It’s been a turbulent six months in the cryptocurrency industry. Since the start of the year, the prices of the two largest currencies, bitcoin and ethereum, have fallen by more than 50 per cent. The bubble in NFTs (Non-Fungible Tokens, digital artworks and artefacts whose provenance is attested by the same blockchain technology that underpins cryptocurrencies) is close to bursting. And even investors in “stablecoins”, which are, as the name suggests, designed to be less volatile, have seen the value of their holdings plummet.
The European Commission is seeking to impose order on this digital Wild West. Brussels officials have long prided themselves on their forward-looking tech laws, but will their latest, the Markets in Crypto-Assets (Mica) act, succeed in reining in a sector that has so far defied regulation?
What does Mica set out to achieve?
The EU says that the Mica proposals form one part of a package of initiatives that “fosters technological development and ensures financial stability and consumer protection”.
Brussels’ appetite for crypto regulation was prompted by Facebook’s ill-fated plans for its own stablecoin, Diem. Some MEPs were concerned that the tech giant would use its network of nearly three billion users to peddle a currency that could challenge the euro. “We must not let [Mark] Zuckerberg become a central bank,” said Stefan Berger, a German MEP responsible for some of the most significant amendments to the regulation.
The Diem project collapsed in February this year after Facebook failed to win over American lawmakers, but its demise failed to allay European policymakers’ concerns about the cryptocurrency landscape. The Mica regulations will introduce a range of requirements for operators of crypto-assets. For the first time, crypto-asset service providers will be liable in the event that they lose their investors’ money. The rules will impose new requirements on companies to prevent market manipulation and insider training, while also complying with money-laundering laws that already apply to traditional parts of the financial services ecosystem.
The rules for issuers of stablecoins, which are pegged to the dollar, will be more rigorous still. Issuers seeking to operate in the EU will be required to hold “sufficiently liquid reserves”. If their stablecoins are linked to non-European currencies, they will also be forced to set up an office in the EU, to ensure the European Banking Authority and national regulators can monitor their activities.
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Could these regulations shield Europeans from the fallout of another market crash?
Perhaps the most significant requirement is that stablecoins hold liquid reserves. While many already do, there are notable exceptions. Terra, the stablecoin blamed for the collapse of the cryptocurrency market in the spring, used an algorithm rather than cash deposits to peg its value to the dollar. When investors spooked by a fall in the US stock market sought to cash out their holdings, the technology underpinning Terra couldn’t keep up. The value of the currency uncoupled from the dollar, before entering freefall and triggering a wider sell-off of crypto-assets.
Under the Mica rules, a coin such as Terra couldn’t legally operate in the EU because its issuers did not hold reserves to cover the value of the currency. The EU will hope the plans lead to better financial stewardship. It is a large enough market to encourage issuers of new stablecoins to adapt their plans to comply with the rules, but while companies that want to issue currencies in the EU will need to be authorised to do so, there are concerns that the supervisory regime will be too light.
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Karel Lannoo, chief executive of the Centre for European Policy Studies, has said that issuers of cryptocurrencies will still face far less scrutiny than companies producing other financial instruments and exchanges. “That raises the question about why distinct rules are needed,” Lannoo wrote in the Financial Times. He is concerned that consumers targeted with advertising on social media will “see no difference between EU or international crypto”. While the regulation seeks to protect consumers from unauthorised coins, in practice there may be little to stop them buying into currencies that would be especially vulnerable in a crash.
What doesn’t the regulation cover?
Some MEPs had called for tighter rules around the environmental impact of cryptocurrencies. Coins such as bitcoin, which use an energy-expensive “proof-of-work” model to demonstrate the integrity of their system, are particularly contentious. Brussels, however, has decided not to act yet. Instead, authorised issuers will be required to disclose the environmental impact of their products. The Commission will use the data gathered from these surveys to formulate future policy recommendations.
The EU is also biding its time when it comes to NFTs. They do not fall within the scope of the legislation, but Commission officials plan to reconsider that at the start of 2024.
Will other jurisdictions follow suit?
In March Joe Biden, the US president, instructed federal agencies to develop a regulatory regime for cryptocurrencies. This could include the creation of a digital dollar, which would reduce the demand for private stablecoins. The plans are at an early stage, but the industry has already mounted an intensive lobbying campaign on Capitol Hill.
In the UK, the Treasury has committed to publishing proposals to regulate crypto-assets. Statements from ministers suggest that the government is planning to take a light-touch approach. Rishi Sunak, the former chancellor, said that he would like the UK to become a “global hub” for crypto after Brexit, while John Glen, former economic secretary to the Treasury, has said that “if crypto-technologies are going to be a big part of the future, then we want to be in, and in on the ground floor”. Proposals are due later this year.
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