Some may still think of digital assets as largely unregulated with little government oversight. But as consumer awareness and interest in digital assets grow, so does attention from policymakers around the world.
This ‘attention’ has produced both praise and punitive action. Last month, three U.S. legislative bills were proposed calling for the creation of “Digital Dollar Wallets” as a means to distribute stimulus payments and Covid-19 relief. And, interestingly, a Digital Dollar may not simply be the digitisation of fiat currency. Congresswoman Maxine Water’s bill, HR 6321, describes a Digital Dollar as “an electronic unit of value, redeemable by an eligible financial institution (as determined by the Board of Governors of the Federal Reserve System)”, nodding toward the possibility of other digital assets.
However, simultaneously, the U.S. Securities and Exchange Commission won their lawsuit with Telegram, halting the Telegram Open Network (TON), as its native gram tokens were deemed unregistered securities.
Policymakers and industry alike continue to grapple with establishing clarity around consistent, regulatory guidance, especially cross-border. But this looks set to change.
In December 2019, the European Commission undertook an exhaustive public consultation, containing more than 150 questions. It considered how crypto-assets should be treated within existing EU financial services legislation and whether a bespoke, unfragmented regulatory regime for the European Union was necessary.
The EU has not yet published a formal policy paper with its decisions. However, this week an unattributed ‘Non-Paper’ containing policy considerations from the consultation began to circulate. The paper drilled down into two areas – crypto-assets that could qualify as ‘financial instruments and would be within the scope of existing EU financial services legislation under MiFID II, and crypto-assets such as utility tokens and payment tokens, which may fall outside the scope of existing legislation.
The legal qualification of a crypto-asset as a financial instrument is complex and depends on the national law transposition of MiFID II. Beyond this qualification, it is not always clear how the existing regulatory framework for financial services applies to such assets and whether that framework is fit for purpose.
If the commission formalises the positions posed in the Non-Paper, the digital asset industry would be largely in agreement with the classification and treatment of security tokens – as a digital representation of a real-world asset (gold, property, equity) which generally would be regulated under existing regimes (i.e. Prospectus Regulation, MIFID II, Central Security Depositary Regulation and the Settlement Finality Directive).
If the crypto-assets qualify as MiFID II financial instruments (e.g. Security Tokens) the Non-Paper suggests 3 possible options:
1) Non-legislative measures; providing guidance on whether and how existing legislation applies to crypto-assets;
2) targeted legislative changes removing provisions acting as barriers to the issuance, trading and post-trading of security tokens and the use of DLT-based solutions; and
3) a pilot regime (e.g. a three-year period) creating a new DLT market infrastructure allowing for the trading and/or settlement of security tokens.
Additionally, the Non-Paper states that products which reference crypto-assets, such as derivatives, are also financial instruments, and therefore financial instrument regulations should apply to them. The industry has challenged this thinking. They maintain it may lead to unintended consequences, such as the development of products that have the same inherent risks but are redesigned to fall outside of traditional derivative classifications.
Bespoke Regime for Non-Security Tokens
According to the Non-Paper, most consultation respondents agreed that the creation of a bespoke regime for crypto-assets that fall outside the perimeter of EU financial services legislation today, including payment tokens, utility tokens and ‘stablecoins’, would be beneficial to the sustainable growth of the crypto-asset ecosystem in the EU. For these crypto-assets, the Non-Paper suggests two approaches, both of which seek to address the current fragmented regulatory landscape.
Option 1 is an opt-in regime and would apply to all issuers and service providers who are subject to EU law. Participants would benefit from EU passporting, enabling them to extend their services cross-border within the eurozone. Participants who do not opt in would be subject to their existing national regimes and would not be granted the ability to passport their services.
Option 2 is a fully harmonised regime for service providers, particularly exchanges and custodial wallets. Participants would be subject to EU law and would benefit from EU passporting. Existing national regulatory regimes on crypto-assets would no longer be applicable.
The Non-Paper suggest that option 2 would be based on four pillars:
1) Issuers would be required to provide clear, accurate and non-misleading information through an information document/white paper;
2) Service providers would be subject to rules preventing conflicts of interest, meeting prudential and capital requirements and business continuity measures
3) Increased consumer protection and market integrity measures; and
4) supervision of issuances of, and the services related to crypto-assets by non-compliant agreements (NCAs) subjected to licensing.
Whether either or both options are implemented, remains to be seen. Option 1 allows for market participants to opt out and therefore could be attractive to smaller participants. However, it is not clear today what exactly the participant would be opting into. Opting out removes the opportunity to passport, which could impact a company’s ability to grow into new markets.
Option 2 appears to seek a better balance between investor protection and industry development. Many industry bodies, such as CryptoUK, have implemented codes of conduct which their members must adhere to, currently addressing the requirements outlined in the pillars noted in the Non-Paper.
The Non-Paper suggests 3 options to regulate stablecoins:
1) Bespoke legislative measures for ‘stablecoin’ issuers;
2) Extending the scope of EMD2, as some ‘stablecoins’ resemble the definition of e-money and are used as payment instruments;
3) Limiting issuances of and services related to ‘stablecoins’ in the EU
The industry majority maintains that stablecoins do not fit within the current definition of e-money, and therefore option 1 would likely be favoured by industry participants.
The Non-Paper states that an EU regime intends to support innovation and fair competition, and “where sectoral legislation would clearly hinder or prevent the use of DLT or security tokens or where proper application of the legislation in a DLT environment cannot be assured, the Commission may present targeted amendments to address these issues.”
It is imperative to the holistic growth of the crypto-asset industry that a 2-tier system does not result from a bespoke regime approach. Firms who opt out may suffer a reputational competitive disadvantage, as larger firms have greater resources to opt in.
Overall, governments around the world continue to demonstrate they understand the potential benefits for financial markets from blockchain technology through development of new market infrastructures, improved efficiencies and reducing risk.
However, an understanding that evolving business models cannot be retro-fit into exiting regimes and that consistent, unfragmented regulatory clarity is imperative for the industry to continue to thrive is equally paramount. It is this author’s hope that our industry’s advocacy efforts have informed and educated EU policymakers as we await the official policy announcement from the Commission in the coming months.
Ian Taylor in conversation with James Bowater. Ian is the Chair of CryptoUK, the U.K. trade body driving policy development between digital asset industry participants and policymakers to educate and nurture an environment that fosters innovation, job creation and investment. He is also an investment banker and crypto enthusiast.