Europe Is Building Its Framework for Digital Finance—What Challenges Remain?
The last week of the French Presidency of the Council of the European Union coincided with the launch of a new chapter in the EU’s digital finance–a political agreement was reached by co-legislators on both the Markets in Crypto-Assets Regulation (MiCA) and the revised Transfer of Funds Regulation (TFR). MiCA’s rapporteur Stefan Berger said that the deal on comprehensive regulation has “put in order the Wild West of crypto-assets and set clear rules for a harmonised market that will provide legal certainty.”
Have these agreements cleared the fog surrounding the future of the crypto-asset industry? Here is a brief outline of what MiCA and TFR aim to achieve and the challenges that remain for the industry in the single market.
MiCA and TFR—what they set out to do
MiCA introduces a harmonised EU-wide regime for trading and issuance of crypto-assets and their service providers, known as CASPs, setting out a single licensing regime across all member states by 2024 that also establishes CASP authorisation and operating requirements. The revised TFR introduces the crypto “travel rule,” the information on payee and payer required for providers such as crypto-asset exchanges and self-custodial digital wallets attaching transfers to prevent illicit finance.
A horizontal EU-wide regime prevents EU businesses and citizens from having to abide by 27 different member states’ national interpretations on how crypto-asset services should be defined and regulated. Small and medium-sized enterprises represent 99% of all businesses originating from the EU. The ability for a fintech to scale up across borders, while competing with large non-EU entities, requires a comprehensive regulatory regime. MiCA and TFR may be a great first step.
Despite the progress, where do the challenges still lie?
The EU’s lens of carefulness and containment
The EU is proscriptive in its regulatory approach and focused on possible negative outcomes of crypto, as opposed to the activation-based prescriptive attitudes of the UK and the United States.
The UK previously announced a plan to make Britain a “global hub for crypto-asset technology and investment,” partly by setting up a Crypto-asset Engagement Group to work closely with the industry in establishing regulation within this field. The United States has set out under its executive order on the development of digital assets to leverage unique digital asset technologies to raise the country’s technologic and economic competitiveness. These jurisdictions test, facilitate and experiment with the innovation of crypto and recognises its underexplored potential.
Meanwhile, the EU’s fears of crypto-asset negatives tends to highlight ongoing debates and regulation efforts in the EU. Prior to MiCA’s political agreement, a vote in the EU Parliament came close to banning Proof-of-Work consensus mechanism, which would have effectively banned cryptocurrencies like bitcoin across the Union – even though studies show that the majority of electricity consumption for bitcoin takes place outside of the EU. TFR’s travel rule is specifically built upon fears of crypto use in money laundering, even as Chainalysis 2022 Crypto Crime Report has shown that the amount laundered through fiat currency is more than 232 times greater than the amount laundered through crypto.
A full-on bitcoin ban in the EU will not prevent its global growth, but it could push users to unregulated spaces, bring back the fog that MiCA and TFR aim to clear. Legal clarity and necessary safeguards are key for a healthy industry, but regulation has to leave space for innovation and growth incentives.
Where do we go from here?
With MiCA and TFR political agreements on the table, there is more ahead in crypto regulation. Legislation spanning all of the financial sector, such as the planned open finance framework, will establish rules about customer data access rights and begging the question on how crypto will be treated as part of a wider financial system. A bespoke DeFi regime will be considered within 18 months of MiCA’s entry into force too, raising unique and previously unexplored questions such as how do we regulate entities in a decentralised environment and who should be responsible for ensuring good practices and compliance when the user base is generally anonymous?
Considering this, what should the industry and regulators do to ensure that blockchain is an EU success?
The crypto-asset industry needs to engage with the EU on how to reinforce its principles of necessity and proportionality and how to not treat provisions favouring competitiveness and innovation as incompatible with consumer safeguards through disproportionately burdensome compliance requirements. Creating or finding a platform to voice such concerns can open doors for dialogue. Trade associations such as Blockchain for Europe can act as an extended regulatory compliance arm for businesses concerned about staying ahead of incoming implementation requirements and yet undefined regulations.
Policymakers should draw careful considerations when thinking about areas of digital finance that are still emerging—such as DeFi and non-fungible tokens, known as NFTs. The EU should recognise that their early, ongoing development depends on the unique benefits being nurtured and explored as complements, not inhibitors to existing financial solutions. This can happen by working together with industry participants and national authorities to fill data gaps that could better inform legislative decision-making and possible obstacles to implementation.
The fog of digital finance is starting to clear in the Union, but in order to stay in the clear, open collaboration between industry and policymakers has to become the building block of EU’s digital finance.