What is Markets in Crypto Assets (MiCA)? Europe's Crypto Law

On 20 April 2023, the long-awaited legislation finally came to life. Lawmakers in the European Union voted 517-38 in favour of the new crypto licensing regime. Being ratified by the European Parliament, MiCA became the first regulatory framework for crypto assets in the world. The Regulation will enter into force somewhere between mid-2024 and early 2025. 

The newly adopted piece of legislation means that the EU will have a unified approach to crypto asset regulation across all 27 Member States, making it possible for crypto companies approved in one country to basically ‘passport’ their business into others with only a minimal amount of required paperwork. 

However, to obtain that initial approval, crypto companies will have to face much higher standards of disclosure, including the preparation of a detail-oriented white paper for each crypto asset offered. Stablecoin issuers, for example, will be subject to even tighter rules. 

Since crypto markets are multi-jurisdictional, MiCA’s regulatory effects could contribute to the creation of a similar legal ecosystem for crypto assets in other jurisdictions as well.  

Additionally, the European Parliament also voted 529-29 in favour of a separate legislation known as the Transfer of Funds regulation which lays down another requirement for crypto operators.

From a landmark draft to ending the ‘Wild West’ - A brief history of MiCA

Late in June 2022, European Union officials managed to agree on a provisional version of the Markets in Crypto Assets (MiCA) framework. The world’s third broadest economy produced a piece of European crypto assets regulation – a landmark moment in the legal recognition of the legitimacy of cryptocurrency and crypto assets investment. The implications of that were examined in this Learn Crypto article: “What is the Threat of Crypto from Regulation?”.

In October 2022, the European Union (EU) came to agree upon the full legal text of this MiCA legislation, including an additional law that would spell out the identification processes of those using crypto to make payments. 

For 2 years the MiCA draft was the subject of many discussions. To avoid any doubts, the final rules were agreed upon last year. It took this long to clear a document of many pages through EU’s legal and translation services. 

However, a minor change happened in the beginning of 2022. A section that could have made it illegal for crypto services to deal in coins based on Proof-of-Work, the consensus mechanism used by Bitcoin and Ethereum. Opponents of this section argued that it would practically equate to a ban on Bitcoin and Ethereum mining in Europe. Instead of this ban, Lawmakers issued a compromise measure that asks crypto companies to report on their environmental impact.

Now that MiCA has passed the finish line, you probably wonder what happens next. Once the European Council approves it, ESMA, the EU’s securities regulator, will produce guidance on the details of how the law should be applied. 

There is some breathing room for crypto companies and Member States to catch up to the regulation and prepare for its coming into force. This article discusses that.

What happens before MiCA comes into force?

Such regulatory approaches are likely to influence changes in other countries or regions as well. Interestingly, MiCA’s adopted text intensely focuses on stablecoins which seems like a logical step after the Terra/Luna market crash and the Tether affair. The consequences of the fast-moving EU crypto-regulation are linked to the probability of a global export of the European-style crypto regulation without checking out whether ‘one-size-fits-all'. On the other hand, after the downfall of stablecoins, it was evident that particular safeguards should be put in place in order to protect investors and users. 

The EU is officially the first one to jump on the regulatory bandwagon, but others have been playing catch-up. The International Monetary Fund published its global financial stability report and called out cryptocurrencies for putting global financial stability at stake. The IMF singled out threats that crypto poses for national currencies, capital flows, money laundering risks, and bank disintermediation. The last one refers to one of crypto’s major advantages, namely removing the intermediary from the financial picture.

Another large economy has not been resting as well. In March 2022, Joe Biden issued an Executive order on ensuring the responsible development of digital assets, and therefore, asked Federal Agencies to report back on the crypto industry, specifically on consumer/investor protection, financial stability, illegal activity, innovation, competitiveness, and financial inclusion.

The US differs from the EU due to its so-called regulation by enforcement. Even though the US doesn’t have a comprehensive legal framework like the EU at the moment, its legal approach to crypto was very strict since the country tried to fit crypto assets into existing laws. Obviously, all broad economies have been moving in the same regulatory direction. Obviously, all broad economies have been moving in the same regulatory direction. 

Before explaining the novel crypto regulation, we should reflect on the interplay between crypto and regulation in general. Regulation of the crypto nature has been broadly considered a threat by the crypto community. Namely, the core values standing behind crypto are decentralisation, transparency, and sovereignty. Traditional financial institutions have been subjected through years to political whims, and crypto provided a decent alternative by offering to remove the middleman and allow users to take back control over their funds and data. In the eyes of regulators, crypto has been viewed as a tool for creating financial instability and illicit conduct, such as fraud and money laundering. The question that pops out is whether regulations could lead to crypto losing its core values, and the movement’s driving ethos to level the playing field.  

Before the stablecoin debacle, states mostly focused on the environmental aspects of crypto. The published versions of regulations globally will depend on the severity of the threat crypto poses for large economies in terms of how much countries could gain in the aspect of the sovereignty of monetary policy and their position in the crypto environment. Now let’s get down to MiCA. In this text, you will learn about the main characteristics of the EU crypto regulation and the legislation’s focus on stablecoins. Most importantly, we will deal with the manner in which it will affect the industry in Europe and crypto users as individuals. 

There is no simple answer to what is MiCA; MiCA is an extensive regulation that emerged as an answer to the question of what should have been done in order to avoid most legal problems stablecoins caused. While some parts indirectly reference the Tether scam case, the regulation is mostly concerned with simply ‘regulating’, namely raising new crypto asset service providers as obedient children of the digitalized EU’s internal market. Interestingly, the regulation singled out the threat asset-referenced tokens pose to monetary policy and sovereignty in light of central banks being able to act on such threats immediately. However, MiCA is not all about taking the DEFI reins since there are many industry and consumer-related benefits on the table as well.

MiCA’s main characteristics 

In contrast to the International Monetary Fund’s report on how crypto is putting the whole global financial situation at stake, EU officials think that there is no room for panic yet. As stated, the crypto-asset market is still modest in size and therefore, doesn’t pose a threat to financial stability at the moment. Having said that, adopting MiCA was a logical step toward the need to protect investors and consumers. Leaving the field unregulated or semi-regulated could hinder the development of the crypto market and leave holders of digital assets exposed to a number of risks.

Why does MiCA matter? First, MiCA’s approach is comprehensive, but not too strict. It seems that the EU truly seeks to become a global leader on the crypto market. It provides legal certainty and safeguards for consumers and investors, while supporting innovation. That is one of the biggest challenges when creating laws – being too mild or pushing too hard always ends up hindering innovation.

1. Reasons and Objectives behind the new regulatory framework: crypto asset service providers at play 

The novel legislation on crypto-assets was developed to introduce distributed ledger technology and digital asset regulation to the EU whilst safeguarding investors and users. As mentioned above, the first-ever licensing regime for crypto exchanges and wallets emerged with a number of requirements regarding stablecoins and stablecoin reserves to avoid market collapses. The 168-page document presented a strong focus on types of crypto assets such as stablecoins and crypto asset service providers.

MiCA’s main objectives can be listed like this:

• Legal Certainty: MiCA aims to provide clear legal definitions and norms for a plethora of crypto assets to reduce ambiguity for investors, consumers, issuers and market participants.
• Investor & Consumer Protection: The regulation seeks to protect investors and consumers by making sure that crypto assets are only offered to the general public after meeting certain requirements, including disclosure of information and risk warnings.
  
• Market Integrity: By setting out rules for market conduct, MiCA aims to enhance market integrity and prevent forms of competition abuse.
  
• Innovation: The new piece of EU legislation wants to enhance innovation within the crypto industry by laying down a harmonised regulatory framework.
  
• Risk Mitigation: MiCA is about mitigating risks associated with the use of crypto assets such as money laundering, by imposing clear obligations on crypto service providers and increasing the powers of national regulators.
  

As stated by the document itself, a clear and transparent framework had to be produced in order to enable crypto assets service providers the possibility to scale up their business and run their ordinary business and cross-border activities smoothly. The regulation should be able to provide equal opportunities for market entry, financial stability, a secure payment system, and less monetary policy risks.  

The new rules may be burdensome for a number of issuers or crypto-asset service providers as it imposes multiple obligations, liability rules, and requirements to draft a bunch of legal documents and introduce procedures. However, the main regulatory objective is reflected in the need to increase the reception of crypto products while decreasing the monetary risks we have encountered in the past.

2. Subject matter, scope of application & legislative approach 

MiCA’s subject matter and scope of application have been dealt with in articles one and two. The regulation’s subject matter can be illustrated as laying down uniform rules for the offering and placing on the market of crypto assets in the light of transparency, disclosure requirements, authorization and supervision, protection of investors and consumers, and measures to prevent anti-competitive behaviour in the crypto market.  

Keep in mind that particular crypto assets have been regulated by former EU legislation. Therefore, MiCA explicitly excludes crypto assets that may qualify as financial instruments as defined by Directive 2014/65/EU, as deposits defined under Directive 2014/49/EU, as funds according to the definition given by Directive 2015/2366/EU other than e-money tokens, as securitization positions in the light of Regulation 207/2402 and as non-life or life insurance contracts or social security schemes. Sounds complicated but it won’t seem like that when we state to which assets MiCA actually applies. And forget about lending or borrowing since this Regulation explicitly excludes these activities as well.

MiCA leaves out several digital assets outside its scope. These are non-fungible tokens, security tokens and decentralised finance (DeFi) as a whole. All these variables either already have their own regulation in accordance with their legal nature as in the case of security tokens, or they encompass specific features that require lawmakers to carry out further analysis to figure out a suitable regulatory framework.

In simple terms, this piece of regulation applies to natural and legal persons and other undertakings that are dealing with the issuance, offer to the public, and admission to trading of crypto assets or that provide services related to crypto assets in the EU’s internal market, others than those that have been decisively excluded. The document mentions three sub-categories to which it strictly applies and these are: 

• Utility tokens 

The regulation applies to utility tokens that are issued with non-financial purposes to digitally provide access to an application, resources, or services available on the blockchain. 

• Asset-referenced tokens 

MiCA definitely applies to asset-referenced tokens or in other words, to tokens that aim to maintain a stable value by referencing several currencies that are legal tender, one or several commodities, one or several crypto-assets, or a basket of such assets, and act as a means of payment to buy goods and services. As can be seen from the definition, we are talking about notorious stablecoins. 

• E-money tokens 

Finally, the legislation applies to e-money tokens or crypto assets with a stable value based on only one fiat currency that aims to function similarly to electronic money. E-money tokens are also considered stablecoins. In the part of the regulation that talks about exclusions, it has been mentioned that such tokens cannot be considered deposits and are excluded from MiCA’s scope of application.

The EU decided to take on an interesting legislative approach by making definitions as wide as possible. Whilst the law has always been associated with clear, direct, and narrow definitions that have been elaborated, whether through case law or expert opinion, the legislator decided that this time we should probably find a way for the law to stop losing the race against technology. Thus, MiCA directly mentions in its explanatory part that crypto assets, e-money tokens, and distributed ledger technology should be defined as widely as possible to capture all types of it that may fall under the current scope of the EU’s legislation.

The regulation further backs up our above-mentioned assumption about a new approach. Namely, any novel legislation adopted in the field of crypto assets should be specific, future-proof, grounded on an incentive-based approach, and able to keep pace with innovation and technological developments. Now we have a narrowly applicable legislative proposal with so many wide definitions. Maybe it was a marathon after all, and now the slow and steady one changed the strategy to succeed.

MiCA’s main focus: All eyes on stablecoins 

As already pointed out, MiCA focuses heavily on the so-called stablecoins. Before we got our hands on the European legislative proposal, we talked about stablecoins and regulatory developments following the Terra collapse. Then came the Tether scam and stablecoins rapidly got a bad reputation. Even though the European Commission considers the crypto market still relatively small, such affairs have the power to disrupt the stability of the internal market. The EU solution can be understood as stablecoins getting another chance.  

The regulation doesn’t define stablecoins on their own, yet it covers two types that are usually described as stablecoins, namely asset-referenced tokens and e-money tokens. For a better comprehension of the document, we have to be able to tell them apart. Hence, asset-referenced tokens refer to several fiat currencies, one or several commodities or one or several crypto assets, or a combo of such assets (referred to as ‘reserve assets’), and e-money tokens refer to one single fiat currency. The line of distinction is drawn in relation to whether the European Banking Authority (EBA) considers stablecoins to be ‘significant’ under certain criteria. Significant stablecoin issuers have to comply with strict investor, capital, and supervisory requirements and create a bunch of legal documents and procedures to safeguard European investors and consumers. MiCA explicitly includes the regulation of the so-called algorithmic stablecoins.

If you are a stablecoin issuer, MiCA wants a cartload of things from you. To avoid another Tether-like affair or Terra-like market collapse, the regulation states many times that information given to token holders and investors have to be clear, fair, and not misleading by prescribing how the white paper and other policy documents should look like. While the creation and publishment of a white paper that fulfils all required criteria may seem central, issuers need to provide information on an ongoing basis as well, specifically in relation to the amount of asset-referenced tokens in circulation and the value and composition of reserve assets on their official website, along with clear policies, governance arrangements, recovery and redemption plans and complaint handling procedures.  

Stablecoins’ reserves: Honesty is the best policy

Finally, we are down to reserves. Fun fact: Tether messed up royally when it came to the subject of reserves. The issuer in question said stablecoins were backed completely and all the time, yet the New York Attorney General found that it wasn’t true. Thus, the EU regulators added special parts about reserves. To cover their liability, issuers should constitute and maintain a reserve of assets matching the risks reflected in such issuers’ liability against holders. Asset reserves should be consistent and prudently managed in such a manner that the issuer doesn’t face currency and market risks. To sum it up, the reserve must amount at least to the corresponding value of tokens in circulation, and reserve changes should be adequately managed to avoid unfortunate consequences. Hence, not playing by EU rules, whether marketing stablecoins at the same time in Europe and third countries or not, leads to liability issues. 

Yet, that is not all you have to know about reserves. MiCA requires the creation of an adequate custody policy for managing reserves and ensuring that the reserve assets are fully segregated from the issuer’s personal assets, that they are not hindered or pledged as collateral, and that the issuer has prompt access to such reserve assets. It seems that the EU regulators have been carefully observing the Tether affair. Furthermore, MiCA prescribes specifically that reserve assets should, depending on their nature, be kept in custody either by a credit institution, or an investment firm, both authorised by certain EU Directives, or by a crypto-asset service provider.

The crypto market and community have been rapidly growing due to the rise of decentralised finance. MiCA doesn’t regulate DeFi per se, but in about 18 months, the European Commission will publish a detailed report on DeFi to take further legislative steps to regulate it. One thing is for sure; requirements for legal presence and not operating in gray zones are here to stay. 

What are the potential industry effects? 

When there is something new that should be dealt with, we often stumble upon the issue of overregulation. While leaving an area unregulated or partially regulated leads to many problems associated with gray zones, legal loopholes, and legal uncertainty, so does overregulation. The legal theory has spoken many times of such situations, pointing out that burdening excessively with rules and regulations stifles development. Thus, creating a legal document means finding a fine balance between burdening and requiring compliance and leaving enough room for innovation and industrial progress. 

MiCA’s creators were well aware of this, and decidedly stated the price of overburdening the industry by highlighting the importance of avoiding undue administrative burdens. Specifically, small and medium-sized enterprises and start-ups should not be subjected to disproportionate and excessive administrative burdens. Furthermore, offers to the public of crypto assets, other than asset-referenced tokens and e-money tokens that don’t exceed an adequate aggregate threshold over a period of 12 months should be excluded from the requirement to create a crypto asset white paper. The main goal after all is to provide a competitive market where offers of crypto assets enable innovative and inclusive manners of financing, especially in relation to small and medium-sized enterprises.

MiCA additionally lays down a set of market abuse rules modelled after the existing rules for the traditional capital market under EU’s Market Abuse Regulation. In other words, the new Regulation sets out a duty of issuers, offerors and persons seeking admission to trading to refrain from insider dealing, unlawful disclosure of inside information and market manipulation.  

To remain compliant with the proportionality principle, lawmakers decided not to transfer the full set of rules from the Market Abuse Regulation to the crypto market to avoid suffocating it in its early stage of development.

What is the Transfer of Funds Regulation (TFR)?

The Transfer of Funds Regulation is a vital piece of EU legislation that sets out rules for financial institutions to prevent money laundering and terrorist financing. Such laws usually require financial institutions to identify and verify the identity of their customers, monitor their transactions, and report suspicious activities. 

In relation to crypto, the Regulation in question implements the ‘Crypto Travel Rule’. This rule is designed to address the challenges of combating money laundering and terrorist financing in the cryptocurrency industry, where transactions can be executed anonymously and across borders of many states.  

The Travel Rule wants to ensure that cryptocurrency transactions are conducted in a transparent and traceable manner, similar to the Transfer of Funds Regulation within the traditional financial sector.

How can MiCA benefit me as a consumer? 

The document’s primary focus, aside from stablecoin regulation, is centered around consumer and investor protection. From simple requirements such as increasing transparency and regulatory oversight to opening the question of liability, MiCA is all about increasing consumer welfare which may lead to wide adoption and use of crypto assets in the future. Particularly, consumer protection obligations will apply to the matters of issuance, exchange, trading, and custody of crypto assets to lay down a secure environment for consumers on European soil.

The EU market is a broad internal market with approximately 450 million relatively wealthy consumers. Due to the sheer size of its market, MiCA coming into force could easily persuade many companies around the globe to adapt the Regulation’s operating standards to maintain globally streamlined digital services and products.

There are a number of consumer-related provisions under MiCA, such as the requirement for crypto asset issuers to continuously act in the best interest of asset holders, and the right to withdraw without incurring costs or explanations up to 14 days after the purchase of assets. Therefore, MiCA benefits consumers by giving them something new, namely a bundle of rights for their protection. Apart from the above-mentioned rights, issuers, and service providers will be obliged to disclose pricing policies and complaint handling systems or face liability otherwise.

With MiCA coming into full effect, unregulated, offshore companies won’t be able to actively target consumers within the EU. This is also due to the recent FTX affair, along with stricter reserve solicitation rules than in traditional markets. One of the reasons behind MiCA’s initiative to protect consumers who buy crypto or engage with crypto asset services refers to the need to prevent the worst affairs experienced during the 2017-2018 ICO craze.

MiCA was seamlessly created to align the objectives of consumer protection, market integrity, and financial stability by learning from past misconduct in the crypto community. Present-day legal systems are more than ever linked to the rise of competitive markets with a high degree of consumer protection rights. For instance, competition law in the times of the 4th industrial revolution is intertwined with consumer protection. Consumers won’t face any problems with MiCA going into full effect as they can only benefit from it. After all, it is easier to invest, purchase and use something if you know where you stand.