Deconstructing MiCA (Part 1): Background, Scope and Biggest Changes

On June 9, 2023, Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on Markets in Crypto-Assets, and Amending Regulations (EU) No 1093/2010 and (EU) No 1095/2010 and Directives 2013/36/EU and (EU) 2019/1937 (MiCA) was officially published in the Official Journal of the European Union (EU). MiCA is a first-of-its-kind legislation that applies to the issuance and provision of services involving crypto-assets and stablecoins. For the first time from a global perspective, various players in the crypto-assets space will be subject to specific sets of requirements pertaining to their supervision, disclosure obligations and protection of crypto-asset holders, among others.

This regulatory analysis will take a closer look at MiCA’s background, scope and the key changes introduced by the legislation. It will also provide information concerning the regulation’s impact, timelines of application and next steps for market participants. This analysis is the first in a series of MiCA-focused pieces.

Background

The European Commission first tabled the MiCA proposal on September 24, 2020. The proposal was introduced as part of the commission’s digital finance package, which aims to enhance the EU’s potential to innovate and remain competitive in the realm of digital finance. However, as emphasised in the commission’s digital finance strategy, support for the EU’s digital finance transformation also includes tackling related risks that may endanger financial stability and consumer protection. In seeking solutions to these problems, the commission made clear that it was to follow the principle “same activity, same risk, same rules”, with the goal of ensuring a level playing field between long-standing and new players in the digital finance space.

In the impact assessment document accompanying the MiCA proposal, the European Commission highlighted that crypto-assets at the EU or global level are not officially categorised, with only some types regulated. To determine which piece of legislation would apply to a particular type of crypto-asset, the impact assessment drew a distinction between:

• Crypto-assets that are classified as “financial instruments” under Section C of Annex I to the Markets in Financial Instruments Directive (MiFID II), such as certain investment tokens and stablecoins.
• Types of stablecoins that may meet the definition of e-money contained under Article 2 of the Electronic Money Directive II (EMD2), particularly due to representing value to which users have a direct claim on the issuer.
• Virtual currency-related services, such as crypto-asset wallet and crypto-to-fiat exchange services captured by Article 2(3)(g)-(h) of Anti-Money Laundering Directive 2015/849/EU, among other provisions.

Despite the applicability of some of the abovementioned EU legislation to crypto-assets, the European Commission emphasised that these regimes were not conceived to take crypto-assets into account. It also perceived the lack of clarity and regulatory fragmentation, borne by member states’ divergent rules at the national level, posed a threat. Regulatory arbitrage was among the key issues that were singled out in this respect, as, in the absence of a unified set of rules, crypto-asset service providers could choose to establish or relocate their business operations based on the flexibility of a certain member state’s crypto-assets regulatory regime.

According to Section 2.2 of the MiCA impact assessment, other issues that were to be addressed through the MiCA proposal included:

• The need for protecting consumers and investors from fraud and other risks.
• Market integrity issues.
• Financial stability risks.

For a graphic representation of the definition of the issues MiCA aims to resolve, see the problem tree in Figure 2, Section 2 of the MiCA impact assessment.

The MiCA proposal was subject to negotiations at the trilogue level – between the European Commission, the Council of the EU and the European Parliament. The co-legislators (the Council and the Parliament) reached a provisional agreement on June 30, 2022.

The formal adoption of the final text of MiCA came almost a year later: 1) on April 20, 2023, by the Parliament; and 2) on May 16, 2023, by the Council.

At the time of adoption by Parliament, Assita Kanko, co-rapporteur for the Civil Liberties, Justice and Home Affairs Committee, said the following with regard to the occasion: “Parliament and Council have found a fair compromise that will make it safer for people of good will to hold and trade crypto-assets. However, it will make it more difficult for criminals, terrorists and sanctions evaders to misuse crypto-assets. Any administrative burden on crypto companies and innovators will be more than offset by the fact that we are unifying the currently fragmented European market that has 27 regulatory regimes.”

Scope of Application of MiCA

Crypto activities in scope

Article 2(1) of MiCA defines the scope of application of the regulation, limiting it to natural and legal persons, as well as certain other undertakings that conduct business activities in the EU involving either of the following:

• The issuance, offer to the public and admission to trading of crypto-assets.
• Providing services connected to crypto-assets.

For further clarity with respect to what constitutes particular “crypto-asset services” relevant in the context of MiCA, Article 3(1)(16) provides a list of ten types of services that fall within the definition:

• Providing custody and administration of crypto-assets on behalf of clients.
• Operating a trading platform for crypto-assets.
• Exchanging crypto-assets for funds.
• Exchanging crypto-assets for other crypto-assets.
• Completing orders for crypto-assets on behalf of clients.
• Placing of crypto-assets.
• Receiving and transmitting orders for crypto-assets on behalf of clients.
• Advising on matters concerning crypto-assets.
• Managing a portfolio of crypto-assets.
• Providing transfer services for crypto-assets on behalf of clients.

As far as possible, the list above resembles the list of “investment services and activities” provided under Section A of Annex I of MiFID II. Moreover, paragraph 90 of MiCA’s preamble sheds additional light on a potential overlap between the abovementioned crypto-asset services and the list of “payment services” specified in Annex I of Directive (EU) 2015/2366 on Payment Services in the Internal Market (PSD2). The same paragraph clarifies that this overlap may particularly occur with respect to the following services:

• Providing custody and administration of crypto-assets.
• Placements of crypto-assets.
• Assisting clients with crypto-asset transfer services.

Additionally, paragraph 91 of the preamble specifies that e-money issuers may, in theory, use the same tools for both e-money token (EMT) management and crypto-asset custody and administration services. However, in the absence of authorisation under MiCA, the use of these tools should only be limited to custody services relating to an issuer’s own EMTs.

Further information on this will be provided in an upcoming piece of VIXIO PaymentsCompliance’s regulatory analysis of MiCA.

Classification of covered crypto-assets

Article 3(1)(5) of MiCA further defines a “crypto-asset” as: “[A] digital representation of a value or of a right that is able to be transferred and stored electronically using distributed ledger technology or similar technology.”

MiCA lays down requirements for three particular sets of crypto-assets:

1. E-money tokens (EMTs): defined as “a type of crypto-asset that purports to maintain a stable value by referencing the value of one official currency” under Article 3(7) and regulated in accordance with the provisions under Title IV of MiCA.
2. Asset-referenced tokens (ARTs): defined as “a type of crypto-asset that is not an electronic money token and that purports to maintain a stable value by referencing another value or right or a combination thereof, including one or more official currencies” under Article 3(6) and regulated in accordance with Title III of MiCA.
3. All remaining crypto-assets which exclude EMTs and ARTs: regulated in accordance with Title II of MiCA. This category covers a wide range of crypto-assets, as recognised by the legislators in paragraph 18 of MiCA’s preamble, which also specifies that utility tokens fall within this category. Respectively, an utility token under Article 3(9) is defined as “a type of crypto-asset that is only intended to provide access to a good or a service supplied by its issuer”.

Crypto activities and assets out of scope

In terms of crypto-assets falling outside the scope of MiCA, Article 2(3) specifies that the regulation does not apply to unique crypto-assets and non-fungible tokens (NFTs). However, paragraph 11 of the preamble qualifies this exemption for certain types of NFTs, particularly “crypto-assets that appear to be unique and non-fungible, but whose de facto features or whose features that are linked to their de facto uses, would make them either fungible or not unique”.

Paragraph 22 of the preamble also excludes decentralised finance (DeFi) from MiCA’s scope, particularly where the provision of such crypto-assets is characterised by:

• Decentralisation in its entirety.
• The absence of any intermediary.

According to paragraph 22, MiCA would still cover activities that are only partially carried out in a decentralised manner.

As MiCA is a gap-filling regulation by nature, Article 2(4) further excludes from MiCA’s scope a list of crypto-assets that relate to matters already regulated in other EU legislation, such as financial instruments, deposits and funds.

Primary Changes Introduced by MiCA

As mentioned above, MiCA is a gap-filling regulation. The primary changes to the status quo brought by the regulation aim to close regulatory gaps regarding matters such as:

• Transparency and disclosure requirements with respect to, for example, issuing and offering crypto-assets to consumers. These obligations include mandatory disclosures also known as “crypto-asset white papers” (CAWPs). As stipulated in Article 6 and Annex I of MiCA (as examples applicable to crypto-assets other than ARTs and EMTs), CAWPs should contain information concerning the issuer/trader/offeror and the crypto-asset project at hand, among other details.
• Licensing requirements, such as the authorisation requirement laid down in Article 16 of MiCA with respect to ARTs issuers.

Once met, authorisation requirements are also coupled with additional corporate governance and conduct of business obligations; for example, ARTs issuers will need to comply with obligations under Articles 27-35 of MiCA, among others.

Additional particular obligations pertaining to the crypto-asset classes described in the previous section will be examined further in an upcoming piece of VIXIO’s regulatory analysis of MiCA.

Significance and Impact

The significance of MiCA can be examined from an internal organisational perspective at the EU level, as well as from an external, global perspective.

EU perspective

MiCA addresses key gaps and omissions in EU financial regulation, leaving aside pre-existing matters covered under payments, securities and insurance legislation, while doing so in a harmonised manner across all EU member states. The regulation covers key issues arising with respect to crypto-asset market players that operate in a centralised manner (i.e., market players whose business operations do not fully follow the DeFI business model lacking intermediaries, as described above), including matters such as supervision and conduct of business.

However, certain challenges could potentially remain unaddressed even in the aftermath of MiCA’s adoption, as recognised in a recent study titled “Remaining regulatory challenges in digital finance and crypto-assets after MiCA”. Commissioned by the Committee on Economic and Monetary Affairs (ECON) and released on April 30, 2023, the study focuses on challenges potentially posed by MiCA, such as:

• The unclear delineation in terms of various types of financial products available in the EU market, which may potentially lead to regulatory arbitrage opportunities.
• The limited guidance on periodic disclosures applicable to certain types of crypto-assets, which could become a larger issue in the additional absence of appropriate bookkeeping and accounting arrangements of the particular crypto-asset service provider.
• Legislation on restructuring and resolution being limited to covering only ARTs, which is examined in light of lessons learned from the height of the decline of the cryptocurrency market (i.e., the “crypto winter”).
• Enforcement at the cross-border level, with the study emphasising that “crypto provides a particularly suitable case for a global oversight coordination body”.

Such challenges may potentially undermine the effect of MiCA, but it remains to be seen how this will play out in practice.

Global perspective

MiCA is the world’s first comprehensive piece of crypto legislation. As such, it could potentially serve as a legislative model for other jurisdictions that are also considering the adoption of similar crypto legislation. At the time of writing, examples of such jurisdictions include Australia, the United States and the United Kingdom.

In adopting MiCA, the EU also recognises that crypto-assets have the potential to enhance the speed, efficiency and pricing of cross-border payments. In this respect, paragraph 2 of MiCA’s preamble points out that this may be the case due to the limited numbers of intermediaries involved in the process. Across the EU, a boost in the cross-border payments market segment may be feasible in light of the additional regulatory clarity and confidence from the public that MiCA’s introduction could bring. However, as crypto-assets are borderless by nature, further regulatory progress may be necessary to ensure a similar level of trust and confidence with respect to cross-border crypto transactions involving other non-EU jurisdictions.

Timeline and Next Steps

As stipulated in Article 149(1) of MiCA, the regulation will enter into force 20 days after its official publication in the Official Journal of the European Union. MiCA was officially published on June 9, 2023, which pushed the entry into force of the regulation to June 29, 2023.

Transitional provisions on MiCA’s implementation will also apply, as follows:

• Title III applicable to ARTs and Title IV applicable to EMTs will be enforceable from June 30, 2024, as indicated under Article 149(3).
• All remaining provisions will be enforceable from December 30, 2024, in accordance with Article 149(2).

As a first next step, crypto-asset service providers must familiarise themselves more closely with MiCA’s scope of application to determine which requirements apply to the type of crypto-assets their business activities are focused on.

Before being able to consider the benefits arising from any potential scaling-up opportunities across the EU, all market players should examine the particular obligations applicable to them; these requirements will be discussed in upcoming parts of VIXIO’s MiCA series.