Can markets in crypto-assets (MiCA) give banks a regulatory edge?

Thu 14 Apr 2022

Crypto-asset markets have been on banks’ radar for some time. While interest and involvement have varied, regulatory developments have been a driving force. In September 2020, the European Union (EU) published a proposal for the regulation of Markets in Crypto-assets (MiCA), offering a uniform legal framework for crypto-assets in the EU. On 14 March 2022, an amended version of MiCA was voted and backed by the European Parliament’s Committee on Economic and Monetary Affairs (ECON).

Apart from providers being subject to anti-money laundering laws, AMLD5, in general, the crypto space is scarcely regulated. So MiCA, which is anticipated to become applicable in Q2 2023, is an important step forward in the right direction.

Key considerations for banks

Crypto-asset service providers in Europe must be authorised EU-based legal entities. Once authorised in one member-state, providers will be automatically allowed to offer crypto services across the EU. The entities will carry a degree of liability for client losses due to cyberattacks and outages. Crypto-asset issuers must publish a white paper and notify the national financial market supervisors of it. They should also be registered legal entities – a requirement that will not apply to the already existing Bitcoin.

Stablecoins have received significant attention and coverage in MiCA. The regulation distinguishes Asset-referenced tokens (ARTs) and E-money tokens (EMTs). The ART is a type of crypto-asset whose value is based on several fiat currencies, one or several commodities or one or several crypto-assets, or a combination of such assets.  The EMT is a crypto asset used as a means of exchange and denominated in one fiat currency which is a legal tender, and requirements for it are similar to requirements for electronic money. To issue either token, the legislation demands an e-money or banking licence, hence giving the banks a regulatory edge. The European Securities and Markets Authority (ESMA) will supervise the issuance of ARTs, while the European Banking Authority (EBA) will oversee EMTs.

Although interest payments on stablecoin liabilities are prohibited, the issuer of such tokens is only allowed to invest in high quality, low risk, liquid assets, including central bank reserves and treasury bonds. The limited interest margin doesn’t promote a viable business model for the issuer and might direct banks toward being service providers. One could also argue that a ban on interest payments for stablecoin holders would deter potential investments, which would decrease competition for the upcoming Digital Euro.   

Banks should also be aware that MiCA does not cover the prudential treatment of any crypto exposures on their balance sheets. Crypto exposures will be governed by the EU Capital Requirements Regulation, and last year the Basel Committee issued their first consultation on the topic.

MiCA’s proof-of-work concept, which limits the use of cryptos that are powered by an energy-intensive process, was voted down by ECON. Still, the European Parliament asked the EC to include crypto-assets mining in the EU taxonomy regulation. Banks looking to explore the crypto market should be ready to reconcile their sustainability objectives with crypto energy use.

Another consideration for banks wishing to get involved in crypto markets is that MiCA allows the central bank to ban any stablecoin that becomes too influential in the EU and threatens the financial system or sovereignty of a country. The risk of a coin being rendered illegal at any moment by the regulator might not be easy for banks to reconcile.

Although uncertainties remain, MiCA offers some visibility on the direction authorities want crypto to take. Whether the market will evolve in the desired way remains to be seen.

Warnings from the regulators

In the meantime, the European Supervisory Authorities (EBA, ESMA and EIOPA) continue to warn consumers of the embedded risks of crypto-assets in their latest publication on 17 March. The warning came in the context of increased consumer activity and interest in these products. The risks outlined for retail consumers stem from crypto’s extreme volatility, availability of misleading information, including social media, lack of protection and transparency, frauds, cyberattacks and product complexity. 

All of these risks have become even more prominent since the ongoing conflict between Russia and Ukraine. It has been noted numerous times in the media, that cryptocurrencies could be seen by the Russian state, elites and oligarchs as a way to circumvent financial sanctions imposed by the West. In her presentation during the Bank of International Settlements Innovation Summit, the ECB president, Christine Lagarde, warned of market players converting the ruble into crypto-assets to escape sanctions. A similar concern voiced by the US Treasury Department earlier in March was followed by U.S. President Joe Biden’s signing of a “whole-of-government” approach to regulating digital assets.

Despite all the risks of this fast-developing asset class, crypto markets also offer a new way to support Ukraine’s resistance in the current conflict. A couple of days after the war started, the Ukrainian officials created a national donations website. They started asking for cryptocurrency donations, and, as of 31 March, over $71m have been raised. The advantages of cryptocurrencies as a flexible and easy-to-use method for charity donations have been a key factor in signing a law on 26 March 2022 legalising the cryptocurrencies sector in Ukraine.

Of course, MiCA is only one of many regulations forming the digital finance package, which is presently in the pipeline of EU regulators. The EU is still at the beginning of this regulatory path. The sooner the road is fully paved, the sooner financial market participants can decide which route they prefer to take to participate in this evolving market.