The EU steps up the debate on a proposed regime for crypto-asset markets

The draft Markets in Crypto-Assets (MiCA) Regulation aims to regulate crypto-asset issuers and service providers and harmonise the legal and regulatory framework applicable within the European Union (EU). The text is central for the future of the crypto-asset ecosystem in the EU and represents a strong competitive challenge in a fast-changing competitive market environment. It will also make it possible to place on an equal footing at EU level all the various players operating in this sector.

A text under discussion

France introduced a new legal framework for digital assets and action plan for business growth and transformation regulation, the PACTE law, on 22 May 2019. The European Commission first proposed a MiCA regulation on 24 September 2020, with the Council of the EU adopting the draft regulation in November 2021.

The European Parliament adopted the draft on Monday 14 March 2022 by, and the  text is now subject to negotiations between the "trilogues" of the European Parliament, the Council of the EU and the Commission. When the draft MiCA regulation is adopted and the text published, it will come into force the following day and enter into effect 18 months later.

Harmonising rules

The MiCA regulation aims to harmonise and create rules regarding: 

• Transparency and disclosure for the issuance and admission to trading of crypto-assets.
• Licensing and supervision of crypto-asset service providers, token issuers and electronic money token issuers.
• Operation, organisation and governance of token issuers and crypto asset service providers
• Consumer protection.
• Prevention of market abuse.

Crucial questions and debate

The draft MiCA regulation is being negotiated and the text presents structuring issues for the future of the sector's participants in France and more widely within the EU.

The crucial issues in the debate, in particular for French digital asset service providers (DASPs), are the questions around: the proof of work, regulated activities and products, a grandfather clause, and own funds

Proof of work 

• What is the proof of work? The proof of work is a consensus used in particular by the first-generation blockchains on which crypto-assets such as Bitcoin and Ethereum are based. A blockchain using proof of work uses miners to verify incoming data on the register, validate the authenticity of transactions and create new blocks. However, this consensus is criticised as being very energy-intensive.
• Why is this issue central? During the debates in the European Parliament, an amendment was tabled to prohibit proof of work. This measure would have had the impact of prohibiting the mining or exchange of key crypto-assets such as Bitcoin.
• What is the solution in the draft MiCA regulation? In the draft regulation adopted by the European Parliament on 14 March 2022, this amendment has been deleted. This implies that trading and mining of crypto-assets based on first-generation blockchains would be possible. Furthermore, it would seem that the draft text, in order to take into consideration the issue of the environmental impact of crypto-assets, would suggest an inclusion of the latter within the taxonomy (applicable to financial services) by 2025. The Commission should, therefore, amend the taxonomy classification to include crypto-assets.

Regulated activities and products

• What activities would be regulated? The draft MiCA regulation would apply to issuers and DASPs. The draft text is not applicable to e-money, financial instruments and financial products (deposits and structured deposits) covered by Directive 2014/65/EU, knowns as the Markets in Financial Instruments Directive 2 (MiFID2), and securitisation as defined by Regulation EU/2017/2402. 

A crypto-asset could qualify as a financial instrument if it has the characteristics and substance of securities (including financial securities) as defined by Section C of annex 1 of MiFID2 and article 2(a) of Regulation EU/2017/1129, the so-called Prospectus 2 Regulation. In this respect, the work of the European Securities and Markets Authority (ESMA) will be decisive. Indeed, the ESMA will be in charge of proposing to the Commission the second-level measures – the regulatory technical standards – specifying in which assumptions a crypto-asset will be qualified as a financial instrument. Utility tokens issued in the context of initial coin offerings to raise capital may incorporate rights similar or even identical to those of a financial security (right to dividends, right to capital, right to governance of the legal vehicle of issue).

• What will happen to NFTs? It would seem that the draft regulation does not apply to non-fungible token (NFTs). Crypto-assets are considered to be non-fungible if they are not fractional and transferable directly to other holders without the issuer's permission, are accepted only by the issuer (including merchant loyalty programmes, represent intellectual property rights, guarantees, a certificate of authenticity of a unique physical asset or any other rights not related to those supported by financial instruments, and are not accepted for trading on a crypto-asset exchange). However, if some NFTs are traded for speculative purposes and listed on trading platforms, then they could be reclassified as security tokens.

Issuing tokens

The draft regulation distinguishes between electronic money tokens and the asset-referenced tokens; so who can issue asset-referenced tokens and electronic money tokens?

Electronic money tokens are defined as a means of payment whose value is stable by being referenced to the value of a legal tender. It would seem that crypto-assets such as the USD coin, or USDC, and tether, or USDT, would fall into this category.

However, the text provides that electronic money tokens that are backed by a fiat currency in the EU are considered as electronic money (within the meaning of Directive 2009/110/EC, the E-Money Directive 2. It would seem that crypto-assets referring to the euro would fall under this definition (such as EUR-L). In this context, issuers and distributors of this type of crypto-asset would be subject to all the regulations applicable to electronic money, which would require them to obtain other regulatory status (electronic money institutions (EMIs) or electronic money distributor).

The asset-referenced token notion is defined as "a type of crypto-asset that is not an electronic money token and that purports to maintain a stable value by referring to any other value or right or combination thereof, including one or several official currencies of a country". These will be asset-referenced tokens crypto-assets that do not fall under the definition of e-money tokens and that refer to:  

• any other value, which could be gold, for example (Tether Gold or PAX Gold);
• right (the nature of the rights in question remains to be specified); or
• a combination of these, including one or more official currencies of a country, so it is possible to question the qualification as asset-referenced tokens of crypto-assets such as the DAI (which aim to have a stable value by referring to several crypto-assets).

The draft regulation sets out the conditions for issuing asset-referenced tokens. Binding requirements have been defined, for example, with regard to own funds (which must correspond to the higher of €350,000, 2% of the average amount of reserve assets, and a quarter of the fixed overheads of the previous year), the internal control framework that must be put in place, the business continuity framework, etc.

The draft regulation also strictly regulates the possibility of issuing electronic money tokens. In the current version of the text, this type of tokens can be issued by:

• credit institutions, or entities exempted under the consolidated version of CRD IV (referred to in article 2(5), points 4 to 23), or EMIs;
• satisfying certain requirements applicable to EMIs; and 
• publishing a white paper.

The European Central Bank will have the power to authorise or refuse the issuance of these tokens (in particular with regard to the potential threat to the financial stability of the EU or to monetary sovereignty in the euro area).

Decentralised finance

What is the future for lending and borrowing on asset-referenced tokens or decentralised finance (defi)? To date, the draft regulation prohibits the generation of interest or any other benefit on asset-referenced tokens. Issuers and DASPs are prohibited from granting a benefit linked to the holding period of asset-referenced tokens.

Lending and borrowing transactions would potentially fall within the scope of this prohibition. These are loan-borrowing or similar solutions, allowing DASPs to pay interest to their clients through the custody of digital assets. These solutions are the preferred instruments of defi. Prohibiting these offers to optimise the return on client portfolios could potentially jeopardise the future of defi in the EU.

Grandfather clauses

Is there a transitional regime for DASPs registered or licensed in France? The draft regulation includes an article on transitional measures. DASPs providing their services under a national statute would be given a period of time to enable them to obtain the new PSAN (Prestataires de Services sur Actifs Numériques) license under EU law. However, the draft regulation provides that Member States could apply a simplified authorisation procedure for providers already authorised to provide crypto-asset services under national law. Applications for authorisation should then be submitted within six months of the entry into force of the text. Nevertheless, national competent authorities will have to ensure that certain applicable requirements are met.

This measure raises questions about its application in France. In particular, market participants are wondering about the practical modalities of implementation:

• Will France confirm the implementation of a transitional regime? 
• Which DASPs will benefit from the simplified authorisation regime? In particular, will registered DASPs be able to benefit from the simplified regime (to date 32 entities are registered as DASPs in France)?

How will the transition from the status of a DASP registered under the PACTE law, France's national regime, to that of a DASP authorised under the MiCA regulation be ensured?

Own funds

• What would be the level of capital required? The draft regulation specifies the capital requirements for DASP. The amount should be at least the higher between: a fixed amount set out in an annex IV to the draft MiCA regulation depending on the nature of the crypto-asset services provided, ranging from €50,000 to €150,000; and one quarter of the previous year's fixed overhead costs (updated annually). 
• What would be the potential impact of this measure? This measure reminds the capital requirement applicable to investment firms depending on the nature of the services offered and the scope of the authorisation. This requirement is likely to have a significant impact on registered DASPs and to limit access to the DASPs status under EU law.