Balancing Innovation and Risk: The EU’s Approach to Regulating Crypto Assets

Regulators across the European Union are not on the same page regarding how best to regulate cryptocurrencies.

With so many different approaches being taken by regulators in different countries, it is no wonder that confusion reigns supreme within the industry and the companies that operate within it. 

Regulators in the EU have been very careful with the crypto market and, in some cases, have even gone as far as to outright ban it.

Let us explore why regulators feel uncertain about their response to cryptocurrencies and why they need to agree upon one common strategy to see innovation flourish within space instead of suffering from stagnation.

European Union regulators warn of the dangers associated with trading crypto assets

The European Supervisory Authorities (EBA, ESMA, and EIOPA – the ESAs) remind consumers that many crypto-assets are extremely risky due to speculation. 

These are not meant for most retail consumers as an investment or even a way of exchanging funds. Consumers may lose all of their invested money if they purchase these assets.

Consumers should be vigilant against false advertisements, including through social media sites such as Instagram and influencers who may promote misleading information about this product or service.

Consuming individuals need to know that there is little legal protection once you enter this realm; because crypto-assets and related products fall outside typical protections under current European Union financial regulations.

Key Risks of Crypto Assets According to the Regulators

European regulators have a strong stance on the risks of crypto assets. Their recent report outlines seven key risks, namely:

  • Lack of Transparency
  • Product Complexity
  • Severe Price Movements
  • Fraud
  • Deceiving Information
  • Lack of Protection
  • Operational risks and Security issues

Let us discuss what regulators think of these risks in detail below:

1. Lack of Transparency

How cryptocurrency prices are set, and transactions can occur without being fully transparent. Some cryptocurrencies are also very concentrated, which impacts the price or liquidity of those cryptocurrencies. 

Without a clear and fair pricing scheme for each coin, you may not receive an equitable price when trading your coins; or you might find it difficult to trade them unless there is already another interested party willing to buy them from you.

2. Product Complexity
Some products providing exposure to crypto assets are complicated, often with features that can greatly increase losses in an unfavorable movement. Due to their complexity, these products are not appropriate for many consumers.
3. Severe Price Movements
Many crypto assets are subject to sudden, drastic price swings and speculation; because most rely solely on consumer demand. You may lose all of the money you invested. The extreme prices also make many crypto-assets unsuitable as a store of value or means of payment.
4. Fraud
Numerous fake crypto-assets and frauds are out there. It would be best if you were very cautious about these because their only purpose is to steal your money using various methods, for example, by tricking you through phishing schemes.
5. Deceiving Information

Crypto assets and related investments can sometimes be aggressively marketed to the public with unclear or inaccurate information. For instance, advertisements via social media may be very short, focusing on the potential gains but not the high risks involved. 

You should also watch out for ‘influencers’ who usually have an ulterior motive when marketing certain crypto-assets and related products – they likely either own them already or have some investment stake – so you should not take anything said too seriously!

6. Lack of Protection
Most crypto-related projects and selling products or services related to cryptocurrencies are unregulated in the EU. If this is the case, you will not have access to the rights and protections given to consumers when it comes to regulated financial services such as complaint processes or methods for redress
7. Operational risks and Security issues

The distributed ledger technology underlying cryptocurrencies has its own set of unique vulnerabilities. Crypto exchanges and wallet providers have been subject to highly publicized cyber-attacks, resulting in significant loss of assets and disruption of services. 

As many consumers lack the knowledge to guard themselves against these exploits, they risk losing their cryptocurrency or suffering losses when hackers exploit their ignorance and steal what was rightfully theirs.

Benefits of new EU crypto regulation

But as time moves forward and with all the new technology and assets, the EU is working on new rules titled Markets in Crypto-Assets to bolster crypto-assets potential and minimize any possible threats.

Members of Parliament have reviewed and amended the European Commission’s proposal, and an interim agreement was reached between both parties back in June 2022.  

It was waiting for final approval from the Parliament and all other EU countries before passing into law.

To encourage the development and use of these technologies, the new regulations are trying to provide legal certainty while supporting innovation, protecting consumers and investors and ensuring financial stability.

In an attempt to promote the growth of these technologies and make them widely available, this Legislation strives to provide legal clarity for innovators, prevent fraud from hurting consumers or investors and ensure fiscal stability.

What is MiCA?

The European Union’s proposed regulation of crypto-assets – MiCA – has now entered its next stage of discussions. In the coming weeks, Europeans in charge of the EU Commission, Council, and Parliament will discuss the regulatory framework set to change cryptocurrency laws across 27 member states drastically. 

Importantly, the latest draft bill has removed a provision prohibiting proof-of-work crypto assets due to their links with energy consumption. If passed, it would effectively result in a de facto ban on Bitcoin, Ethereum (even though this is undergoing conversion to proof-of-stake), and Litecoin – all major mining-based cryptocurrencies – as well as impacting any service acting as custodian for these coins.

Thankfully, just when tension between EU lawmakers seemed at an all-time low (in light of an April proposal extending KYC/AML regulations forbidding anonymous cryptocurrency transactions), news broke about ‘MiCA’ entering another phase of discussion.

Objectives of MiCA
MiCA has created a single licensing regime across the European Union for cryptocurrencies that do not fall under current financial regulations. This way, there will be unified Legislation throughout Europe and new rules designed for these ever-changing markets.

As stated in the details of the law, MiCA has four important objectives:

  1. Instilling appropriate levels of consumer and investor protection and market integrity
  2. Providing legal certainty for crypto assets not covered by existing EU financial services legislation
  3. Supporting innovation by promoting the development of crypto-assets and the wider use of DLT (distributed ledger technology)
  4. Ensuring financial stability with specific rules for so-called stable coins, which includes provisions when they are electronic money
How will MiCA affect Legislation?

MiCA describes crypto-Asset Service Providers as anyone whose occupation or business is the provision of one or more crypto-asset services to third parties professionally. The European legislators have decided against using virtual since FATF also uses it.

Under MiCA, the definition of crypto-asset services is such that a business providing at least one of the following activities – including but not limited to exchanging cryptocurrencies and fiat currencies or operating an exchange for cryptocurrencies – may be classified as a CASP:

  • exchanging crypto assets and fiat currency
  • exchanging one class of cryptocurrency for another
  • the custody and administration of cryptocurrency on behalf of third parties
  • the operation of a trading platform for cryptocurrency
  • execution of orders for cryptocurrency on behalf of third parties;
  • placing cryptocurrencies
  • receiving and transmitting orders for cryptocurrencies on behalf of third parties
  • and providing advice about cryptocurrency investments

The final category captures the broad aspect of what a MiCA does. This category encompasses advice from an operation in this space, regardless of whether they are categorized as a VASP under the Irish Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Act 2021.

The Bottom Line

Under the new regulations by MEPs, all transfers of crypto assets must contain information about where the asset came from and who it will be. This data will be accessible to authorities who are looking into this matter.

The restrictions do not apply for personal transactions without a third party involved – for example, someone exchanging bitcoins via an online trading platform.

Despite different regulatory regimes applying to whatever category of ‘CASP’ crypto business falls into, the common theme is that firms operating in this space must get used to the obligations that come with being a regulated entity. 

These obligations may include minimum capital requirements, liability cover (if lost because of a hack), and adherence to market abuse rules, among many others, depending on what type of services are offered.

For companies involved in this industry to compete effectively against other stakeholders entering their respective markets who may not be subject to these types of regulations yet – they need put policies and procedures into place now that show they are both prepared for them when they happen as well as making sure it does not completely disrupt their existing operations.

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