The Council of the EU has published a further draft of the proposed Regulation on markets in cryptoassets (MiCA). This note summarises the key provisions and replaces our previous notes on MiCA's evolution. It is provided by way of information and not advice. It seems likely that MiCA will be published officially in 2023, with a wide range of transitional arrangements and dependencies on regulatory technical standards being developed by various EU regulatory agencies. Being a regulation, it will apply without needing to be implemented at national level. MiCA's impact will be significant, given the 'libertarian' origins of distributed ledger technology and cryptocurrencies and the goals of many purists, but likely welcomed by those seeking to harness the benefits of the technology to replace legacy systems. If you have queries about the regulatory implications of cryptoassets or related activities, please let us know.

Scope

MiCA is aimed at those crypto-assets that fall outside of the scope of other EU financial services legislation.

Aside from certain anti-money laundering requirements, there are currently no regulations for services related to these unregulated crypto-assets, including for the operation of crypto-asset trading platforms, the exchange of crypto-assets for money or other crypto-assets, or the custody of crypto-assets.

Some EU member states are further ahead than others in regulating crypto-assets, so a dedicated EU-wide framework is considered necessary to clarify the applicable legal framework and provide a means of passporting from a ‘home’ state across the EU (and EEA), as well as to address EU environmental impacts and convergence through international organisations.

MiCA is guided by the principle of ‘same activities, same risks, same rules’ and of ‘technology neutrality’.

Crypto-assets that fall under existing EU financial services legislation should remain regulated under the existing regulatory framework regardless of the technology used for their issuance or their transfer, rather than MiCA. This excludes crypto-assets that qualify as financial instruments as defined under MiFID including structured deposits, as funds or ‘money’ as defined in the context of the second e-money directive (EMD2) and payment service directive (PSD2), as securitisation positions in the context of the Securitisation Regulation, and as non-life or life insurance contracts, pensions products or schemes and social security schemes. However, e-money and funds received in exchange for e-money, are not treated as deposits covered by the Deposit Guarantee Directive, so e-money tokens (EMTs) cannot be considered as deposits that are exempt from MiCA. ESMA will publish guidelines on criteria and conditions for crypto-assets to be financial instruments.

Digital assets that cannot be transferred to other holders do not fall within the definition of crypto-assets. Therefore, digital assets which are only accepted by the issuer or the offeror, being technically impossible to transfer them directly to other holders are excluded from the scope of this Regulation. Examples of such assets include some loyalty schemes, where the loyalty points can be exchanged for benefits only with the issuer or offeror of these points.

Non-Fungible Tokens

MiCA will not apply to crypto-assets that are unique and not fungible with other crypto-assets, including:

• digital art and collectibles, whose value is attributable to each crypto- asset’s unique characteristics and the utility it gives to the token holder;
• crypto-assets representing services or physical assets that are unique and not fungible, such as product guarantees or real estate.

While these crypto-assets might be traded in market places and be accumulated speculatively, they are not readily interchangeable and the relative value of one crypto-asset in relation to another, each being unique, cannot be ascertained by means of comparison to an existing market or equivalent asset. Such features limit the extent to which these crypto-assets can have a financial use, thus limiting risks to users and the system, and justifying the exemption.

However fractional parts of a unique and non-fungible crypto-asset should not be considered unique and not fungible.

The issuance of crypto-assets as non-fungible tokens in a large series or collection should be considered as an indicator of their fungibility. The sole attribution of a unique identifier to a crypto-asset is not sufficient to classify it as a unique or not fungible.

The assets or rights represented should also be unique and not fungible for the crypto-asset to be considered unique and not fungible.

Just because a crypto-asset is considered exempt from MiCA on the basis that it is unique and not fungible does not mean the cryptoasset might not be separately regulated as a financial instrument.

MiCA will also apply to crypto-assets that appear unique and not fungible, but whose de facto features or features linked to de facto uses would make them either fungible or not unique. The authorities will adopt a ‘substance over form’ approach, under which the features of the asset in question should determine the qualification, not its designation by the issuer.

Three types of Cryptoasset under MiCA

 The classification of cryptoassets under MiCA is based on whether crypto-assets seek to stabilise their value by reference to other assets:

• E-money tokens (‘EMTs’) are crypto-assets that aim at stabilising their value by referencing only one official currency, a function very similar to e-money, as defined in EMD2. Such crypto-assets are electronic surrogates for coins and banknotes and are likely to be used for making payments.
• Asset-referenced tokens (‘ARTs’) that aim to maintain a stable value by referencing to any other value or right, or combination thereof, including one or several official currencies, basically all other crypto-assets than EMTs whose value is backed by assets.
• All other crypto-assets that are not ‘ARTs’ or ‘EMTs’, which cover a wide variety of crypto-assets, including utility tokens, subject to certain exemptions discussed below.

E-money and crypto-assets referencing a single official currency of a country differ in some important aspects. Holders of e-money always have a claim on the electronic money institution (EMI) and have a contractual right to redeem their e-money in fiat currency at par value. By contrast, some crypto-assets referencing one fiat currency do not provide their holders with such a claim on the issuer, do not provide a claim at par or limit the redemption period. To avoid circumvention of EMD2, the definition of ‘EMTs’ captures all crypto-assets referencing a single fiat currency and such EMTs must be issued either by a credit institution (bank) or an EMI with the right to redeem the tokens at any time and at par value against the reference fiat currency.

Regulated activities and actors

MiCA governs offerors of cryptoassets, those seeking admission to trading; issuers (entities which have control over the creation of crypto-assets) and the providers of certain other types of professional services (‘cryptoasset service providers’ or ‘CSPs’) who:

• operate a trading platform for crypto-assets, exchanging crypto-assets for funds or other crypto-assets by dealing on own account,
• ensure the custody and administration of crypto-assets, and the transfer of crypto-assets, on behalf of third parties.
• place crypto-assets, engage in the reception or transmission of orders for crypto-assets, the execution of orders for crypto-assets on behalf of clients,
• provide advice on crypto-assets; and
• manage portfolios of crypto-assets.

Where crypto-asset services are provided in a fully decentralised manner without any intermediary they do not fall within the scope of MiCA.

Where crypto-assets have no identifiable issuer, they do not fall within most parts of MiCA, but CSPs providing services in relation to such crypto-assets are covered. In particular, MiCA requires all offerors or persons seeking admission of those crypto-assets to trading to be legal persons; and retail holders of crypto-assets must be informed about the characteristics, functions and risks of crypto-assets they intend to purchase.

White papers:

When making a public offer of crypto-assets, other than ARTs or EMTs, or when seeking admission of crypto-assets to trading on a trading platform, the offeror or persons seeking admission to trading should produce, notify to the local regulator and publish an information document (‘white paper’) containing mandatory disclosures on:

• the issuer, offeror or person seeking admission to trading;
• the project to be carried out with the capital raised;
• the public offer;
• the rights and obligations attached to the crypto-assets;
• the underlying technology used for such assets; and
• the related risks.

Information in white papers and marketing communications, including advertising messages and marketing material must be fair, clear and not misleading. Advertising and marketing material must be consistent with the information in the white paper.

White papers and operating rules of trading platforms must be in at least one official language of the home Member State and any host Member State, or in a language customary in the sphere of international finance (currently English).

These white papers must be notified to local regulators in the home or host state (where a branch is held), as well as marketing communications where requested.

Non-EEA offerors must notify the competent authority of the Member State where the crypto-assets are intended to be offered of their white papers to, as well as marketing communications where requested.

Cryptoassets that are not ARTs or EMTs

This general category covers a wide variety of crypto-assets, including utility tokens, but is subject to a range of exemptions (which are not applicable if a cryptoasset qualifies as an ART or EMT).

Specifically, most of MiCA will not apply to the wider type of cryptoasset where it is:

• offered for free or automatically created as a reward for the maintenance of the DLT or the validation of transactions in the context of a consensus mechanism;
• a utility token that represents the purchase of an existing good or service or enables the holder to collect the good or use the service;
• exclusively offered to qualified investors and can be exclusively held by such qualified investors, or that, per Member State, are made to a small number of persons (but some requirements related to the conduct and organisation of the offeror remain applicable);
• the subject of an offer that does not exceed a certain threshold over a period of 12 months (but some requirements related to the conduct and organisation of the offeror will still apply).
• Subject to a right to exchange the cryptoasset for goods and services in a limited network of merchants with contractual arrangements with the offeror (subject to registration/evaluation when issuance reaches €1m), except crypto-assets which are typically designed for a network of service providers which is continuously growing.

However, such exceptions:

• do not include crypto-assets representing stored goods which are not meant to be collected by the purchaser following the purchase; and
• cease to apply when the offeror or another person on his behalf communicates its intention of seeking admission to trading or the exempted crypto-assets are admitted to trading on a trading platform.

Even where the exceptions apply, the Directives on unfair business-to-consumer commercial practices and unfair terms in consumer contracts will apply to exempt offers to the public involving business-to-consumer relations.

Offers to the public

The mere admission of crypto-assets to trading on a trading platform or the publication of bid and offer prices is not to be regarded in itself as an offer of crypto-assets to the public, only where it includes a communication constituting the offer to the public.

An offer to the public of utility tokens for goods that are not yet available or services that are not yet in operation must not exceed twelve months.

The operator of the trading platform becomes responsible for complying with the information requirements when the crypto-assets are admitted to trading on its own initiative and the white paper has not been prepared or upon agreement with the person seeking admission to trading.

The person seeking admission to trading should remain responsible when it provides false or misleading information to the operator of the trading platform; and for matters not delegated to the operator of the trading platform.

Regulators will not ‘approve’ a crypto-asset white paper before publication, but will have the power to:

• request amendments to the white paper and any marketing communication, and where necessary, to request the inclusion of additional information.
• suspend or prohibit a public offer or the admission of such crypto-assets to trading on a trading platform where such an offer to the public or admission to trading does not comply with the applicable requirements;
• to publish a warning that the offeror or person seeking admission to trading has failed to meet those requirements, either on its website or through a press release.

Crypto-asset white papers and, where applicable, marketing communications that have been duly notified to a competent authority should be published, after which the crypto-assets can be offered or admitted to trading on trading platform throughout the EEA.

Offerors of crypto-assets, other than ARTs or EMTs, must monitor and contract a third party to safeguard the funds or other crypto-assets raised; ensure that any funds or other crypto-assets collected from holders or potential holders are duly returned as soon as possible where a time limited offer is cancelled for any reason.

Retail holders who are acquiring crypto-assets, other than ARTs or EMTs, directly from the offeror, or from a crypto-asset service provider placing the crypto-assets on behalf of the offeror, should be provided with a right of withdrawal during a limited period of time after their acquisition (not after the end of the subscription period and not where the price of such crypto-assets would depend on the fluctuations of crypto-asset markets).

Offerors and persons seeking admission to trading of crypto-assets, other than asset- referenced tokens or EMTs, should act honestly, fairly and professionally, should communicate with holders and potential holders of crypto-assets in a fair, clear and truthful manner; and identify, prevent, manage and disclose conflicts of interest.

Civil liability rules should apply for the information provided to the public through white papers.

Asset-referenced tokens

Issuers of ARTs will be subject to more stringent requirements than issuers of other crypto-assets.

When a crypto-asset falls within the definition of an ART, it will be regulated irrespective of how it’s designed, including the mechanism to maintain a stable value.

This includes ‘algorithmic stablecoins’ that aim to maintain a stable value in relation to an official currency of a country or one or more assets via protocols that provide for the increase or decrease of the supply of tokens based on demand. But even offerors or persons seeking admission to trading of algorithmic crypto-assets that do not aim to stabilise value by referencing one or more assets should comply with requirements for cryptoassets generally.

Issuers of ARTs must have a registered office in the EU. In order to offer ARTs to the public or seeking an admission of ARTs to trading on a trading platform the local regulator will need to authorise the issuer and approve the white paper, except where:

• the ARTs are only offered to qualified investors;
• the offer is below a certain threshold,

but even then the issuer must produce a white paper to inform buyers about the characteristics and risks of the ARTs and notify the regulator before publication.

Banks will not need MiCA authorisation to issue ARTs, but would be subject to the other requirements for issuers (except own funds requirements and the approval procedure regarding qualifying shareholders), and would need to produce a white paper for buyers about the characteristics and risks of ARTs to be approved by the relevant competent authority, before publication. The regulator would also have the power to restrict or limit a credit institution’s business; and suspend or prohibit an offer to the public. Where MiCA overlaps with banking regulation the more specific or stricter requirements apply.

Issuers of ARTs must:

• provide holders of ARTs with clear, fair and not misleading information, some of which must be on a continuous basis, including the amount of ARTs in circulation and the value and the composition of the reserve assets;
• disclose any event likely to have a significant impact on the value of the ARTs or reserve assets, irrespective of whether such crypto-assets are admitted to trading on a trading platform for crypto-assets;
• act honestly, fairly and professionally and in the best interest of the holders of ARTs;
• put in place a clear governance arrangements, ensure management are ‘fit and proper’, have adequate capital, as well as procedure for handling the complaints, manage conflicts of interest and so on;
• constitute and maintain a reserve of assets matching the risks reflected in their liability in such a way that the issuer does not face market and currencies risks and the reserve amounts at least correspond to the value of tokens in circulation and that changes in the reserve are adequately managed to avoid adverse impacts on the market of the reserve assets;
• arrange custody of reserve assets entirely segregated from the issuer’s own assets at all times, so the reserve assets must not encumbered or pledged as collateral, and the issuer must have prompt access to those reserve assets;
• invest the reserve assets in secure, low risks assets with minimal market, concentration and credit risk, with all profits or losses resulting from the investment borne by the issuer;
• prepare a recovery plan providing for measures to be taken by the issuer to restore compliance with the requirements applicable to the reserve of assets;
• a plan for the orderly redemption of the tokens to ensure that the rights of the holders;
• establish and maintain appropriate contractual arrangements with third-parties.

The crypto-asset white paper on ARTs should include information on the stabilisation mechanism, on the investment policy of the reserve assets, on the custody arrangements for the reserve assets, and on the rights provided to holders.

Custodians of reserve assets that back ARTs should be held responsible for the loss of those reserve assets as against the issuer or olders of ARTs, unless they prove that such loss is due to an event beyond their reasonable control. Concentration among custodians should be avoided if suitable alternatives are available.

ART holders are entitled to request to sell or redeem their ARTs from the issuer at any time; and the issuer may redeem the ARTs either in fiat currency (other than e-money) equivalent to the market value of the referenced assets or by delivering the reference assets, at the holder’s option (with sufficiently detailed and easily understandable information on forms of redemption available).

Issuers and CSPs should not pay interest of any kind to holders of ARTs.

Some ARTs and EMTs should be considered significant when they meet, or are likely to meet, certain criteria, including a large customer base, a high market capitalisation, or a high number of transactions; so they and their issuers should be subject to more stringent requirements than other ARTs or EMTs.

An ART will be considered widely used as a means of exchange when the number and value of transactions per day of that nature is higher than 1m and €200 million (or other currency equivalent) respectively.  Use as a means of exchange means associated with the payments of debts, including where the ART is used for settlement of transactions in other crypto-assets.

ART transactions must be monitored whether settled on-chain and off-chain, including those between clients of the same CSP.

E-money tokens

EMTs should be deemed to be ‘electronic money’ as defined under EMD2 and issuers should be authorized as EMIs and comply with the relevant operational requirements, including the prudential, issuance and redeemability of e- money tokens, unless otherwise specified.

Issuers will need to produce a white paper and notify it to their competent authority, even if exemptions under EMD2 apply to EMTs.

The white paper must contain all relevant information concerning the issuer, the offer or admission to trading necessary to enable potential buyers to make an informed purchase decision and understand the risks relating to the offer; and indicate that holders have a right to redeem their EMTs against funds denominated in the official reference currency at par value at any time.

Holders of EMTs must have a redemption right against the issuer at par value with funds denominated in the reference currency free of charge.

No type of interest may be paid to holders of EMTs.

Where an issuer of EMTs invests the funds received in exchange for EMTs, such funds must be invested in assets denominated in the reference currency to avoid currency risks.

Issuers of such significant EMTs will be subject to additional requirements, such as higher capital requirements, interoperability requirements and a liquidity management policy, increased own funds requirements, custody and investment rules for reserve assets.

Issuers must have recovery and redemption plans to ensure that holders’ rights are protected on wind-down.

Cryptoasset services and service providers

Crypto-asset services should only be provided by legal persons that have a registered office in the Member State where they have substantive business activities (including the supply of crypto-assets services). This means a CSP must have its head office or ‘effective management’ in the EU (where the key management and commercial decisions that are necessary for the conduct of business are taken), and at least one of the directors should be resident in the EU. CSPs must be authorized in their home member state, and thereby entitled to passport throughout the EU.

EU residents may receive crypto-asset services from a third-country CSP at their own initiative, without those services being deemed as provided in the EU; but where a third-country CSP solicits clients or potential clients in the EU or promotes or advertises crypto-asset services or activities in the EU, the third-country CSP must be authorised in the EU.

Crypto-asset services should be considered ‘financial services’ for distance marketing purposes (which includes a 14 day ‘cooling off period’).

CSPs must:

• always act honestly, fairly and professionally in the best interest of their clients.
• provide their clients with clear, fair and not misleading information and warn them about the risks associated with crypto-assets and make their pricing policies public;
• establish a complaint handling procedure and should have a robust policy to identify, prevent, manage and disclose conflicts of interest;
• comply with prudential requirements set as a fixed amount or in proportion to their fixed overheads of the preceding year, depending on the types of services they provide;
• maintain governance and management fitness requirements typical of other types of regulated firms.

CSPs must be separately authorized under EMD2/PSD2 to make payment transactions in connection with the crypto-asset services they offer.

CSPs will be subject to additional requirements that specific to certain types of cryptoasset services, such as:

• When providing custody and administration of crypto-assets on behalf of third parties: have a contract with their clients meeting certain requirements; implement a custody policy available to clients in an electronic format; the client might keep control over the crypto-assets or means of access may be transferred in full control of the CSP, but the CSP must not actively use the customers' crypto-assets on their own account or encumber them; and CSPs must be liable for any damages resulting from an ICT-related incident (cyber-attack, theft or any malfunction). Hardware or software providers of non-custodial wallets do not fall within the scope of this Regulation.
• When operating a trading platform for crypto-assets, have detailed operating rules; ensure their systems and procedures are sufficiently resilient,  be subject to pre- and post-trade transparency requirements; set transparent and non-discriminatory rules based on objective criteria, governing access to the platform; ensure timely settlement of trades; have a transparent fee structure; avoid the placing of orders that could contribute to market abuse or disorderly trading conditions; have the possibility for timely settlement of transactions on and off chain (off-chain, initiated on the same business day, on-chain settlement may take longer as it is not controlled by the CSP).
• When exchanging crypto-assets against funds or crypto-assets using their own capital: establish a non-discriminatory commercial policy; publish either firm quotes or the method they are using for determining pricing and any limits they wish to establish; be subject to post-trade transparency requirements.
• When executing orders for crypto-assets on behalf of third parties: establish an execution policy, aiming to obtain the best result possible for their clients, including when the CSP is the client’s counterparty; take all necessary steps to avoid misuse of information related to clients’ orders; implement procedures for the prompt and proper receipt and sending of orders; not receive any monetary or non-monetary benefits for transmitting orders to any particular trading platform or other CSP; monitor the effectiveness of order execution; notify clients of any material changes to their order execution arrangements or policy. The exchange of crypto-assets for funds or other crypto-assets when made by the issuer or offeror itself will be not be a regulated crypto-asset service.
• When placing crypto-assets for potential users: communicate to those persons information on how they intend to perform their service before the conclusion of a contract; manage and disclose conflicts of interest when placing crypto-assets with their own clients and when the proposed price for placing crypto-assets has been over/underestimated. Placing of crypto-assets on behalf of an offeror is not considered to be a separate offer of those crypto-assets.
• When providing advice on crypto-assets or portfolio management of crypto-assets: make an assessment whether the crypto-assets or management services are suitable for the clients, considering their experience, knowledge, objectives and ability to bear losses; not recommend the crypto-asset to the client, or begin the provision of management services without adequate information or if considered unsuitable; provide a report including a suitability assessment and the advice given; provide periodic statements, including a review of their activities and performance of the portfolio.

Overlapping regulated activities

Some of the regulated crypto-asset services may overlap with regulated payment services, in particular custody, placing and services from custodians that are associated with the transfer of crypto-assets. This may require a CSP to hold separate authorisations for those other activities.

Tools provided by EMIs to manage an EMT may not be distinguishable from regulated custody services, but EMIs may provide such custody services without prior authorisation (only in relation to the EMTs they issue). Distribution of EMTs on behalf of issuers would amount to placing crypto-assets but registered distributors (EMD agents) may distribute EMTs on behalf of EMIs without cryptoasset/placing authorisation.

A crypto-asset transfer service involves the transfer of crypto-assets from one distributed ledger address to another address on behalf of a third party, but this will not apply in the case of the validators, nodes or miners to the extent they may be part of confirming a transaction and updating the state of the underlying blockchain/ledger.

Many CSPs also offer some kind of crypto-asset transfer service (e.g. custody and administration, exchange or execution of orders). When those services are associated with the transfer of EMTs, such services would likely amount to a payment service under PSD2, so would need be provided by a credit institution, EMI or payment institution.

MiCA does not currently address lending and borrowing in crypto-assets (‘decentralaised finance’ or ‘DeFi’), but the case for regulation of DeFi is being considered (which would be consistent with ‘same activities, same risk, same rules’).

Specific rules will prohibit certain misconduct, including insider dealing, unlawful disclosure of inside information and market manipulation where crypto-assets are admitted to trading on a trading platform for crypto-assets, taking into account the use of social media, smart contracts for order executions and the concentration of mining pools. Crypto-assets that are the underlying assets of regulated derivatives that are themselves subject to market abuse regulations in a regulated market will be subject to the market abuse provisions of MiCA.

Regulatory supervision

ESMA will establish an EU register of crypto-asset white papers, ART/EMT issuers and CSPs.

The EBA will supervise the issuers of ARTs, once such ARTs have been classified as significant.

E-money/payments regulators will supervise issuers of EMTs, with dual supervision by the EBA of significant EMT issuance unless at least 80% of the number of holders and of the volume of transactions of these significant EMTs are concentrated in the home Member State of a non-euro currency.

Whistleblowers will be able to bring new information to the attention of competent authorities in connection with infringements of MiCA.

GDPR will apply to the issuing, offering, or seeking admission to trading of crypto-assets and the provision of crypto-asset services that involve the processing of personal data.

Transition arrangements

MiCA’s date of application will be deferred in order to allow for the adoption of regulatory technical standards, implementing technical standards and certain necessary delegated acts.

Issuers of crypto-assets, other than ARTs and EMTs, that have been issued before MiCA takes effect will be exempted from the obligation to publish a white paper, but certain obligations will apply when such crypto-assets were admitted to trading on a trading platform for crypto-assets before MiCA takes effect.

There will be transitional provisions for issuers of ARTs that operated before the effective date.

Member States without strong prudential requirements for their local CSPs may apply the stricter MiCA requirements within an 18-month transitional period.

Conclusion

MiCA is obviously intended to be far-reaching in its effects and will significantly impact an environment that has been largely populated by players with a 'libertarian' outlook. Even the early developments in e-commerce were driven by entrepreneurs who were more sympathetic to traditional regulation, and often seeking to integrate as closely as possible with the world of 'bricks and mortar'. Now it's the regulators' turn to try to assimilate technology that is often driven with the opposite goal in mind!

If you have queries about the regulatory implications of cryptoassets or related activities, please let us know.