Parliament approved the inaugural European Union regulations aimed at tracking crypto-asset transfers and combatting money laundering. Under this “travel rule,” VASPs must share originator and beneficiary details on all crypto transfers, eliminating their attractiveness to money launderers. So crypto regulations in Europe can be complicated.
The agreement includes safeguards to combat market manipulation and protect consumers, with expectations that other regions will raise their standards accordingly.
Markets in Crypto-Assets Regulation (MiCA)
Thursday marks a momentous two days for cryptocurrency-based markets as the European Union plenary gave final approval to two monumental and interdependent regulatory initiatives that will set the course for virtual value regulation for decades to come. MiCA, which will create the world’s most extensive legal framework for crypto assets, seeks to combat fraudsters while improving market integrity while mandating actions taken against fraudulent service providers as well as protecting consumers, the environment, and anti-money laundering (AML) activities by crypto asset service providers.
The second initiative, a comprehensive digital operational resilience framework, seeks to provide EU financial institutions with a common basis for digital operation and support. Authorized crypto-asset service providers must prepare and test their own internal operating resilience (ISOR) and IT systems before managing third-party risks effectively.
Both initiatives will have wide-ranging ramifications on the cryptocurrency industry and could prompt other regions to raise their standards to match those of Europe, according to Teunis Brouns, head economist for digital finance and regulation at ING. They form part of an overall strategy comprising the DLT pilot regime and the Digital Operational Resilience Act (DORA).
MiCA will have a profound effect on anyone releasing or trading crypto-assets such as asset-reference tokens and so-called stablecoins, their trading venues, and wallets where they’re held, filling a longstanding gap in EU law by placing these services under similar supervision to traditional financial services and providing key provisions like transparency, disclosure, and authorization in addition to market manipulation protection, consumer safeguards, and environmental safeguards.
Preparing to comply with MiCA will be an extensive task for those already providing crypto-asset services, and may involve reviewing documentation, policies, and procedures as well as risk assessments. Furthermore, applying for MiCA authorization could take more time and possibly cost money depending on their size, complexity, and scale of operations – potentially necessitating dedicated personnel for compliance monitoring purposes.
Markets in Stablecoins Regulation (MiStaCoin)
Stablecoins are a type of crypto asset designed to maintain an even price against fiat currencies, providing trade opportunities on cryptocurrency exchanges and serving as collateral for various crypto loans. Stablecoins also reduce inefficiencies caused by having to convert cryptocurrency transactions back to fiat currencies for settlement, though if their backing by real assets is insufficient they may become unstable. On-chain collateralized stablecoins rely on market participants trusting its long-run peg, while off-chain collateralized stablecoins rely on trust between themselves and the custodian holding their real-world assets – in both cases any breach could lead to a run on the stablecoin and loss of value.
Stablecoins must be supported by a stable ecosystem made up of users, exchanges, brokers, and other institutions in order to limit this risk. A system must exist that facilitates digital asset transfers as well as financial applications being run on it; additionally, they should offer user-friendly interfaces, oracles, governance/voting mechanisms, and development grants or foundations as well as having a treasury for holding their coins safely.
On-chain collateralized stablecoins can be made more secure by mandating that their issuance or redemption always correspond to the proper amount in reserves. In practice, this means the stablecoin’s issuer must either set aside real-world assets in reserve for holders to exchange their stablecoins against, or provide incentives through tokens to motivate holders to return them. Some decentralized on-chain stablecoin initiatives even use additional tokens as incentives to motivate holders to return their stablecoins.
MiCA stipulates several requirements for stablecoins, including white papers that act like prospectuses. White papers must provide information about the stablecoin itself, its project or company behind it, and any risks associated with holding it. White papers help create transparency and clarity in the market while helping prevent fraud or manipulation. Furthermore, the EU’s new rules mandate stablecoin businesses be licensed and hold reserves similar to traditional banks.
Transfer of Funds Regulation (TFR)
The TFR is the first EU piece of legislation designed to enable the tracing of crypto asset transfers similar to how traditional money transfers can be traced, a big part of crypto regulations in Europe. Its primary goal is to detect suspicious transactions; however, some privacy issues arise as well – for instance, CASPs must now verify ownership when sending more than EUR 1000 transfers; additionally registering their transactions histories in a public registry will also be required and they are forbidden from engaging in interactions with DeFi protocols and decentralized exchanges.
These new rules aim to prevent payment systems from being used to launder money or finance terrorism – an admirable goal we support fully. They are based on recommendations by the Financial Action Task Force (FATF), an international body dedicated to fighting money laundering and terrorist financing; yet in some ways go far beyond what FATF recommends and may have unintended repercussions.
One issue raised by the TFR is its application to transactions between individuals without CASPs but without self-hosted wallets; this raises privacy issues as each transaction involving value below EUR 1000 will require you to transmit personal data with it; privacy rights are fundamental rights enshrined within the Universal Declaration and European Convention of Human Rights but don’t appear to be recognized under its provisions.
TFR will require that all CASPs provide information on both the originator and beneficiary of every transfer regardless of amount, which will prove challenging since costs for smaller transactions will increase substantially and hinder CASPs from providing low-cost solutions that enable underprivileged people to gain access to financial services – one of FATF’s primary objectives.
MiCA initiatives, such as TFR and KYC compliance products from IDnow will create a regulatory environment to support Europe as it matures as a crypto hub. At IDnow we believe KYC compliance plays a crucial role in this process and we are ready to support issuers and providers of this technology with our products.
Anti-Money Laundering Regulation (AML)
The European Union has issued several Anti-Money Laundering Directives which must be implemented by each member state to combat money laundering, terrorist financing and sanctions evasion, another big part of crypto regulations in Europe. Key preventative actions included identification, record-keeping, and central reporting methods of suspicious transactions.
The First Anti-Money Laundering Directive introduced a range of measures, imposing obligations upon banks to perform Customer Due Diligence (CDD) checks on both new and existing customers as well as report any suspicious transactions to appropriate authorities in order to prevent misuse of financial institutions and protect the EU Single Market.
As a follow-up to the success of the First Directive, a second directive was passed in order to expand the anti-money laundering regime and cover a wider array of professionals including lawyers, notaries and accountants as well as high-value goods such as cars, yachts, and real estate. Furthermore, provisions were made for exchanging information among EU states.
On 20 July 2021, the European Commission unveiled a package of legislation intended to strengthen EU anti-money laundering and counter the financing of terrorism regulations. This legislation includes updating aspects of previous AMLDs with an updated sixth AMLD as well as creating an Anti-Money Laundering Authority.
6AMLD seeks to fill any remaining crypto regulations in Europe gaps in money laundering and terrorist financing enforcement by providing a new definition of money laundering and strengthening predicate offenses. Furthermore, this legislation makes clear that individuals are accountable for crimes committed by legal entities they own or control and increases fines and prison terms on those responsible.
The Directive also implements measures designed to increase transparency and decrease the risk of exploitation for vulnerable groups such as minors and the elderly. Beneficial ownership registers must be publically available across Member States, firms are required to carry out enhanced due diligence checks on customers from high-risk third countries, and money laundering and terrorist financing crimes must carry a jail sentence of at least four years.