The Markets in Crypto-Assets Regulation (MICA) is the first all-encompassing effort to tackle cryptoassets and brings rules contained in Mifid, Market Abuse and the Prospectus Regulation to the cryptoasset industry.
The regulation was initially drafted after Facebook’s Libra/Diem stablecoin project posed concerns over financial stability. While that project was since dropped, the need for such regulation has only been made more clear with the explosive bankruptcy of crypto exchange FTX and other crypto services such as Terra and Celsius.
“There is a real sense in the industry that we can position Europe as a leader for crypto because MICA is really the most comprehensive, thorough and defined regulatory framework out there,” said David Carlisle, VP for policy and regulatory affairs at Elliptic. “Even though MICA is quite rigorous and could be burdensome from a compliance perspective, many crypto businesses see it as ultimately favourable because their number one concern is clarity about what the rules will be.”
In other jurisdictions, enforcement-led and piecemeal approaches have been preferred meaning that, while they may provide a lighter touch regime for firms when they’re fully established, for now there is a lot of uncertainty for firms operating in the spaces.
The European Council published the agreed text for MICA on the October 5 2022. It is expected to be ratified in Q1 of 2023 and will come into force 20 days later. Firms in scope will then have 12 or 18 months before they need to comply with the requirements of the regulation.
See also: FTX collapse fans flames of crypto regulation debate
What’s new under MICA?
For firms registering under the regime, a big benefit will be the passporting licence which means firms will not need separate licences to operate in different EU member states, but one EU-wide registration.
“This common regime and a passporting approach to licensing will be very significant game changers,” said Caroline Malcolm, head of international public policy and research at Chainalysis. “It will open up services across Europe and allow new entrants to scale, which wasn’t really viable before.”
However, it should be noted that firms will still need to register in each country separately under anti-money laundering regulations, even if only one MICA licence is required.
The regulation includes requirements for prospectuses upon issuance, as well as redemption rights for stablecoin issuers against a reserve – both for e-money tokens and asset-reference tokens.
“Another big thing that's new, is they have imposed quite onerous caps and monitoring requirements around stablecoins that are used as a means of exchange,” said Sophia Le Vesconte, senior associate at Linklaters.
The requirements will apply to asset-reference tokens and e-money tokens denominated in a foreign currency. “There is a lot of speculation and concern that these caps will effectively ban some USD denominated stablecoins from being available in the EU because they already far exceed the caps that are being imposed here,” she added.
For firms looking to comply with the regulations, MICA will no doubt be a big change to factor into internal policies and compliance.
“Before MICA, there was, to some extent, a regulatory vacuum at an EU level,” said Le Vesconte. “This raised various concerns around unregulated risks, for example in relation to consumer protection or financial stability. But at the same time, there were also concerns that an unregulated environment is not conducive to healthy innovation. You can end up with a bit of a Wild West, where standards vary significantly and it is not easy to differentiate the good actors from the bad ones, which can undermine confidence in the market as a whole.”
See also: EU agrees on MICA regulation
Who does the regulation apply to?
Due to the borderless nature of crypto, the regulation won’t just impact firms registered in the EU but will impact other firms who market crypto to customers in the EU. That said, how the EU would enforce the requirements for firms based outside the member states is a very different story.
Another key issue around the scope of the regulation is how it will apply to decentralised finance.
In Mifid, the focus is on regulating the underlying entity such as a bank. In some instances, this works well and the custodian or exchange can be relied upon, but in others – for decentralised assets, for example – this creates issues.
“The biggest concern from our point of view is on the liability of crypto custodians,” said Teunis Brosens, head economist for digital finance and regulation at ING.
In the regulation, the liability of crypto custodians is very broad, Brosens explained. “This boosts the investor protection perspective, but it also means the custodian is liable for events that it can neither address nor control, such as a bug in a smart contract, or an exploit elsewhere on a blockchain that it has no influence on,” he said. “That creates liability risks that the custodians cannot manage.”
This could lead to a scenario where there are no custodians in the EU, or they offer the services at a very high price, pushing EU investors to look to non-EU custodians.
Policymakers appear to be aware of these issues and have addressed these concerns.
“The EU have clarified that MICA is not intended to apply to truly decentralised arrangements,” said Le Vesconte. “But where there are centralised entities that are performing their services as part of a wider decentralised arrangement, those entities will likely be caught under this regime.”
For example, in the case of a decentralised algorithmic stablecoin with no issuer because it’s based on a smart contract, the obligation might fall on the trading platforms that lists that stablecoin to comply with the whitepaper requirements.
European legislators are already working on a new regime to cover decentralised finance – MICA 2.0.
See also: FTX customers won’t see investments anytime soon
Evolving tech
Other issues are the innovative and evolving nature of crypto as a currency and asset-class, which has meant the industry has changed substantially in the few years since the regulation was initially proposed.
“Non-fungible tokens (NFTs) are a demonstration of how quickly the market is moving,” said Simon Treacy, senior associate at Linklaters. “When the draft legislation was originally published in 2020, no one really was talking about NFTs and yet 18 months later, it was front and centre of conversations in this area.”
As the legislation developed, the scope has been tidied up such that NFTs do not fall in the remit of the regulation. “That’s with a huge caveat that some tokens that use the technology standards associated with NFTs may not be treated as non-fungible for the purposes of MICA, because they have other features that make them more akin to a liquid financial asset,” noted Le Vesconte.
This raises concerns about innovation that could occur in the next 18 months, before the regulation is implemented.
“The technology platforms used to deliver such tokenised products will no doubt evolve fast,” agreed Ben Regnard-Weinrabe, partner at Allen & Overy. “It’s very likely that whatever definitions are included in this proposal will quickly become redundant because the technology moves at breakneck speed.”
Amendments to the proposal surrounding the definitions of cryptoassets and distributed ledger technology are a prime example of the need to shift terminology.
“This creates the difficult question of – how do you cope with the rapid diversification of products and technology within a piece of legislation?” said Regnard-Weinrabe. “At a certain point, you cannot, and you just have to say – ‘this is what we have now, and we’ll have to revisit it soon.’ But that option inevitably comes with a time lag.”
