”

-MiCA

These statements are quite ambiguous and could be problematic when classifying or sanctioning certain assets due to the lack of specifics, we don’t know how many NFTs in a collection count as too many or how similar they need to be to be within the scope of MiCA.

Launchpads

“crypto-asset service provider’ means a legal person or other undertaking whose occupation or business is the provision of one or more crypto-asset services to clients on a professional basis, and that is allowed to provide crypto-asset services in accordance with Article 59”

-MiCA

While there is no explicit mention of ICOs or IPOs, there are a lot of different Articles that directly could impact the use of launchpads and different fundraising platforms.

A big part of the regulations that will impact ICOs particularly will be the need for whitepapers and all the characteristics that they need to include for them to be valuable.

“The most important instrument for this are the Whitepaper regulations. Pursuant to Art. 4 para. 1 MiCA, issuers are prohibited from offering crypto[5] offer crypto securities to the public or offer admission to trading on a trading platform for crypto securities if they have not prepared, notified and published a crypto securities white paper. The whitepaper must contain the information required in Art. 5 para. 1 MiCA, such as a detailed description of the project, the issuer and the actors involved as well as information on the underlying technologies and risks. Furthermore, according to Art. 5 para. 2, the information must be fair, clear and not misleading. In addition, according to Art. 5 para. 4 MiCA, the whitepaper must not contain any statements about the future value of the crypto assets if the future value cannot be guaranteed by the issuer. These regulations require the issuer to disclose certain information and update it on an ongoing basis as needed. For consumer convenience, the white paper must also contain a summary of the material information in concise and non-technical language.”

-Harting

This is what will be considered the most impactful to the launchpad space, however, if launchpads were to be considered in any of the other articles of MiCA for hosting ICOs, which projects fit into the scope of MiCA, they could be in serious trouble.

DAOs and dApps

“This Regulation should apply to natural and legal persons and certain other undertakings and to the crypto-asset services and activities performed, provided or controlled, directly or indirectly, by them, including when part of such activities or services is performed in a decentralized manner. Where crypto-asset services are provided in a fully decentralized manner without any intermediary, they should not fall within the scope of this Regulation. This Regulation covers the rights and obligations of issuers of crypto-assets, offerors, persons seeking admission to trading of crypto-assets and crypto-asset service providers. Where crypto-assets have no identifiable issuer, they should not fall within the scope of Title II, III or IV of this Regulation. Crypto-asset service providers providing services in respect of such crypto-assets should, however, be covered by this Regulation.”

-MiCA

MiCA does not define what decentralized is, it mentions it and with the context and knowledge, you can craft an idea about what decentralized is however this could be changed at any time because it is too ambiguous. In some cases, dApps give the same services that need to comply with regulations, DEXs being one example.

In a paper published by Guilherme Maia1 & João Vieira dos Santos from the Faculty of Law of the University of Lisboa and Lusófona, the following is stated:

“Nevertheless, most DeFi projects have some degree of centralization, which generally means having an identifiable intermediary that would be the liable entity within MiCA. As stated in the latest recommendations of the Financial Action Task Force (FATF), DeFi “applications or platforms are often run on a distributed ledger but still usually have a party with some measure of involvement, such as creating and launching an asset, setting parameters, holding an administrative “ key” or collecting fees”45. In other cases, DeFi projects are purely decentralized models that rely only on smart contracts and, therefore, are not within the scope of MiCA since its provisions would not apply if there is no legal or natural person to be held accountable. For this reason, it is essential to know when we are facing a decentralized protocol, so when MiCA does not apply to a DeFi project.

Hence, a decentralized shall be presumed to exist when there are no fees attributed to one entity or a small group of entities, and there is no interface controlled by one entity or a small group of entities. Following finding out some criteria to help us identify when we might be facing a decentralized protocol and, therefore, an activity that is out of the scope of MiCA, one final question remains to be answered. We still aim to scrutinize how the Law should treat DeFi, which means projects that use a decentralized protocol, as we qualify it here”

How can ValidEntry solve part of these issues?

“Any legislative act adopted in the field of crypto-assets should also contribute to the objective of combating money laundering and terrorist financing. For that reason, entities offering services falling within the scope of this Regulation should also comply with applicable anti-money laundering and counter-terrorist financing rules of the Union, which integrate international standards.”

-MiCA

With MiCA implemented, clear visibility will be provided into the parties involved in cryptocurrency transactions, enabling greater accountability. Crypto exchanges will be mandated to identify traders and uphold KYC protocols accurately. MiCA introduces additional measures to combat money laundering, enhancing the overall security of crypto transactions.

ValidEntry services can help entities establish compliance with MiCA:

Confidential Verification: ValidEntry conducts KYC verification in a completely confidential manner, ensuring that only the necessary information is revealed without compromising user privacy, keeping the concept of decentralized mostly intact.

Secure Identification Protocols: ValidEntry employs advanced Zero Knowledge techniques to establish the identity of users without divulging unnecessary personal information. This helps crypto exchanges and other crypto asset providers meet KYC requirements while safeguarding user privacy.

Robust Anti-Money Laundering Measures: ValidEntry incorporates stringent anti-money laundering protocols to detect and prevent suspicious activities. This ensures compliance with MiCA’s anti-money laundering provisions, bolstering the integrity of crypto transactions.

Conclusion

MiCA is the beginning of serious and needed changes in cryptocurrency, this is just a way of testing the limitations and adjustments that need to be made for a more sustainable future. There’s already speculation about what MiCA 2.0 will cover, including things like lending and staking, something that hasn’t been covered fully but already has been implied in MiCA.

This article covered only some of the effects MiCA will have on stablecoins and other types of crypto assets.

To learn more about how ValidEntry services can help you establish compliance with MiCA, visit our website https://www.validentry.com/.

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