EU encryption regulation bill passed, US alarmed

Author: Gyroscope Finance

Currently, global crypto regulation is floating like a duckweed, with major crypto country, the United States, wavering between the SEC and CFTC, while Singapore, India, Japan, and other regions are still exploring. Despite Hong Kong’s positive policies, its independence is in doubt.

The much-anticipated EU Markets in Crypto-Assets Regulation (MiCA) was finally settled on May 16th.

Although the scheme was voted through at a plenary session of the European Parliament on April 20th, it wasn’t until May 16th that the Council of the European Union, comprising 27 member states, unanimously approved the MiCA Act, officially announcing the world’s first regulatory mechanism for virtual assets with the most complete regulation and the clearest framework.

Currently, global crypto regulation is floating like a duckweed, with major crypto country, the United States, wavering between the SEC and CFTC, while Singapore, India, Japan, and other regions are still exploring. Despite Hong Kong’s positive policies, its independence is in doubt.

Against this backdrop, the EU’s move undoubtedly provides a typical demonstration for global virtual asset regulation and has extremely significant milestone significance. Moreover, this regulation means that virtual asset compliance has opened the curtain on the world stage and legal certainty will drive rapid development in the crypto industry.

01. Why the EU?

After the passage of the bill, many people had this question. In fact, in the global crypto market, Europe is not an important player, and its market share is not high compared to Asia and North America. Citing the CryptoComBlockingre exchange review report for December 2022, European exchanges accounted for 5.4% of monthly trading volume in global exchanges, lower than Asia (83.3%) and North America (10.6%), but it was the first to launch a crypto framework.

From a historical perspective, European crypto regulation has gone through a phase of exploration to in-depth understanding:

The initial exploration began in 2015, when cryptocurrencies were in a period of rapid development, but the main market was led by China. At that time, Europe was skeptical about the nature of crypto assets, and the European Court of Justice ruled that cryptocurrencies such as Bitcoin were not financial instruments but legal tender, so they did not need to pay value-added tax.

This situation continued until 2018, when the European Commission issued the Fifth Anti-Money Laundering Directive (5AMLD), which brought cryptocurrency asset service providers (CASP) within the scope of anti-money laundering and counter-terrorism financing regulation, requiring them to conduct customer due diligence, report suspicious transactions, and retain transaction records.

Under this directive, countries in the European Union began to take different paths. Countries with a leading mindset, such as Germany, Austria, Malta, and Lithuania, have opened up exclusive virtual asset licensing systems, while some countries monitor the cryptocurrency field mainly through anti-money laundering means. There are also completely unregulated areas, and the regulation presents a fragmented and chaotic situation. Institutions need to apply for compliance licenses or regulation in different countries. Due to the universality of the EU license, this brings space for regulatory rent-seeking, and regions such as Lithuania that are easier to obtain licenses have become the main focus of exchanges and other institutions.

In 2019, the European Banking Authority (EBA) released a report stating that due to the fact that cryptocurrency assets are largely not subject to EU legal jurisdiction and constitute significant consumer protection and money laundering risks, the Commission should take action. After Libra sparked controversy over private currency and legal tender, the EU continued to prudently regulate cryptocurrencies and decided to use them first in the formulation of technological regulatory standards.

In September 2020, the European Commission proposed the Market in Crypto-assets Regulation (MiCA) and the Digital Operational Resilience Act (DORA), aiming to establish a unified regulatory framework for crypto-assets and crypto-asset service providers, regulate the classification, definition, issuance, trading, supervision, etc. of crypto-assets, and require crypto-asset service providers to comply with higher technical and operational standards.

In June 2021, the European Commission issued the Sixth Anti-Money Laundering Directive (6AMLD), which further expanded the scope of money laundering and counter-terrorism financing offenses and increased the punishment for conspiracy crimes, environmental crimes, tax crimes, etc.

With the improvement of regulations and the development of the crypto market, the penetration rate of the EU market is also constantly increasing. According to the Chainalysis 2022 Global Cryptocurrency Adoption Index, the EU ranks fourth among 154 countries and regions worldwide, second only to Vietnam, India, and Pakistan. Against this background, in October 2022, the European Parliament committee passed the MiCA Act and the amended Funds Transfer Regulation (TFR), the latter requiring cryptocurrency asset service providers to provide identity information of the transferor and the payee when transferring cryptocurrency assets, in order to facilitate tracking and monitoring of suspicious transactions.

In April 2023, the European Parliament voted on the final version of the MiCA bill at its plenary session and officially incorporated it into EU law.

Throughout the entire development process, as the understanding of the crypto industry gradually deepened and the market pushed for it, the EU’s regulatory requirements for it continued to increase. Following the Libra incident, the increase in regulatory requirements, the absence of unified regulations, the fragmentation of existing regulations, and the maintenance of dominance all contributed to the EU’s proposal of MiCA. However, more importantly, the market’s current situation of small market share and high adoption reduced the resistance to the power distribution of the construction of the European crypto regulatory mechanism. This was particularly evident in the US, where the two major regulatory agencies were in a stalemate, with the struggle for dominance being a reason for the contestation of the authority of the crypto industry.

02, Scope of Application of MiCA

From the perspective of the scope of application, the main crypto assets covered by MiCA are divided into four categories: traditional crypto assets, asset reference tokens, e-money tokens, and other crypto assets.

Crypto assets are the most intuitive category for users, which can be transmitted and stored electronically through distributed ledgers or similar technologies, with digital representations of value or rights, such as the well-known BTC and ETH.

Asset reference tokens (ARTs), as the name suggests, maintain stable value by referencing the value of several legal tenders, one or several commodities, one or several crypto assets, or a combination of the above-mentioned assets. This category includes all crypto assets that do not meet the conditions of “e-money tokens”. The key criterion is that ARTs maintain stability based on the value of legal tenders. Taking Digix (DGX) as an example, a typical asset reference token, it is backed by an equal amount of physical gold stored in a vault.

E-money tokens (EMTs) differ from ARTs in the configuration of the underlying assets that support prices. ARTs use non-cash assets or a basket of currencies, while EMTs mostly use a single currency and are closer to the concept of e-money.

Other crypto assets that are not considered ARTs or EMTs, such as “utility tokens”, are defined as providing digital access to a certain commodity or service, provided on a DLT, and are only accepted by the issuer of the token. Unlike security tokens, they are not considered financial instruments in most countries and only need to comply with anti-money laundering rules to be used.

It should be noted that MiCA does not directly include NFTs and the DeFi sector, but according to industry insiders, the issuance of large series and collections in the NFT field will also be included.

In terms of regulatory entities, the European Banking Authority and the European Securities and Markets Authority are the main bodies at the EU level, while the European Central Bank is in charge of stablecoin regulation, and designated regulatory agencies in each country cooperate with EU-level implementation. It is worth noting that MiCA does not apply to the European Central Bank (ECB), central banks of each country, the European Investment Bank, the European Financial Stability Fund, the European Stability Mechanism, and public international organizations.

There are different regulatory requirements for different asset issuers.

For ART issuers, approval from the national regulatory agency must be obtained in advance. The basic requirements are that the entity must be registered in the EU, have a minimum of 2% of its own funds of the total issue amount, and have a sound risk management framework for reserve management, such as custody and hot and cold wallets.

EMT issuers are limited to certified electronic money institutions (EMIs) or credit institutions. Compared with ART, the requirements are relatively broad, and only notification obligation to the regulatory authority is required. The basic requirements are the same as those for ART, but interest payments to holders of such tokens are prohibited for the protection of monetary sovereignty. The protection of monetary sovereignty runs through these two major categories. If daily associate transactions exceed a certain limit (1 million for ART and 200 million euros for EMT), the issuer will stop issuing the token.

The most complicated category is the cryptocurrency asset service provider, which is subject to different regulations for different entities. For example, traditional securities brokers do not need licenses to provide crypto brokerage services. However, companies involved in cryptocurrency custody, trading platforms, fund deposits and withdrawals, storage, trading orders, and asset management must obtain CASP (crypto-asset service provider) licenses from the national supervisory authorities in the EU.

In addition to basic requirements such as governance, asset custody, complaint handling, outsourcing, clearing plans, and information disclosure, cryptocurrency asset service providers must maintain minimum own funds for life, with trading platforms requiring 150,000 euros, custodians and exchanges (brokers) requiring 125,000 euros, and other categories requiring 50,000 euros.

However, for cryptocurrency providers, this capital requirement is just the tip of the iceberg, and other implicit compliance requirements are more difficult. Some industry insiders have expressed dissatisfaction with this, believing that strict rules increase administrative burdens and do not conform to the actual meaning of cryptocurrency. For example, the EU authorities’ mandatory special review of self-custody wallets exceeding 1,000 euros ($1,097) undermines the anonymity that cryptocurrency should have.

03, “Anxiety” in the United States

Although there are still issues such as anonymous disputes, increased administrative burdens, and the lack of DeFi and NFT regulation, the overall content of this regulatory bill has preliminarily constructed a complete, implementable, and mechanism-transparent cryptographic regulatory norm. It not only breaks the current situation of independent countries having their own court, establishes a regulatory coordination scheme, but also creates strong conditions for consumer protection, further promoting innovation and development in the field of cryptography.

For cryptocurrency service providers, obtaining CASP means that they can legally provide cryptocurrency services in all 27 member states of the European Union, and unlicensed offshore exchanges were previously required to exit the market, leaving more room for domestic service providers. However, on the other hand, the inevitable increase in compliance operating costs will force some exchanges to leave the EU.

It is reported that after a transition period of 18 months, MiCA will be officially implemented in January 2025, but the rules for stablecoins will begin to be implemented after a transition period of 12 months, and are expected to take effect from mid-2024.

“The United States is already alert, and Patrick McHenry, chairman of the US House Financial Services Committee, clearly stated that the European Union’s new cryptocurrency regulation MiCA puts the region in a leading position in Web3 technology. “The Europeans have a technologically advanced legal path, reflecting America’s backwardness. In terms of technological deployment, we should be the world leader, not lag behind Europe.”

Coincidentally, the Hong Kong Securities and Futures Commission recently issued the “Guidance on Cryptocurrency Trading Platforms”, which further clarified the regulatory path for virtual assets, and the complementary regulatory patterns between the mainland and Hong Kong are becoming increasingly prominent.

Only in terms of encryption, due to the unique combination of technology and financial attributes, blockchain is not a competition at the level of artifacts, but a comprehensive competition in the direction of institutions. Whoever becomes the place for policy decisions first has a first-mover advantage. In this context, small areas that can flexibly turn are naturally more advantageous than large countries. Hong Kong, Singapore, and Dubai have already begun to dance with long sleeves, and the EU’s sudden joining has further pressured the large countries that have not yet acted.

And for the United States, which is still in the center of power struggle, it seems that falling behind is far more than just one step.

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