The limitations of the EU’s new cryptocurrency regulations

The final vote on the European Union’s much-awaited set of crypto rules, known as the Markets in Crypto Assets (MiCA) regulation, was recently deferred to April 2023. It was not the first delay — previously the European lawmakers rescheduled the procedure from November 2022 to February 2023. 

The setback, however, was caused solely by technical difficulties, and thus, MiCA is still on its way to becoming the first comprehensive pan-European crypto framework. But that will happen only in 2024, whereas during the second half of last year, when the MiCA text had already been mostly written, the industry was shaken with a number of shocks, provoking new headaches for regulators. There’s little doubt that in an industry as dynamic as crypto, the whole of 2023 will bring some new hot topics as well.

Hence, the question is whether MiCA, with its already existing imperfections, could qualify as a truly “comprehensive framework” a year from now. Or, which is more important, will it for an effective set of rules to prevent future failures akin to TerraUSD or FTX?

These questions have certainly appeared in the mind of the president of the European Central Bank, Christine Lagarde. In November 2022, amid the FTX scandal, she claimed “there will have to be a MiCA II, which embraces broader what it aims to regulate and to supervise, and that is very much needed.”

Cointelegraph reached out to a range of industry stakeholders to know their opinions on whether the Markets in Crypto Assets regulation is still enough to enable the proper functioning of the crypto market in Europe.

EU DeFi regulations still a ways off

One main blindspot with regard to the MiCA is decentralized finance (DeFi). The current draft generally lacks any mention of one of the later organizational and technological forms in the crypto space, and it surely could become a problem when MiCA arrives. That certainly drew the attention of Jeffrey Blockinger, general counsel at Quadrata. Speaking to Cointelegraph, Blockinger imagined a scenario for a future crisis: 

“If DeFi protocols disrupt the major centralized exchanges as a result of a broad loss of confidence in their business model, new rules could be proposed to address everything from money laundering to customer protection.”

Bittrex Global CEO Oliver Linch also believes there is a global problem with DeFi regulation and that MiCA won’t make an exception. Linch said that that DeFi is inherently unregulatable and, to some degree, even a low priority for regulators, as the majority of customers engage in crypto mainly through centralized exchanges.

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However, Linch told Cointelegraph that just because regulators can supervise and engage with centralized exchanges most easily doesn’t mean there isn’t an important role for DeFi to play in the sector.

The lack of a distinct section dedicated to DeFi doesn’t mean it’s impossible to regulate. Speaking to Cointelegraph, Terrance Yang, managing director at Swan Bitcoin, said that DeFi is to some degree transferable to the language of traditional finance, and therefore, regulatable:

“DeFi is just a bunch of derivatives, bonds, loans and equity financing dressed up as something new and innovative.”

The yield-bearing, lending and borrowing of collateralized crypto products are things that investment and commercial banks are interested in and should be regulated similarly, Yang believes. In that way, the suitability requirements as formulated in MiCA can actually be helpful. For instance, DeFi projects may potentially be defined as providing crypto asset services in MiCA’s vocabulary.

Lending and staking

DeFi may be the most notable, but surely not the only limitation of the upcoming MiCA. The EU framework also fails to address the growing sector of crypto lending and staking.

Given the recent failures of the lending giants, such as Celsius, and the rising attention of American regulators to staking operations, EU lawmakers will need to come up with something as well.

“The market collapse in the last year was spurred by poor practices in this space like weak or non-existing risk management and reliance on worthless collateral,” Ernest Lima, partner at XReg Consulting, told Cointelegraph.

Yang noted the particular problem of disbalance in the regulation of lending and staking in the Eropean Union. Ironically, at the moment, it is the crypto market that enjoys an asymmetrical advantage in terms of loose regulation when compared to the traditional banking system in Europe. Legacy commercial or investment banks and even “traditional” fintech companies are overregulated relative to the arguably heavily under-regulated crypto exchanges, crypto lending and staking platforms:

“Either let the free market work with no regulation at all, except maybe for fraud, or make the rules the same for all who offer economically the same product to Europeans.”

Another issue to watch is the nonfungible tokens (NFTs). In August 2022, European Commission Adviser Peter Kerstens revealed that, despite the absence of the definition in MiCA, it will regulate NFTs as cryptocurrencies in general. In practice, this could mean that NFT issuers will be equated to crypto asset service providers and required to submit regular accounts of their activities to the European Securities and Markets Authority at their local governments.

Cause for optimism 

MiCA was largely met with moderate optimism by the crypto industry. Despite a few rigidities in the text, the approach seemed generally reasonable and promising in terms of market legitimization.

With all the tumult in 2022, will the next iteration of the EU crypto framework, a hypothetical “MiCA-2,” be more restrictive or crypto-skeptical? “The further delays MiCA has faced have only highlighted the idle approach taken by the EU to introduce legislation that is needed more now than ever before, particularly given recent market events,” Linch said, claiming the necessity of tighter and swifter scrutiny over the market.

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Lima also anticipates a closer approach with more issues covered. And it is really important for European lawmakers to pace up with the regulatory updates:

“I expect a more robust approach to be taken in some of the technical standards and guidelines that are currently being worked on and will form part of the MiCA regime. We might also see greater scrutiny by regulators in authorization, approval and supervision, but ‘crypto winter’ will have long since thawed by the time the legislation is revised.”

At the end of the day, one shouldn’t get caught up in the stereotypes about the tardiness of the European Union’s bureaucratic machine.

It is still the EU, and not the United States, where there is at least one large legal document, scheduled to become a law, and the main effect of the MiCA was always much more important symbolically, whereas the urgent issues in crypto could actually be covered by less ambitious legislative or executive acts. It is the mood of these acts, however, that remains crucial — the last time we heard from the EU it decided to oblige the banks storing 1,250% risk weight on their exposure to digital assets.