CryptoLaw Newsletter #6 - 15 June 2021

EU MiCA amendments by MEPs, BIS proposes prudential regime for crypto, US CFTC Commissioner says DeFi may be illegal

Scroll down for our Spotlight of the week: MEPs proposed 1,160 amendments to the EU’s draft Markets in Crypto-Assets Regulation.

By Ann Sofie Cloots

Crypto prices dropped some more (before rising again), but this did not slow down regulatory activity. The legal highlights of the week:

Digital assets

  • EU – MEPs submitted over 1,100 amendments to the draft Markets in Crypto-Assets (MiCA) Regulation. In our weekly Spotlight below, we discuss some of the proposed amendments, which reflect very different views on the best way to regulate crypto-assets. Many amendments would bring crypto-asset regulation closer to the rulebook for financial institutions (such as AML, best-execution rule for trades, reporting and auditing rules, own-funds requirements and measures to counter market manipulation). Others want the current text to go the opposite way, and acknowledge crypto-specific practices such as allowing tokens to be issued by Decentralized Autonomous Organization. Unsurprisingly, some amendments zoomed in on environmental sustainability in the mining of crypto-assets. See the Spotlight section below for more info.

 

  • El Salvador – Just days after President Nayib Bukele announced plans to make bitcoin legal tender, the Assembly passed the BitcoinLaw by 62 out of 84 votes. El Salvador is the first country in the world to make bitcoin or any other digital asset legal tender. Other countries have announced they may follow suit.
    • So what does the BitcoinLaw say? It’s a short, 16-article document. Bukele had tweeted this translation of the bill. The law states that bitcoin is ‘unrestricted legal tender’, that taxes can be paid in bitcoin but accounting will be done in US dollars, and that bitcoin transactions will not be subject to capital gains tax. The government will ‘provide alternatives that allow the user to carry out transactions in bitcoin and have automatic and instant convertibility from bitcoin to USD if they wish’. The BitcoinLaw provides for Regulations to be adopted to specify this bitcoin-USD conversion mechanism.
    • The law will enter into force 90 days after its publication in the Official Gazette.
    • Some commentators argued that El Salvador’s move could ‘create more turbulence’ in crypto, as US regulators may want to prevent de-dollarization through bitcoin adoption as legal tender. (MarketWatch)
    • A day after the adoption of the BitcoinLaw, President Bukele tweeted he instructed the state-owned geothermal electric company to draw up plans for bitcoin ‘volcano-powered bitcoin mining’ (using the country’s volcanoes for ‘cheap, 100% clean, 100% renewable’ bitcoin mining). Apparently after an impromptu Twitter Space chat that Nic Carter started.
    • In Paraguay, a member of Parliament saw a chance to propose rules that could Paraguay a mining- and crypto-friendly hub. Congressman Carlos Rejala wants to submit a bill soon to introduce crypto-friendly provisions and pointed to cheap and abundant energy that could attract miners and other crypto companies. If his first bill is adopted, he plans to propose another one to make bitcoin legal tender, like in El Salvador. (Coindesk)

 

  • IMF – It did not take long for the International Monetary Fund to voice its concern over the BitcoinLaw in El Salvador. Soon after the BitcoinLaw was passed, an IMF spokesman said the supranational body had economic and legal concerns over the move. El Salvador is seeking nearly US$1 billion of assistance from the IMF and the passing of the BitcoinLaw may complicate those negotiations. Investors also did not seem to appreciate the bitcoin move, with one Citi client note calling it ‘noise’. Investors are demanding higher premiums to hold the country’s debt. (Reuters)

 

  • South Africa is preparing a ‘phased and structured’ regulatory framework on cryptoassets, according to a Position Paper published by the country’s Crypto Assets Regulatory Working Group (WG). The Position Paper makes 25 recommendations, such as giving explicit powers to the Central Bank to require crypto exchanges to report transactions. One argument against regulating crypto has been that it gives crypto legitimacy. However, the Position Paper takes another stance, saying the current lack of regulation ‘prevent[s] authorities from having ‘line of sight’ of crypto-asset’ activities. Bringing crypto under the regulator perimeter helps address ‘the most pertinent and immediate risks that have been identified around AML/CFT, cross-border financial flows and consumer protection’. The proposed regulatory remit ‘should not be interpreted as any type of endorsement of crypto assets (whether tacit or explicit)’, the Paper warned. Instead, the plans are needed due to strong crypto interest from retail investors, the difficulties regulators face to keep an eye on crypto if it remains outside of their regulatory remit and international developments such as the FATF updates on crypto-assets and the Basel Committee guidance. However, the WG reiterated that ‘with or without regulation, crypto assets remain inherently risky and volatile’. Decentralized crypto-assets ‘leads to the challenge of decentralised responsibility in the event of something going wrong: because there is no central intermediary, issuer or ledger keeper, consumers essentially have no recourse to any authority or entity to address or resolve user errors’, the Position Paper states.

 

  • BIS – The Basel Committee on Banking Supervision of the Bank of International Settlements (BIS) wants banks to set aside more capital to cover their bitcoin exposure. The Committee published a consultation document on the prudential treatment of cryptoasset exposures.
    • The consultation document classifies cryptoassets into 2 groups – those that are covered by existing rules (Group 1a and 1b) and those that are not (Group 2).
    • Group 1 consists of (a) tokenized traditional assets, for which the Committee suggests capital requirements at least equivalent to those of traditional assets (and potentially capital add-ons); and (b) stablecoins, for which the Committee wants new guidance on how to apply existing rules to reflect the risk of stabilisation mechanisms (also with potential capital add-ons).
    • Group 2 covers cryptoassets such as bitcoin. The Basel committee wants a new conservative prudential regime based on a 1250% risk weight – meaning banks would need to set aside capital to cover any bitcoin losses in full.
    • The Committee pointed to the often-cited risks of financial stability, liquidity, credit and market risk, operational risk, money laundering and legal and reputational risks.
    • It says is wants a ‘simple’ prudential regime at present, as the market and technology are evolving. It sees this consultation document as just a first step of a longer process: ‘Given the rapidly evolving nature of this asset class, the Committee is of the view that policy development for cryptoasset exposures is likely to be an iterative process, involving more than one consultation.

 

  • India – India’s federal Enforcement Directorate launched investigations into a crypto exchange WazirX for violations of foreign exchange rules. WazirX was acquired in 2019 by Binance, the largest crypto-exchange by volume in the world. (Reuters) India is also considering to drop its proposed crypto ban. (Cointelegraph)

 

  • Tanzania’s President Samia Suluhu Hassan calls on the Central Bank to prepare for the use of crypto-assets. (@pesa_africa on Twitter and Forbes)

 

  • Russia – A member of the Duma criticized Russia’s reluctance to embrace crypto. ‘Short-sightedness can be costly for Russia. Cryptocurrencies are the reality. Either we will accept it, or we will lose,’ Fedot Tumusov said. (Cointelegraph)

 

  • UK – Bank of England’s Christina Segal-Knowles said stablecoins are not that radical. ‘Stablecoins are not launching us off into some brave new world.’ (Cointelegraph)

 

  • Tunisia’s Finance Minister wants to decriminalize bitcoin ownership. (Coindesk)

 

  • South Korea – The Financial Services Committee plans to ban cross-trading on crypto-exchanges, which industry representatives say would cause crypto revenue to dry up. (Cointelegraph) The FSC also wants banks to treat crypto exchanges as high-risk clients. (Coindesk)

 

  • Thailand – The Securities and Exchange Commission of Thailand announced a ban on meme coins and NFTs for crypto exchanges. The ban also prevents crypto exchanges from trading a digital asset issued by themselves or related persons.

 

  • Italy – The head of the country’s securities regulator is concerned about the spread of cryptocurrencies without clear regulation. ‘If it takes too long at a European level to come up with a solution, (Italy) will have to take its own measures’. (Reuters)

 

  • Netherlands – The head of the Dutch Bureau for Economic Policy Analysis called for a bitcoin ban. (nl) In his opinion piece, Pieter Hasekamp said cryptocurrencies are incapable of being a payment tool outside of criminal circles and that they are no more than a contagious narrative. A burst of the crypto bubble is inevitable, in his view. However, Dutch Finance Minister Wopke Hoekstra disagreed, saying that crypto monitoring is more effective than a crypto ban. (Coindesk)

 

  • US New York State’s Assembly rejected Senate Bill 6486, which wanted to bitcoin mining powered by coal and other dirty energy sources. A 3-year moratorium on all proof-of-work mining is therefore off the agenda. (Cointelegraph)

 

  • US State-chartered banks in Texas can custody cryptoassets, the Department of Banking affirmed. (Decrypt)

 

  • US – SEC Chair Gary Gensler was asked once more whether concerns over fraud or manipulation were holding back an ETF approval. ‘“Investors should be aware—I’m saying this in my own voice—that the underlying Bitcoin cash markets, there’s not the robust oversight that you have in the stock market or the derivatives markets,” Gensler responded. (CNBC) Note: see our blog post on frontrunning/market manipulation here.

DeFi

  • US – DeFi derivatives may be illegal under the Commodity Exchange Act, said CFTC Commissioner Dan Berkovitz.

In a pure “peer-to-peer” DeFi system, none of these benefits or protections exist.  There is no intermediary to monitor markets for fraud and manipulation, prevent money laundering, safeguard deposited funds, ensure counterparty performance, or make customers whole when processes fail.  A system without intermediaries is a Hobbesian marketplace with each person looking out for themselves.  Caveat emptor—“let the buyer beware.” Not only do I think that unlicensed DeFi markets for derivative instruments are a bad idea, I also do not see how they are legal under the CEA.’

CBDC

  • Brazil – Banco Central do Brasil pushed back its CBDC timeline with 2 years, eyeing a CBDC adoption in 2-3 years. (Coindesk)
  • Nigeria – The Central Bank if Nigeria said it had been researching CBDCs for 2 years and may launch a pilot later this year. (Coindesk)
  • BIS – A BIS survey of 50 central banks found that: ‘While most central banks have yet to take a firm decision on issuing a CBDC, the survey responses show a tentative inclination towards allowing use of a future CBDC by tourists and other non-residents domestically. They have a cautious approach to allowing use of a CBDC beyond their own jurisdiction.’

Spotlight

The EU’s draft Markets in Crypto-Assets Regulation was published in September 2020. Members of the European Parliament had until the end of May this year to submit amendments to the draft text. No less than 1,160 amendments were proposed, according to XReg Consulting, which published a high-level summary of the amendments. The discussion below is based on that overview.

  • Environmental footprint: a number MEPs (mainly from the S&D and Green parties) propose sustainability indicators for crypto-assets. They want to require proof-of-stake (PoS) as consensus mechanism, instead of the energy-intensive proof-of-work (PoW) currently used for the most popular blockchains such as the Bitcoin and Ethereum blockchain. Crypto-asset service providers should not provide any services, allow trading or custody of crypto-assets that do not meet the sustainability standards, per the proposed amendments.
    • Note: PoS makes the energy-intensive mining mechanism of PoW obsolete. Another potential benefit is greater decentralization than the current mining on PoW blockchains. However, PoW has been around for much longer than PoS and has long been considered to be more secure than PoS. The Ethereum blockchain has been working on a PoS consensus mechanism for years – much longer than originally anticipated, which shows that a switch from PoW to PoS may not be as simple as some MEPs may assume. Nevertheless, PoS research and testing has made much progress. Some newer blockchains already rely on PoS instead of PoW. The Ethereum blockchain has been testing a PoS alternative in parallel with the current PoW blockchain and the plan is to complete the move (the ‘merge, in Ethereum-speak’) to the PoS consensus mechanism by the end of this year. This could reduce Ethereum’s energy consumption by at least ~99.95%. If the proposed MiCA amendments on PoS are passed, this would likely result in a de facto ban for EU crypto exchanges to trade bitcoin or for custody providers to offer bitcoin custody services, as it is unlikely the Bitcoin community will move to a PoS consensus mechanism anytime soon.

 

  • DAOs: some MEPs want to allow crypto-assets issued by Decentralized Autonomous Organizations (DAOs). The current MiCA text requires a ‘legal entity’ (such as a company or a foundation). DAOs do not have legal personality and new laws would need to be adopted if at some point lawmakers would want to change this. In the US, the state of Wyoming adopted a law that recognizes DAOs as a special type of limited liability company. It is a slightly odd, hybrid solution, merging the framework of a traditional LLC legal entity with rights and obligations tailored to a DAO, such as changes to fiduciary duties. MiCA’s current legal entity requirement was criticized for erecting barriers for decentralized finance (DeFi) to flourish in the EU. If the proposed amendments to MiCA makes it to the final text, this could certainly make life easier for DeFi developers and crypto-exchanges offering DeFi token trades.

 

  • Retail investors: many MEPs want to delete the requirement that public offers of crypto-assets must be restricted to qualified investors only. Although such a restriction could protect the retail public from outright scams, it also undermines the appeal of crypto-assets as a class of assets open to anyone, regardless of financial resources or financial sophistication. For example, a retail buyer was able to purchase Polkadot’s native DOT token before it was listed on Coinbase Pro. Views differ on whether that’s a retail investor protection concern or, on the contrary, a retail investor opportunity. Most MEPs appear to align with the latter (although they still favour strict rules on disclosure and marketing, auditing, etc.)

 

  • Prior approval of whitepaper: some propose that any whitepaper must obtain prior approval by ESMA. This makes a whitepaper look more like a prospectus for traditional securities (which may seem slightly odd, as any security token is excluded from MiCA’s scope and covered by existing EU financial regulation such as MiFID II and the Prospectus Regulation.) Some asked that any change to a whitepaper should be pre-approved by a ESMA or a national authority.

 

  • Anti-Money Laundering: AML has been high on the agenda for regulators keeping crypto on their radar. The Financial Action Task Force (FATF) published a proposed update to its AML guidance for Virtual Assets and Virtual Asset Service Providers, that attempted to bring more crypto activities under the AML rulebook. The public consultation on the draft update closed in April and FATF is expected to discuss any amendments during its meeting later this month. Some amendments want to ban so-called privacy-preserving coins. Note that one of those coins, Zcash, can be received and traded on Coinbase by its US users (not EU or UK users).

 

  • Copy/paste part of the traditional finance rule book: Several amendments propose to extend rules already applied to financial institutions and other companies to crypto-asset issuers and service providers. Examples include reporting and auditing requirements, own-funds obligations, disclosure of conflicts of interest, periodic stress-tests, EU-wide passporting rights, disclosure on pricing mechanisms for crypto-exchanges, prudential and insurance obligations, real-name bank accounts (a hot topic in Korea right now) and insider dealing and market manipulation rules.

 

It’s clear that MEPs take different views on how crypto-assets should be regulated. Although some amendments leave room for more crypto-tailored rules, the overall trend is to call for stricter regulation more in line with traditional market regulation. This mirrors the tougher crypto-stance taken in many jurisdictions around the world right now, including South Korea, the US, South Africa and China, and the approach by supranational bodies such as FATF and the BIS Basel Committee.

Next steps for MiCA:

  • The European Parliament will discuss the amendments over the summer and propose a revised text, likely in the Fall.
  • Negotiations will continue between the European Parliament, Council and Commission. A final text may be approved as early as the end of the year.

 

Quote of the week

We may have passed the point at which Bitcoin can be “banned” by any government, but more stringent regulation and aggressive government investigations look likely.’ (Barron’s Avi Salzman)

 

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