Agreed upon text for MiCAR, Markets in Crypto-Assets Regulation, was published by the European Council in October 2022, with expectations that the regulation will be ratified in early 2023. Once approved, the law will come into force within 20 days and regulatated entities will have between 12-18 months to establish compliance. This raises significant questions for how organisations can deal with cryptocurrencies, how NFTs will be regulated and when the new regulatory framework will apply. This article discusses the key points.
What are the objectives of the Markets in Crypto-Assets Regulation?
MiCAR aims to regulate, simplify and make the post-trading of crypto assets more secure within the EU member states. With MiCAR, everything involving crypto-assets would theoretically be covered under a uniform set of rules. Four specific objectives of MiCAR are:
- Increased protection against fraud for consumers
- Removal of regulatory barriers for dealing with crypto-assets
- Provide companies with new sources of financing
- Open up the development of new business models via crypto payment methods as well as new investment opportunities.
With this law, the EU is working to increase the attractiveness of the European market and strengthen consumer protection when dealing with crypto-assets. To realise the objectives, the European Parliamentand the Council, have agreed on a draft framework for MiCAR.
During the MiCAR transition phase, participants in the crypto market have time to learn about the new requirements. The regulations are also open for comments. Regulatory authorities are to launch educational campaigns. In addition, further, supplementary regulations can be expected. For example, the European Securities and Markets Authority (ESMA), is working on a demarcation of MiCAR from MiFID (Markets in Financial Instruments Directive).
When looking at MiCAR, it is first important to understand the categorisation of the different tokens to understand the scope of the rules. The regulations distinguish between:
- Value-referenced tokens: these tokens are also called "stablecoin." They are cryptocurrencies that use different nominal currencies (one or more legal tender, commodities or cryptocurrencies) to achieve value stability.
- E-money tokens: E-money tokens refer to stablecoins that reference an official currency.
- Utility tokens: These tokens provide access to a digital good or service that is available via distributed ledger technology (DLT) and is only accepted by the issuer of the token.
- Significant and non-significant tokens: The decision as to whether a token is a significant value-referenced token is determined by the size of the carrier's customer base, the value of the tokens issued, the number and value of transactions conducted with the tokens, the size of the asset reserve, the significance of the issuer's cross-border activities, market capitalisation and interconnectedness with the financial system.
- Non-Fungible Tokens: NFTs are a special case and are not regulated under any other categories. They are, according to MiCAR, "a digital representation of value or rights that can be electronically transferred or stored using distributed ledger technology or similar technology." The definition is deliberately broad to capture innovations and tokens in the future easily.
The law will apply to states of the European Union. In the case of cross-border issuances, other issuers must also comply with the regulations. For example, if crypto assets or crypto services are issued for Swiss issuers in Germany, MiCAR applies.
So who will be responsible for what in the EU? The key decisions are:
- MiCAR vs MiFID: It remains to be seen when crypto-assets will have to be regulated via the Markets in Financial Instruments Directive instead of the Markets in Crypto-Assets Regulation. For this, the European Securities and Markets Authority (ESMA) is developing another set of rules within the 18 months following the MiCAR decision.
- E-money tokens: The issuance of e-money tokens will be reserved for supervised credit institutions.
- Significant and non-significant tokens: For significant tokens, authorisation must be granted by the European Banking Authority (EBA); for non-significant tokens, the national authority decides.
- NFT: Non-fungible tokens are included in MiCAR as soon as they belong to a collection. More on this later.
Important key points within MiCAR
The text of the MiCAR is final and can, therefore, no longer be changed. In the future, there will be a "MiCAR 2" as a supplement that clarifies issues that have not been discussed or are unclear. Until then, the MiCAR is valid with the following important points:
Environmental protection: The environmental protection passage is to be observed in the issuance, distribution and trading of crypto assets. Issuers and crypto exchanges must disclose the climate and environmental impact for the consensus mechanisms used (for example, whether they are using "proof of work" or "proof of stake" approaches) and will be required to provide whitepapers with “an independent assessment of the likely energy consumption of the crypto-asset where the proof-of-work model is used” (Article 5.1, point (bb)), and (ii) “information on sustainability indicators related to the issuance of the crypto-asset, including whether it has been mined in compliance with the EU sustainable finance taxonomy” (Article 5.1, point (bc)).
ESMA will develop Regulatory Technical Standards (RTS) to define methodologies for sustainability. Within two years of MiCAR coming into force, the EU Commission will present a report on the environmental impact and define further rules.
- Travel rule: The travel rule is intended to provide more financial transparency in the fight against fraud with cryptocurrencies. For example, according to MiCAR, central exchanges must now collect user data for transactions of more than €1,000 to "unhosted wallets."
- Transitional and grandfathering provisions: These apply to existing cryptocurrencies and facilitate the transition. The full MiCAR regulation must be applied to new projects.
- Independent asset class: Crypto assets are considered an independent asset class and thus strengthen investor protection.
- Market abuse rules: Insider trading will be prohibited, and ad hoc publicity will be required, among other things.
- Awareness campaigns: Regulators are to raise awareness of the new MiCAR prohibitions or at least consider a campaign.
MiCAR and NFTs
One area of confusion is how MiCAR deals with NFTs, which can be used to transfer digital assets, such as artwork, on the blockchain.
NFTs were included in the first draft of MiCAR but were taken out by the EU Parliament. Instead, there was agreement on a text that states NFTs are only covered under the law if they are truly non-fungible (in legal language, "exchangeable," "replaceable"). They must also belong to a collection.
A collection is the term used to describe a large number of NFTs issued on a subject. The problem is that national authorities decide what is and what is not a collection. Under the current situation, one EU state could decide differently than another. In case of disagreement, the goal of being able to refer to a uniform set of rules has yet to be achieved.
So the case of NFTs and MiCAR still needs to be resolved. In addition, the ESMA is working on another set of rules. This should clarify when a token falls under MiCAR and when under MiFID.
Conclusion and assessment
The EU needs a framework that regulates the issuance and trading of crypto assets. In this way, consumers can be better protected. At the same time, crypto-assets and their handling of them in the EU will become more attractive for companies. MiCAR is the first attempt at a uniform set of rules for the EU.
It remains to be seen what ESMA will publish to distinguish MiCAR from MiFID. With MiCAR, many questions on the regulation of NFTs still need to be solved. Here, it is a matter of waiting to see which regulatory framework will treat NFTs and how. The foundation stone for a uniform crypto regulatory framework has thus been laid, and further specifications are expected.
Organisations are likely to need support from blockchain experts to navigate compliance with regulation. Moreover, organizations should also consider the opportunities presented within this regulation—including the use of blockchain-based systems to manage ESG reporting. For example, crypto mining data can be captured on a blockchain and leveraged for reporting on energy consumption and environmental compliance. Similarly, organisations can rely on industry experts to implement technology that ensures their know your customer and anti-money laundering controls are in place and aligned to the requirements in MiCAR and other future regulations.
The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, its management, its subsidiaries, its affiliates, or its other professionals.