COVID-19 – a catalyst for digital assets and crypto trading regulation?

Worldwide shrinking GDPs, global economic slowdowns, countless governmental rescue packages and fiscal incentives, only strengthened the desire for inflation resistant hedges amongst investors.

For centuries, precious metals such as gold and silver have been one of the safest investments one could make in any crisis. For this reason, many investors started buying gold during the COVID-19 pandemic as well. However, with borders shut, logistical problems arose for buying gold, forcing many investors to look for other alternatives. As in previous crises, investors turned increasingly to digital assets like Bitcoin. As with any asset class, digital assets where initially hit by the COVID-19 pandemic and dropped in price significantly, but digital assets surged in price in no time as investors started increasingly investing in digital assets and more people started looking at this emerging technology. Not only did the COVID-19 pandemic make small investors increasingly interested in digital assets, but for the first time since the financial crisis in 2008, institutional investors became open to crypto investments pouring hundreds of millions into the industry. So much so that experts started referring to digital assets, in particular Bitcoin, as the new gold. It is unquestionably an interesting time for the development of blockchain technology. At the same time the rising demand and interest in digital assets only intensify the call for more security and clarity in crypto regulation on a European level.

A potential EU framework for crypto assets

At least since the speech of Ursula von der Leyen, president-elect of the European Commission to the European Parliament, in November 2019, the EU has finally recognised the importance and necessity of an EU-wide regulation of crypto assets.

Since then, the EU Commission has launched a consultation for an EU-wide framework for crypto assets. The consultation ended in March 2020 and showed great interest (received feedback from close to 200 industry experts) in the regulation of crypto assets. As the EU Commission's Inception Impact Assessment paper shows, the Commission focuses mainly on three types of crypto assets:

• crypto assets that fall within the scope of existing EU financial services legislation (e.g. MIFID II, Prospectus Regulation and the Central Security Depositary Regulation);
• crypto assets that fall outside of the scope of existing EU financial services legislation (e.g. non-security assets such as Utility tokens); and
• so called "Stablecoins" the main purpose of which is generally to reflect the value of an underlying asset.

For crypto assets that fall within the scope of existing EU financial services legislation, the aim is to provide clarity on how the existing framework applies to such assets and to make sure that it is adequate for the purpose. Furthermore, the operational risks associated with such technologies shall be effectively regulated (e.g. cyber-resilience).

For crypto assets that fall outside the scope of existing EU financial services legislation the aim is to protect consumers from operational risks and fraud and create a framework that provides sufficient consumer and investor protection allowing crypto assets to officially become a new asset class for investments by EU citizens.

"The rising demand and interest in digital assets only intensify the call for more security and clarity in crypto regulation on a European level."

In order to implement the planned changes, the EU Commission intends to make use of non-legislative measures such as guidelines, as well as targeted legislative changes to the existing regulations and tailor-made new measures, including the creation of a new market infrastructure for trading and settlement of crypto assets.

On 24 September 2020, the European Commission adopted an expansive new Digital Finance Package that will transform the European Economy in the following years to come. Importantly, the new regulatory framework also includes the announced comprehensive legislative proposal on cryptoassets not covered by existing EU financial services legislation (eg, the Markets in Financial Instruments Directive (MiFID) II (2014/65/EU), E-Money Directive and PSD II), called Markets in Crypto-assets (MiCA). MiCA’s main aim is to help streamline distributed ledger technology and virtual asset regulation on an EU-wide level while simultaneously protecting its users and investors.

Accordingly, with the above MICA will regulate 3 subcategories of crypto assets, namely:

• Utility tokens, which are issued without any financial purpose and are intended to provide access digitally to applications, services or resources available on a distributed ledger and that are accepted only by the issuer of that token to grant access to such application, services or resources available;
• Asset-referenced tokens, whose main purpose is to be used as a means of exchange and that purports to maintain a stable value by referring to the value of several fiat currencies, one or several commodities or several crypt-assets, or a combination of such assets;
• e-money tokens, whose main purpose is to be used as a means of exchange and that purports to maintain a stable value by being denominated in (units of) a fiat currency.

Beyond that the proposal provides for a number of provisions concerning entities engaging in the issuance of crypto assets and services related to crypto assets in the union.

In our opinion this ultimately means that blockchain technology and crypto assets have come to stay. It is now only a question of time until there is a harmonised EU crypto regulation in place, allowing the market to mature. We at Schoenherr constantly follow the developments and will inform you as soon as new results are available.

author: Dominik Tyrybon