The EU Approach to Regulating Digital Currencies

The Markets in Crypto-Asset Regulation (‘MiCA’) seeks to accelerate the uptake of distributed ledger technology (DLT), with privately issued cryptocurrencies among the token variants subject to MiCA, which are asset-referenced tokens (‘ARTs’) and e-money tokens (‘EMTs’). The non-binding text of MiCA’s recitals exempts fully decentralized cryptocurrencies without an intermediary (like Bitcoin) from this product regulation. At the same time, crypto-asset service providers (‘CASPs’) delivering certain crypto-asset services like brokerage, transfer, and custody of crypto-assets will be subject to licensing and supervision regardless of the extent to which the cryptocurrencies are decentralized.

Categorizing and Regulating Digital Currencies and Related Services

After introducing MiCA’s taxonomy, the paper provides an overview of the product rules on ARTs and EMTs. The regulation of ARTs can be seen as a rigid regulatory response to the Libra/Diem project that seeks to all but prevent large-scale global stablecoins. Compared to ARTs, the rules on EMTs are light-touch, piggybacking on large existing EU rules on e-money. The exemption of fully decentralized cryptocurrencies, as put forward in MiCA’s Recital 22, creates delineation issues and, if broadly understood, runs counter to the increase in (apparently) fully decentralized cryptocurrency schemes.

Furthermore, the basic pillars of MiCA’s CASP rules are laid out. Essentially, all CASPs are fiduciaries and subject to governance, asset segregation, and operational risk requirements. However, MiCA presupposes a crypto-insolvency law which is in its infancy. Second, MiCA’s activity-based definition of crypto-asset services reflects the state of play in 2020. It does not cover currency services that are important today, such as crypto-lending and crypto-staking. Some of these services may qualify, however, under EU fund regulation as collective investment schemes. Ironically, MiCA, which is designed to fill gaps in EU financial law, relies itself on general EU financial regulation to remove its own shortcomings.

Conclusions of the Paper: MiCA’s Approach to Digital Currencies

The unique feature of EU cryptocurrency law is that it neither follows the approach for securities, nor commodities, nor payments or credit institutions, but that it instead boasts the first, to our knowledge, bespoke set of rules for the two main types of privately issued cryptocurrencies: EMTs (in particular, traditional stablecoins) and ARTs (eg, the global stablecoin project Libra/Diem). As such, it combines regulatory examples from other types of financial regulation. The product rules for ARTs and EMTs combine features known from payment services and investment funds. In turn, the rules on CASPs provide for licensing and fiduciary duties, thus setting the stage for an understanding of CASPs as fiduciaries of the token-holders.

Like all regulations in times of speedy innovation, MiCA faced the risk of becoming outdated even before its entry into force, since the concepts are untested and innovation is ongoing and responsive to forthcoming regulation. To some extent, this risk has materialized due to the activity-based scope of crypto-asset service regulation in MiCA’s Title V, as crypto-lending and crypto-staking fall outside of MiCA’s scope. We welcome that more traditional concepts of EU financial law (namely, investment fund regulation), better tested by the winds of time and innovation, stand ready to fill some of MiCA’s gaps.

The difficulties regarding MiCA’s scope serve as an example of the more general issue of how to regulate innovation. Regulators could best address this issue using broad default rules asking for the application of traditional concepts of financial law (such as ‘securities’ or ‘transferable securities’), subject to regulatory waivers. While these rules may, from the outset, harm innovation, regulators can always waive the requirements upon application, albeit they will find themselves unfit to widen ex-post from the initially narrow scope of financial law.

The authors’ full article can be accessed here.

Dirk Zetzsche is a Professor of Financial Law (inclusive finance) at the University of Luxembourg.

Julia Sinnig is a Postdoctoral Researcher at the University of Luxembourg.