The regulatory environment for the crypto ecosystem has generated significant drag for both the industry’s development and overall crypto adoption. Last month, a large step toward regulatory clarity took place, as the EU Parliament finalized a sweeping set of rules aimed at bringing more certainty and standardization to the crypto market in Europe. The Markets in Crypto Assets (MiCA) regulation is the world’s most comprehensive regulatory framework for crypto assets created to date. Its approval will provide a better regulatory environment for the European crypto market, and will help reduce regulatory arbitrage among member states.
Is this proactive approach to crypto regulation a stroke of political genius?
Some observers have suggested that by approving this new regulatory framework before the US and UK, European politicians have set the EU up to attract more investment and new entrepreneurs in the crypto space. Only time will tell if this ends up being true, but while there are aspects of the regulation that can be improved (more on this below), we do believe that in the near term MiCA’s comprehensive framework is giving the EU an advantage over the US and UK when it comes to being a desirable place for crypto businesses.
What is MiCA?
MiCA was proposed in 2020 as a way to ensure that crypto businesses, market participants, and investors in the EU understand the rules of the road for crypto assets. The EU Parliament overwhelmingly approved the new regulation on April 20, 2023 by a vote of 529-29. MiCA covers both crypto asset issuers as well as service providers, and its intention is to protect consumers without disrupting innovation. The regulation will take effect over the next two years.
MiCA classifies crypto assets into a number of different groups, including Asset-Referenced Tokens (ARTs), E-Money Tokens (EMTs), and Utility Tokens (UTs). Under the regulation, stablecoin issuers must be authorized by the Central Bank and meet certain requirements. Crypto Asset Service Providers (CASPs) are also required to be authorized and subject to governance and liquidity rules. MiCA does not apply to security tokens or unique non-fungible tokens (NFTs).
MiCA brings many positive elements...
Our positive sentiment toward MiCA is shared by most of the crypto industry, which was overwhelmingly pleased that the regulation was more constructive than initially thought and avoided misguided ideas like banning mining or requiring wallet registration.
There are five areas where we think MiCA is really going to shine.
First, it will provide much more regulatory clarity. The EU’s unified approach to crypto regulation across all member states will in theory allow companies to operate seamlessly across the EU.
Second, MiCA provides more transparency. Any entity that wants to offer a crypto asset must have a detailed white paper that discloses information about the asset, its use, rights associated with it, and risks.
Third, MiCA will make digital assets more attractive to institutional investors and large corporations that have avoided the space because of regulatory uncertainty.
Fourth, there will be better oversight as CASPs will be subject to liquidity and other requirements and stablecoins will need to keep reserves segregated from their own assets.
Finally, the new regulation will be a standard-setting initiative that will have a “Brussels effect”, allowing other countries and regions to take similar approaches to crypto asset regulation.
Beyond these five items, it’s also important to note how this is setting the EU apart from the US and UK in particular. In the US, the SEC has taken a regulation-by-enforcement approach, even for the industry’s largest, regulated, and generally conservative businesses (i.e., Coinbase).
And while over 10% of British citizens have invested in crypto, the UK government has been slow to actually put forth actual rules for the sector (in spite of recent positive initiatives). Now, the EU has provided a blueprint that can be replicated elsewhere. Hopefully, this will spur more legislative and regulatory activity in the US and UK.
…but also got a few things wrong in our view.
While MiCA helped clean up the room, it left its closet messy by missing a few key elements to this industry that we think need to be considered.
For example, it does not provide guidance on DeFi (Decentralized Finance), staking, and lending. DeFi is one of the most promising areas of crypto—it has massive potential to disrupt existing banking and financial services with more client-centric products; transparency in fees and risks borne by investors; and accessibility to a broader public.
DeFi is one of the obvious crypto verticals where banks, financial institutions and service providers will leverage crypto assets, especially through the tokenization of traditional financial assets, as JPMorgan has said that “tokenization is a killer app for traditional finance”; and connecting them to DeFi protocols.
CASPs might find themselves dealing with uncertainty in these areas as a result, so some regulatory clarity for DeFi would have gone a long way. This is something we have seen in Brazil, where the Central Bank took the courageous and forward-looking view that DeFi is here to stay and should be at the core of the regulatory effort. They built the crypto asset regulatory framework with a view that it would need to leverage and live with DeFi in the future.
In France, the Central Bank recognizing that “...the regulation of disintermediated finance cannot simply replicate the systems that currently govern traditional finance” is currently considering an approach that may be instructive; drawing on non-financial regulations, such as those governing product safety, it would put the burden of regulatory compliance on the DeFi product directly, thus only such ”safe products” would be manufactured or distributed in the region.
Broadly, Europe has been doing well in crypto ETP offerings and has one of the most vibrant environments for collateralized crypto ETPs. However, there is a lack of guidance in MiCA for ETFs/ETPs, which will make it more difficult for investment fund providers to navigate the regulatory landscape.
We also think MiCA does not go far in helping connect the current financial infrastructure with crypto. If Europe is to win in the technology and blockchain wars, it should be because of its strong financial sector, not despite it. A path in MiCA to enable crypto investment managers to operate under the existing UCITS rules would have been a fantastic signal to investors that the regulation and protection of traditional finance extend to their crypto investments.
Finally, there is much conversation around all the bad so-called crypto investment products retail investors can access online, but unfortunately very little is said about how hard it is for the same retail investors to access regulated financial products in trusted channels through their brokers, banks, or wealth managers. Banks, retail investment platforms, and wealth managers are missing out on the opportunity to build a business for their clients - a BCG report in 20223 found that about 95% of crypto wealth is bypassing traditional wealth management channels.
MiCA failed to end the de facto two-tiered regimes where clients can easily access all sorts of tokens on exchange platforms, but nothing within the regulated and trusted channels of the banks and investment platforms they use.
Is MiCA a sign of things to come?
We do think MiCA is helping to spur regulatory activity on this front. We are already seeing policymakers outside the EU acting to create their own crypto asset frameworks.
A week after MiCA’s approval, the chair of the US House Financial Services Committee stated that broad crypto legislation will be introduced this summer4 and the UK government just closed the comment period on its flagship crypto regulation framework5.
For now, the EU is in the pole position and is poised to benefit from its regulatory leadership. However, if Europe is to win the war to be the preferred geography and standard-setter for crypto assets, we believe it has to move fast—and iterate faster.
The EU’s first mover advantage is a big one, but it’s only one battle in a war that is not constrained by geography. In other words, governments across the world are competing to give the crypto industry the regulatory clarity it needs to thrive. The EU can’t afford to idle if it wants to stay ahead of the pack.