Cypto Asset Regulation in the EU is About to Enter a Unified Era：A Historical Review and a Future Outlook

As one of the largest economies in the world, the EU has an important demonstration and leading role in the regulatory policy on crypto assets. Studying the historical evolution and future trend of the EU's crypto market regulatory policy has theoretical significance and practical value for understanding the EU's legislative ideas and practical experience in this field, analyzing different regulatory models and their effects in countries around the world, and exploring future crypto regulatory strategies and measures.

This paper will analyze the history, current situation and future development direction of the European Union's identification of the nature of crypto assets and regulatory policies, in order to provide reference and inspiration for policy formulation.

1 How does the EU improve the framework for defining cryptocurrencies

Initial Regulation (2014)

Back in 2014, the European Central Bank (ECB) issued a report clarifying what a cryptocurrency is, namely that it is "a digital token that is not issued or backed by a central authority or public body, whose value depends on market supply and demand, and can be traded peer-to-peer through a specific network protocol." This is the first formal assessment of cryptocurrencies by the EU, laying the groundwork for subsequent regulatory policies.

Terrorism and the Challenge of Super-sovereign Currencies (2015-2019)

European Union's Fifth Anti-Money Laundering Act (5AMLD)

On the night of November 13, 2015, seven locations in central Paris and the northern suburbs were hit by a series of terrorist attacks. It was the worst violence in France since World War II and the worst terrorist attack in Europe since the Madrid train bombings in 2004. A similar terrorist attack took place in Brussels in March 2016. These two disasters have exposed the vulnerabilities of EU 4AMLD, in particular the risk of ignoring funding channels such as cryptocurrencies.

In order to strengthen the fight against money laundering and terrorist financing, the European Commission put forward a series of legislative proposals in 2016, including the formulation of 5AMLD. Subsequently, 5AMLD was adopted by the European Parliament and the Council in May 2018 and entered into force in January 2020 with the aim of increasing the transparency of financial transactions to combat money laundering and terrorist financing. One of the main elements of 5AMLD is that the platforms of virtual currency exchange and custodian wallet providers will be treated as "obligated entities" and subject to EU regulations. This means that it will face the same regulatory requirements as banks and other financial institutions, such as implementing customer due diligence controls, regularly monitoring virtual currency transactions, and reporting suspicious activity to government entities.

However, as 5AMLD is a "directive" type in secondary law of EU law, it is not directly applicable. It was therefore up to member states to amend their national laws to ensure implementation. As a consequence, 5AMLD, while bringing cryptocurrency service providers into the scope of regulation, does not establish a uniform and harmonized legal framework. The definition, classification and regulation of cryptocurrencies in EU countries are also different, which is not conducive to cross-border collaborative supervision.

Diem Challenges

The Diem stablecoin is a global payment project proposed by Facebook in June 2019. Unlike general cryptocurrencies, Diem relies on Facebook's 2 billion users worldwide and is linked to a basket of currencies, which has the identity of an independent currency, posing a challenge to financial sovereignty and stability. In addition, Diem is issued in Geneva, Switzerland, which may have a significant impact on the future financial stability, monetary sovereignty and people's rights and interests of the EU. Its proposal has been warned by EU experts and institutions at the beginning.

The regulatory framework based on 5MALD cannot effectively deal with "super-sovereign currencies" such as Diem, and the loose definition of the original cryptocurrency has also brought difficulties to cross-regional regulation. A new framework for defining cryptocurrencies is imminent.

MiCA's Cryptocurrency Definition Framework (2020 to date)

Under the direct stimulation of cross-border regulatory pressure and Diem, the draft of the Markets in Crypto-Assets Regulation (MiCA) proposed by the European Commission in 2020 classifies crypto assets into three categories in order to unify EU national regulation. These include: e-money tokens (EMTs), asset-referenced tokens (ART) and other crypto-assets. The draft has been approved by the European Parliament and is expected to come into force in 2024.

E-money tokens is a crypto asset linked to a single fiat currency that can be used for payments or transfers. It is intended as an electronic alternative to cash. For example, electronic currency tokens linked to the euro fall into this category.

Asset-referenced tokens is a crypto asset that is linked to multiple fiat currencies or other assets with the purpose of maintaining a stable value. What is commonly referred to as a "stablecoin" is an asset reference token.

Other crypto assets is any crypto assets that do not fall into the first two categories, including most cryptocurrencies and utility tokens. Bitcoin, Ethereum, etc., fall into this category.

According to MiCA's classification, stablecoins such as Diem belongs to EMT or ART and is subject to stricter regulatory requirements such as white paper approval, reserve management, liquidity assurance, information disclosure, etc. However, MiCA does not cover crypto assets such as DeFi, NFT and security tokens that qualify as other regulated instruments.

2. Historical evolution of the EU's main regulatory policies

After reviewing the development of the definition of cryptocurrency in the EU, let's look at the history of its major regulatory policies. These regulatory policies are based on the cryptocurrency definition framework, and the time period is generally similar.

2.1 Start and Exploration (2014)

2014 is the first year of the European Union's cryptocurrency regulation. Prior to this, the EU did not have specific regulatory rules for cryptocurrency exchanges, only a few generally applicable financial laws and directives, such as AMLD4. Whether these financial laws apply to cryptocurrencies is also vague.

2.2 Supervision of Initial integration (2015-2019)

In 2015, the European Court of Justice ruled on whether Bitcoin transactions should be subject to VAT provisions. It determines that payment in Bitcoin is payment for a service, subject to VAT provisions. At the same time, according to the spirit of the provisions of Article 135 (1) (e) of the EU VAT Directive, the exchange of cryptocurrencies and fiat currencies is exempt from VAT. The ruling provides certain tax benefits for cryptocurrencies in the EU.

In 2018, the AMLD5 brought cryptocurrency exchanges under the scope of anti-money laundering and anti-terrorist financing regulation, requiring them to verify customer identity, record transaction information, report suspicious activities. This sets certain compliance requirements for cryptocurrency exchanges operating services in the EU. In the same year, the European Central Bank issued an opinion recommending that the EU should develop a unified regulatory framework for crypto assets to address the potential impact of crypto assets on financial stability, consumer protection, and market integrity. This guidance is also one of the origins of MiCA.

During this phase, several important judicial and legislative initiatives marked the beginning of the EU's partial regulatory approach to crypto asset services. But the EU still lacked a unified and comprehensive regulatory framework.

2.3 Unified Regulatory framework for MiCA (2020 to date)

The upcoming MiCA puts forward regulatory requirements such as licensing, registration, information disclosure, and code of conduct for entities providing crypto asset services (including exchange services). At the same time, the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) are given corresponding supervisory functions. The introduction of MiCA will provide a clear and consistent regulatory framework for cryptocurrency exchanges in the EU, and will also influence crypto legislation in countries around the world, accelerating the transition of the global crypto market from the "barbaric growth" stage to the "legal era."

MiCA has developed a detailed licensing system for crypto asset traders. Specifically, traders are required to obtain a CASP (crypto-asset service provider) license from the competent EU national authorities. All CASPs are required to comply with regulations regarding their governance, asset custody, complaint handling, outsourcing, wind-down plans, disclosure, and permanent minimum capital. Different CASPs have specific regulatory requirements to meet, such as:

Custodian: need to establish custody policy and regularly inform the client's assets;

Trading platforms: need to implement market manipulation detection and reporting systems, or disclose current buy and sell prices and trading depths;

Exchanges and brokers: need to have non-discrimination policies in place and execute orders at the best possible results and prices.

3 EU's regulatory plan for stablecoins, DeFi, and NFT

3.1 Stablecoins

MiCA has clear regulatory standards for stablecoins. MiCA requires stablecoin issuers to establish sufficient liquidity reserves at a 1:1 ratio and partly in the form of deposits to protect consumers, and to apply for license and registration with the European Banking Authority (EBA). MiCA also limits the number of daily transactions of non-euro-backed stablecoins to 1 million and daily transactions to 200 million euros.

3.2 DeFi

Since the information structure of DeFi is different from that of traditional finance, standard policies cannot effectively regulate DeFi, so MiCA has not included DeFi in the scope of supervision for the time being. However, MiCA does not completely ignore the development of DeFi. MiCA is piloting DeFi's "embedded regulation" program, which enables automated oversight and execution of DeFi projects and participants through DLT technology. In 2022, the European Union has issued a public tender for the DeFi Embedded Regulatory Study on Ethereum. The study bid is estimated at €250,000 and is expected to take 15 months to complete.

3.3 NFT

MiCA does not specifically use the term NFT, but its specific text description does refer to NFT. MiCA defines an NFT as a unique crypto asset that is not fungible from other crypto assets. Its regulation of NFT is relatively relaxed, requiring compliance with general rules such as marketing communications, information disclosure, and technical security, and does not require submission of a white paper or application for a license. However, if the NFT involves copyright, intellectual property or other legal issues, the relevant legal provisions need to be complied with.

4 Future development trend

The EU's crypto asset regulatory policy has gone through a process from inception to exploration and then to integration over the past few years, and is currently at a critical turning point with the introduction and implementation of MiCA. MiCA will provide a unified and harmonized regulatory framework for crypto asset markets within the EU and will also have a profound impact on the global crypto asset market. On this basis, we can foresee that the EU's crypto asset regulatory policy may show the following trends in the future:

Active regulation: The EU's regulatory attitude towards crypto assets is open and positive. The EU's regulatory principles are risk-based, technology-neutral, market-driven and internationally harmonised. Regulatory measures based on different types and sizes of crypto assets; do not discriminate or favour particular technologies or business models; encourage market competition and innovation; and cooperate and communicate with other countries or regions. The EU will also support research and pilot projects in the field of crypto assets, such as the DeFi Embedded Regulatory Study, to explore more advanced and adaptive regulatory options.

Rule refinement: The objective of the EU's regulation of crypto assets is to ensure that crypto assets are safe, reliable, transparent and effective, preventing crypto assets from negatively affecting financial stability, monetary policy, payment systems and consumer interests. Any crypto asset that wants to enter the EU market must comply with MiCA's rules. With the implementation and enforcement of MiCA, the EU will continue to improve and refine its regulatory standards and measures on crypto assets in response to the rapid changes and diversification of the crypto asset market.

Integration trend: The EU regulatory framework for crypto assets is a unified and harmonized framework that aims to eliminate regulatory differences and uncertainties among member states within the EU and promote the integration and development of the EU's internal market.

The EU has made significant progress and achievements in the regulation of crypto assets. The EU needs to continue to improve its regulatory framework for crypto assets in order to adapt to the rapid changes and diversification of the crypto asset market. And coordinate and cooperate with other countries or regions to achieve consistent regulation on a global scale. The EU's characteristics of openness and positivity, balance and flexibility, unity and coordination in the regulation of crypto assets provide useful reference and inspiration for other countries or regions.