We always accuse Europe of being slow, inflexible and unwilling to change, but this time the Old Continent has bypassed all its competitors and is at the forefront of regulating crypto markets. On 20 April, the European Parliament approved the European Markets in Crypto-assets Regulation (MiCA), opening the door to the civilised development of a modern financial industry in the EU.
The new game rules have neither surprised nor frightened the crypto asset market participants operating in Lithuania, as the regulation already in place in Lithuania has moved towards the same principles as those defined by MiCA. Therefore, this new regulation is not something very radical, but Europe’s resolve seems unusual compared to the treading or even hostile rest of the world.
In the US alone, in 2023, the Securities and Exchange Commission (SEC) has treated some crypto companies as securities-related activities and fined well-known market players such as Coinbase, Kraken, Paxos, Gemini Genesis Global Capital, etc., without much discussion. The People’s Bank of China banned all cryptocurrency operations at the end of September 2021. However, cryptocurrency and cryptocurrency-related operations are currently legalised through Hong Kong.
The EP also adopted the first EU rules to trace cryptocurrency transfers and prevent money laundering and terrorist financing. To this end, the „travel rule“, which is already used in traditional finance, was adopted. From 2025, this rule will oblige crypto service providers to transmit all information on the recipient and the sender of the funds with the crypto order, and this information will have to be stored in the databases of the sender’s and the recipient’s platforms respectively.
The adoption of MiCA is expected to lead to the so-called „Brussels Effect„, where well-developed EU standards for the relevant market are „copied“ and implemented in third countries.
MiCA and its relation with the Lithuanian market
MiCA has finally legalised the virtual asset industry and created additional opportunities for Lithuania. While some countries, including Lithuania, had already introduced regulatory rules for cryptocurrency service providers, the MiCA will harmonise the regulatory environment in all EU Member States, creating a single market for the sector across the 27 EU Member States.
While waiting the adoption of MiCA, Lithuania adopted stricter, interim regulation at the national level in November 2022 to manage the risks associated with new crypto businesses coming to Lithuania.
Lithuania, considered one of the cradle of EU’s fintech, has already earned the status of a cryptocurrency innovation-friendly country. Between November 2022 and 20 April 2023, 353 virtual currency service providers have been authorised in Lithuania, each of which had to raise at least EUR 125,000 in share capital. This means that as of November 2022, we can count more than €44 million invested in Lithuania in the form of share capital alone, not counting all the additional investments related to actual operations, new jobs created and the unique technological know-how that has reached our country in a very short time.
The prospects for financial market innovation and its financing offer much greater potential for raising capital in the future. If Lithuania is one of the first in the EU to designate the authorities responsible for the implementation of the MiCA Regulation, to adopt implementing legislation, and to develop guidelines for industry participants, thus creating legal certainty, we will have a real chance to replicate the country’s success in the fintech sector.
What does MiCA regulate?
MiCA Regulation focuses on crypto service providers and the regulatory requirements applicable to them, imposes various obligations, such as the content of a whitepaper when issuing a new cryptocurrency, other requirements for issuers of different types of cryptocurrencies (e-money, asset-linked, etc.), the licensing, maintenance and operating conditions for cryptocurrency providers, etc.
In the definition of crypto service providers, MiCA includes a range of crypto-related services, such as accepting and transmitting orders on behalf of third parties, storing and administration of crypto asset, exchanging cryptocurrencies etc. Requirements will depend on the type of activity, e.g., a minimum share capital of EUR 50 000, EUR 125 000 or EUR 150 000. Additional capital requirements are foreseen in MiCA for stable crypto assets.
MiCA does not regulate other crypto-related services such as decentralised finance (DeFi), non-exchangeable tokens (NFTs) or crypto lending activities. It should be noted that the European Commission will carry out a comprehensive assessment over the next 18 months and, if necessary, make proposals for specific regulatory regimes for NFTs, DeFi and cryptocurrency lending activities.
What should crypto service providers expect?
Authorised crypto service providers, both in Lithuania and in other EU Member States, should expect an evolution of regulation and compliance towards a more transparent, mature and trustworthy market, but no revolution.
Currently, authorised crypto service providers (crypto exchange and wallet platforms) are subject to a number of local regulatory requirements, such as a minimum share capital of €125,000, good repute for shareholders and directors, the obligation to ensure full compliance with anti-money laundering and anti-terrorist financing rules, etc.
On the other hand, once the MiCA Regulation enters into force, it will not be enough for existing crypto service providers to „tick the box“ and obtain an EU-wide crypto service provider license. Each cryptocurrency business will have to demonstrate the adequacy, maturity and compliance of its business processes with the new requirements before obtaining a license. For example, a comprehensive commercial framework, a description of governance arrangements, policies on IT systems and security measures, the appointment of qualified and experienced managers, adequate segregation of customer funds, cyber protection, etc. will need to be in place.
In addition to these „hard“ requirements, crypto service providers will be subject to „soft“ ones, such as a ban on market manipulation, enabling customers to change their minds and return purchased crypto asset purchased during the ICO (initial coin offering) within 14 calendar days, to create effective customer consultation and complaint handling channels, etc.
Up until now, the crypto market has been severely lacking in regulation to manage systemic market risks, such as safeguarding client funds and ensuring segregation. Cases such as the bankruptcy of FTX (one of the largest cryptocurrency exchanges) were largely due to inadequate protection of client funds, the use of client funds for operational purposes, the investment of client funds in affiliates, etc. These reasons may seem like basic business hygiene from the outside, but the absence of a regulatory environment and a supervising public authority has often led to the abuse of a stronger (business) position in a relationship with the client so far. With MiCA this will change and the rules of the „game“ that have been developed and refined over decades in traditional finance will enter the virtual asset sector.
Although MiCA will only enter into force in the second half of 2024, the requirements set out in the Regulation already set a certain market standard and customer expectations for crypto service providers. Therefore, crypto businesses should not wait for the Regulation to enter into force and should start preparing for the new regulatory reality now. This will give them a competitive advantage over latecomers and ensure a smooth transition to harmonised EU regulation.