In Cryptoland, autumn is usually the open season for regulators. Unprecedented as it was, 2020 is no exception to this trend. Tensions are high on both sides of the Atlantic: While the markets were still processing the news from the US Commodity Futures Trading Commission, which took action against the derivatives exchange platform BitMEX, the Financial Conduct Authority, the British financial watchdog, decided to ban private investors from using cryptocurrency derivatives a total of.
The tightly packed news cycle has somewhat dampened the impact of yet another regulatory bombshell dropped a week earlier and is expected to have a significant lasting impact on the global financial system: the European Union's proposed legislation on crypto asset markets.
The far-reaching framework that aims to provide clarity on regulation to digital economy companies based in the European Economic Area is likely to be particular to two interconnected areas of the crypto industry that dominated the narrative for much of 2020 Meaning: stablecoins and decentralized financial applications. What gives?
Stable coins as a threat to stability
Currently, the draft known as the "Crypto Assets Markets Regulation" or MiCA is in the form of a proposal from the European Commission, the EU executive. It still has to go through a fairly lengthy legislative process before it becomes law, which means it can take months and even years for the new rules to take effect.
The text makes it clear that stable coins, which are also referred to in the document as “asset-referenced tokens” and “e-money tokens”, are at the top of the minds of European legislators: MiCA highlights and offers this asset class to a tailor-made legal framework.
According to the proposed law, stablecoin issuers must be registered as a legal entity in one of the EU member states. Other requirements include provisions relating to capital, investor rights, safekeeping of assets, disclosure of information and governance agreements.
Albert Isola, the Minister for Digital and Financial Services of Gibraltar, told Cointelegraph that the reason the European Commission was paying more attention to stablecoins was the Authority's concern about the financial stability of the euro area:
As a digital payment method, it is widely believed that stable coins bring significant benefits, allowing for greater financial inclusion and a more efficient method of transferring money. They are also seen as a potential risk to financial stability and integrity and could affect the effectiveness of monetary policy. It seems logical that the European Union may not welcome any body other than the European Central Bank that issues euros in electronic form.
Isola mentioned that “disruptors” like the potential stablecoin scale have the potential to significantly decentralize control over currencies.
Seamus Donoghue, vice president of sales and business development at digital financial infrastructure provider Metaco, cited the impressive growth of the stablecoin market in recent months as a prerequisite for regulatory attention, which he described as a "positive response":
The market capitalization of the USDC stablecoin alone increased 250% from $ 520 million to $ 1.86 billion in 2020, with growth accelerating significantly over the past two months. Banking regulators have also undoubtedly noted that while the asset class remains relatively small in the context of traditional payments, it can have a huge impact on regulated banks and payment companies.
The ghost of Libra
The fact that the finance ministers of Germany, France, Italy, Spain and the Netherlands issued a joint statement in early September outlining the stable coin operations in Europe illustrates the deep concern of EU leaders over the preservation of the monetary sovereignty of the Union The union should be stopped until legal, regulatory and supervisory problems have been addressed, ”said Konstantin Richter, CEO and founder of the blockchain infrastructure company Blockdaemon.
Richter added that some of the more visible figures in European financial policy, such as German Finance Minister Olaf Scholz, have spoken out in favor of introducing the legal framework.
Most of the experts who spoke to Cointelegraph mentioned the Facebook-backed stablecoin Libra as a starting point for EU thinking about the dangers and opportunities that asset-related tokens pose.
MiCA begins with a justification that discusses that the crypto asset market is still too "modest" to pose a serious threat to financial stability. Things can change, however, the authors admit, with the advent of "global stablecoins that seek wider adoption by incorporating functions to stabilize their value and taking advantage of the network effects emanating from the firms promoting these assets." " To date, there has been a single stablecoin project that falls within the scope of this description: Libra.
Mattia Rattaggi, CEO of FICAS AG – a Switzerland-based crypto investment management firm – believed that stablecoins are the blockchain technology application with the highest probability of major impact – something regulators are aware of:
Stablecoins caught the attention of regulators over 12 months ago with Facebook's presentation of Project Libra and have been closely monitored by the public and regulators around the world since then. Regulators recognize that stablecoins need to improve the efficiency of the payment system – especially the international one – and promote financial inclusion.
The MiCA proposal is a further hedge against the possible disruption of currency stability in the euro zone and sets even stricter compliance requirements for issuers of tokens to which assets are classified as "significant". The significance criteria include the size of the customer base, market capitalization, transaction volume and even the "significance of the cross-border activities of the issuers and the networking with the financial system".
Bad news for DeFi?
Stablecoins largely support another sprawling domain of crypto-finance activity: a variety of applications and protocols that exist under the umbrella of decentralized finance. Given the rigor of the proposed requirements regarding tokens that assets relate to, it is obvious how complicated things can get when, for example, most of the liquidity locked in a given decentralized protocol is in a stable coin that does not meet the MiCA Standards.
Another important source of uncertainty is the requirement that all Crypto Asset Service Providers (CASPs) applying for a license to operate in the EU must be legal entities based in one of the Member States. Whether the European authorities treat individual DeFi apps as CASPs remains an open (and central) question. However, if this is the case, development teams managing DeFi logs could be forced to find workarounds that expand the term "decentralized" incredibly thinly.
In response to the proposed regulation, members of the International Association for Trusted Blockchain Applications expressed concern that the MiCA could effectively exclude European residents from participating in DeFi markets.
Martin Worner, Chief Operating Officer and Vice President of blockchain tooling provider Confio, believes compliance issues could be resolved by implementing on-chain governance mechanisms that are tailored to the legal framework of specific jurisdictions:
(This could) be achieved in a self-sovereign framework in which the institutes can develop compliant DeFi instruments that work in their area of responsibility. Just as there are rules for businesses in different jurisdictions and how they conduct cross-border transfers, so would the blockchain.
Elsa Madrolle, international general manager of blockchain security firm CoolBitX, told Cointelegraph that by the time MiCA went into effect, the DeFi landscape will likely have changed, just as the ICO landscape changed rapidly after the initial boom. At this point, "it will be clear what is required of DeFi projects in order to operate in the EU or look for EU customers."
Madrolle believes DeFi projects will fall into one of two categories at this point – regulated and unregulated – and the big question will be whether the rest of the world will adapt to the European framework.
Nathan Catania, partner at XReg Consulting – a regulatory and policy firm that recently released a breakdown of the proposed regulatory framework – hopes regulators will be able to reconcile MiCA requirements with DeFi's non-regulation. Catania said:
I believe that a project that is sufficiently decentralized and does not professionally provide the service to third parties cannot be considered a CASP and there is still room for DeFi projects.
Today, many DeFi protocols are far from being fully decentralized. The battles over how much decentralization is good enough are still ideological and mostly fought within the crypto bubble. It looks like the day will come for regulators to join this debate, but with some very tangible implications for crypto businesses.