After more than 2 years of long and intense discussions between EU lawmakers, on 20th of April 2023, the long-awaited Regulation on Markets in crypto-assets (MiCA) was finally adopted by the EU Parliament paving the way for the EU to become the first major jurisdiction with the comprehensive regulatory framework on crypto-assets.

Intended to become a backbone of the EU regulatory framework on crypto-assets, MiCA creates a common set of rules applicable to issuers and offerors of crypto-assets as well as persons looking to engage in the provision of regulated crypto-asset services in the EU (like crypto-exchanges, wallet providers etc.). Alongside MiCA, the EU Parliament has also adopted the Transfer of Funds Regulation that will introduce the FATF Travel Rule for crypto-transactions and ensure that crypto transfers, same as other financial transactions, can be traced based on the mandatory exchange of relevant information about the beneficiary and the originator of the transfer.

In this first part of our three-part series “Navigating MiCA” we provide an overview of the new EU regulatory framework on crypto-assets, its scope of application and the expected timeline.

Background

Ever since the ICO boom in 2017, the EU was lacking a harmonized regulatory framework on crypto-assets. In this absence of a common approach to regulation of crypto-assets at the EU level, individual Member States have been trying to create national frameworks that would address the gaps in regulation and supervision of this rapidly evolving industry in their respective jurisdictions. In this process, some jurisdictions like Malta have used the opportunity to position themselves as crypto-friendly jurisdictions, some have only applied AML/CTF registration regime to crypto-companies (like Ireland) while some others like Germany, have been expanding the scope of application of the existing financial services regulations to entities engaging in the provision of crypto-asset related activities.

With the aim of bridging these divergences in national frameworks, the EU Commission has proposed MiCA as part of its Digital Finance Package in September 2020. Aimed to become a cornerstone of regulation of crypto-asset, MiCA introduces a harmonized set of rules that aims to create a level playing field for issuers of crypto-assets and crypto asset service providers operating within the Union that shall enable them to explore the full potential of the EU Single Market.

Taxonomy of crypto-assets

MiCA contains a very broad definition of a crypto-asset by defining it as any digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology.

Given that different types of crypto-assets pose different risks to investors, MiCA introduces a common taxonomy of crypto-assets by differentiating between the following three groups of crypto-assets in relation to each of which a separate set of regulatory requirements will apply:

a) Asset referenced tokens: crypto-asset that is not an e-money token and that purports to maintain a stable value by referencing another value or right or a combination thereof (e.g. commodities, other crypto-assets etc.), including one or more official currencies.

b) E-money tokens: crypto-asset that purports to maintain a stable value by referring to the value of one official currency (for instance EUR, GBP or USD).

c) Other crypto-assets: a catch all category that aims to cover all other crypto-assets such as crypto-currencies (Bitcoin, Ether etc.), various types of investment and utility tokens provided that they do not qualify as transferable securities under existing financial regulations applicable in the EU.

Crypto-assets that qualify as other regulated instruments under existing financial regulations in the EU, such as transferable securities, structured deposits, e-money or securitizations, will remain outside the scope of the new regime. Further crypto-assets that will remain outside the scope of MiCA include digital currencies issued by central banks (the so-called central bank digital currencies “CBDCs”) or by other public international organizations (such as the International Monetary Fund).

The new requirements under MiCA will not apply to utility tokens that provide access to an existing good or service, enabling the holder to collect the good or use the service. That being said, the use of utility tokens for the purposes of fundraising for the development of future infrastructures for the provision of goods or services to token holders will still be under the scope of the new rules. Further, by replicating the existing exclusions under the PSD2 framework, new regime will not apply to tokens that grant the token holder a right to use them in exchange for goods and services in a limited network of merchants with contractual arrangements with the offeror. It is noteworthy that the aforementioned exemptions automatically cease to apply when the offeror of crypto-assets or another person acting on his behalf communicates an intention to seek admission to trading for exempted crypto-assets or once exempted crypto-assets get admitted to trading on a trading platform.

What about NFTs?

Whether the so called non-fungible tokens (NFTs) will be regulated under MiCA was a topic that was subject to a lot of speculation in the industry and policy-making circles in recent months. In the end, tokens that are unique and not fungible based on their key characteristics were left outside the scope of MiCA.

However, by taking substance over form approach, EU lawmakers have clearly pointed out that the sole attribution of a unique identifier to a crypto-asset is not sufficient to classify a token as a unique or not fungible. Therefore, the issuance of crypto-assets as fractional representations of an NFT or NFTs in a large series or collection will be considered as an indicator of their fungibility and such tokens would be deemed as regulated crypto-assets under MiCA.

Scope of application of the new regime

MiCA introduces a single set of common rules applicable to persons that are engaging in the issuance, offer to the public and admission to trading of crypto-assets or that provide regulated services related to crypto-assets in the EU.

Prior to offering regulated crypto-assets to the public, the offerors will need to comply with a number of transparency, disclosure and notification requirements that are aimed at ensuring that prospective investors in the EU are provided with sufficient information about the characteristics, risks and rights and obligations attached to crypto-assets, before making their investment decision. Further, offerors of asset-referenced and e-money tokens will need to comply with certain additional transparency and disclosure requirements and their issuers will need to meet strict authorization requirements that EU lawmakers have designed with the aim of creating a bespoke regulatory framework for stablecoins.

MiCA also introduces a long list of requirements that will apply to crypto-asset service providers (CASPs) who are defined as legal persons (or other undertakings) whose occupation or business is the provision of one or more of the following crypto-asset services to third parties on a professional basis:

• The custody and administration of crypto-assets on behalf of third parties;
• The operation of trading platforms for crypto-assets;
• The exchange services (crypto-fiat, fiat-crypto, crypto-crypto)
• The execution of orders in crypto-assets on behalf of third parties placing crypto-assets;
• The reception and transmission of orders for crypto-assets on behalf of third parties;
• Placement of crypto-assets’ which includes the marketing, on behalf of or for the account of the offeror or a party related to the offeror, of crypto-assets to purchasers;
• Portfolio management service in relation to crypto-assets;
• Transfer services for crypto-assets on behalf of clients’ that include transfer of crypto-assets on behalf of a natural or legal person, one distributed ledger address or account to another; and
• The provision of advice on crypto-assets.

Prior to starting with the provision of regulated crypto-asset services to customers in the EU, prospective CASPs will need to apply for authorization from the national competent authority (NCA) in the EU Member State of their establishment. In order to obtain authorization, they will need to ensure compliance with a number of organizational, governance, conduct and information requirements that apply to crypto-asset service providers under the new regime.

What about DeFi?

Unlike to traditional centralized venues, MiCA will not apply to decentralised finance (DeFi) exchanges which enable their participants to engage in peer-to-peer financial transactions through the platform, provided that such protocols function in a fully decentralized manner. With the aim of preventing circumvention of the new regime, EU lawmakers have emphasized that new rules under MiCA will still apply to natural and legal persons and other undertakings and to the crypto-asset services and activities performed, provided or controlled by them, even in cases when part of such activities or services is performed in a decentralized manner. That being said, partially decentralized schemes (like for instance structures where an entity stands behind and takes profits gained by an exchange that is promoted to function as a DeFi platform), will fall under the scope of the new regime and entities standing behind them will be subject to compliance with the new rules.

The EU Commission was given a mandate to assess the development of decentralized-finance in the crypto-assets markets and of the adequate regulatory treatment of decentralized crypto-asset systems and produce a report to the EU Parliament and the Council 48 months after the date of entry into force of the new regime.

Territorial scope

The new regime will have quite far reaching territorial scope of application, given that MiCA will apply to all persons that aim to offer crypto-assets or provide crypto-asset services to EU residents, regardless of the geographical location of their establishment.

However, EU lawmakers have left a very limited possibility for non-EU firms to provide regulated crypto-asset services to EU customers, where the engagement is made at the exclusive initiative of the customer. By following the old reverse solicitation principle common in the financial services industry, MiCA acknowledges that where a third-country firm provides crypto-asset services at the exclusive initiative of an EU customer, license obligation will not apply. Nonetheless, where a third-country firm solicits clients or potential clients or promotes or advertises crypto-asset services or activities to customers in the EU, the license requirement will be triggered and the firm will be deemed as providing regulated crypto-asset services in the EU without a license. Where a non-EU firm is relying on this reverse solicitation option, it will be prohibited from marketing new types of crypto-assets or crypto-asset services to the EU customer at whose exclusive initiative the service was provided in the first place.

It is also worth mentioning, that prospective CASPs that envisage to seek authorization under MiCA will need to be legal entities with the effective management in one of the 27 EU Member States. That being said, application for MiCA license and active provision of regulated crypto-asset services from a non-EU country (e.g. UK, US) to EU residents will not be a feasible option for companies that are looking to establish a footprint in the EU.

Timeline

The final text adopted by the EU Parliament, is now to be formally approved by the EU Council. MiCA will enter into force 20 days following its publication in the EU Official Journal, and will start to apply in two phases: 12 months after entry into force, the first part of MiCA that introduces rules on the offering of asset-referenced and e-money tokens will start to apply, while the second part that creates a new authorization framework for CASPs operating in the EU will start to apply following the expiry of 18-month transitional period (approximately in Q4 2024).

In Part 2 and Part 3 of our series, we will provide detailed overview of the authorization regime for crypto-asset service providers as well as overview of the key requirements offerors of regulated crypto-assets will need to comply with under MiCA.