2021: The Year of EU Crypto-Asset Regulation?

Fiat-backed 'stablecoin'

In the midst from the global COVID-19 pandemic and world lockdown, the Libra Association published a brand new form of the white paper supporting its Libra crypto-currency. Initially founded and supported by Facebook, Inc., after which endorsed by a few large companies , the Geneva-based Libra Association is home of a new “stable coin,” i.e., a cryptocurrency designed to be backed with a reserve of hard currencies in an attempt to stabilise the price of the “coin” by linking its value to that particular of its reserve.

Although the Libra Association had asked the Swiss Financial Market Supervisory Authority for an assessment on how the authority would classify the project and guidelines were issued on 11 September 2021, other regulators and governments around the world voiced out a number of concerns about the project. The revised form of the Libra white paper contains a number of changes designed to address such regulatory concerns.

Stable coins that include a reference to one or several existing legal currencies, such as Libra, pose specific issues, that have been summarised in detail in the G7 Working Group report on stable coins published in October 2021 and led to a ban in the EU. On December 5, 2010, the EU Council and Commission jointly stated that no global “stablecoin” arrangement should begin operation in the Eu before the legal, regulatory and oversight challenges and risks happen to be adequately identified and addressed.

Until recently, the regulation of crypto-assets was primarily left to national initiatives, with States adopting diverging approaches. However, a fundamental distinction seemed to emerge between crypto currencies on the one hand and tokens on the other hand. As summarised by the EU Parliament in its April 2021 study on crypto-assets:

“Cryptocurrencies , for example Bitcoin and Litecoin, are those crypto-assets that are designed or meant to perform the roles of currency, i.e.to function like a general-purpose medium of exchange, a store of value along with a unit of account. They're intended to constitute a peer-to-peer alternative to government-issued legal tender. Tokens, however, are those crypto-assets that provide their holders certain economic and/or governance and/or utility/consumption rights. Generally speaking, they're digital representations of interests, or rights to certain assets, services or products. Tokens are typically issued on an existing platform or blockchain to raise capital for new entrepreneurial projects, or to fund start-ups or even the development of new innovative services.“

In a number of jurisdictions around the world, the emergence of crypto-assets gave rise to a particular legislative and regulatory responses aimed at addressing the most urgent issues raised by their development, albeit sometimes only partially because of the difficulty to proceed using their legal qualification. Actually, all crypto-assets have different functionalities, as well as their inclusion within the existing regulatory framework needs a case-by-case analysis. This method is clearly the one retained, for instance, through the Swiss FINMA in the ICO guidelines published in February 2021 or even the UK FSA, for whom “whether an ICO falls within the FCA's regulatory boundaries or otherwise are only able to be decided case by case. Many ICOs will fall outside the regulated space. However, for the way they're structured, some ICOs may involve regulated investments and firms in an ICO might be conducting regulated activities“.

Most of the legislative and regulatory work so far thus focused on investor protection poor ICOs and, to a lesser extent, money-laundering issues. For instance, in France, the PACTE law was adopted in April 2021 and established a legitimate framework for fundraising through the issuance of virtual tokens and digital asset service providers . In the usa, the approach was rather to pay attention to substance over form using the consequence that US securities laws will be applicable for most ICOs. As stated by the SEC Chairman inside a December 2021 statement, “replacing a conventional corporate interest recorded inside a central ledger with an enterprise interest recorded via a blockchain entry on a distributed ledger may alter the form of the transaction, however it does not change the substance“. According to this method, the SEC initiated several enforcement actions against ICO issuers that had didn't register their offering in accordance with US securities laws.

Public consultation

To address the greater general issues raised by crypto-assets within the EU, on 19 December 2021, the ecu Commission launched a public consultation right into a Directive/Regulation creating a European framework for markets in crypto-assets.

The introduction to the consultation notes that crypto-assets have “the potential to bring significant benefits to both market participants and consumers” but also acknowledges the possibility difficulties presented, such as the challenge to financial stability that comes from the emergence of “stablecoins” as a new subset of crypto-assets.

The consultation builds on advice obtained from the European Banking Authority and the European Securities and Markets Authority around the applicability and suitability from the existing financial services regulatory framework to crypto-assets and can inform the Commission services' ongoing focus on crypto-assets. The consultation document notes this features a possible common regulatory approach at EU-level for crypto-assets that aren't currently covered by EU legislation.

The consultation document is really a working document and does not constitute a formal proposal by the European Commission. However, the consultation document supplies a useful indication from the main regions of focus for that Commission and areas identified for potential regulatory reform:

• Clarity as towards the classification of crypto-assets potentially distinguishing between “payment tokens”, “investment tokens”, “utility tokens”, and “hybrid tokens”;
• A bespoke regime for crypto-assets not currently included in EU financial services legislation, which might or might not include certain types of crypto-assets ;
• Greater regulatory requirements on crypto-asset service providers .
• Requirements to guarantee the proper identification of transacting parties in crypto-assets;
• A widening from the AMLD definition of virtual currency, classification of obliged entities and conditions for regulation and licensing of providers;
• Increased oversight and supervision of crypto-asset providers; and
• Amendments to existing legislation to ensure appropriateness for security tokens and also the use of distributed ledger technology.

National implementation of amendments towards the Anti-Money Laundering Directive

Concurrently, the implementation within the EU in the Anti-Money Laundering Directive contains numerous changes that will further impact crypto-asset professionals. The amendments to the previous iteration from the AMLD include:

• A new definition of virtual currencies;
• The inclusion of virtual currency providers and custodian wallet providers as obliged entities ; and
• The requirement that exchange platforms and custodian wallet providers be registered.

The prospect of forthcoming changes to money laundering rules has caused numerous crypto firms to reconsider their operations. For example, crypto payments start-up Bottle Pay turn off its operations in December 2021, awaiting the entry into force of the revised version of the AMLD. Similarly, crypto mining pool Simplecoin and bitcoin gaming platform Chopcoin were reported to possess closed their operations in December 2021, citing the new rules as the catalyst for closure.