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The Third Path for Cryptocurrency

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Last week the EU crypto legislation MiCA was formally signed into law.
Last week the EU crypto legislation MiCA was formally signed into law.

The European Union has made a significant decision regarding cryptocurrencies and crypto-financial activities. They will now be regulated under specific rules. In June, a year and a half period of implementing new regulations began. And now, let's explore why this is important, even if you have never dealt with cryptocurrencies in your life.


Cryptocurrency is gradually becoming a commonplace thing, silently and almost unnoticed. Finally. It all started, as we remember, with a small sect of supporters of anarchic money that was not regulated by anything or anyone. It began with the concept of money that was meant to eliminate the need for a central bank. Money like Bitcoin or Ethereum. Currently, it seems that there are still no central banks for cryptocurrencies, but financial authorities are gradually gaining clearer control over the actions of crypto enthusiasts and crypto owners.

With the new regulations, tens of millions of Europeans will have access to cryptocurrencies under the protection of a set of laws. This means that the rapid proliferation of crypto-financial activities into our everyday lives will begin: investing through mobile applications, making payments with bank cards or smartphones, using virtual in-game currencies and social networks.


A Celebration of Financial Anarchy

It couldn't have been any other way. While the crypto community frolicked on the sidelines of the global financial system, it attracted little attention. The insane surge in popularity of crypto-financial activities in 2017 caught the eye of regulators. This was followed by approximately two years of slow domestic work by government authorities and financial regulators in search of approaches. But then the pandemic happened. And now, the EU has approved a more or less comprehensive code of conduct for crypto-financial activities called MiCA (Markets in crypto-assets).

The very idea of cryptocurrency implied that the rules within a particular blockchain system, on which that cryptocurrency is based, would be determined by the community that ensures the functioning of that blockchain. And everything would be self-regulated. However, the crypto asset market adhered to such principles only until around mid-2017. After that, it was flooded by a noisy crowd of eccentrics, fraudsters, scammers, and poorly educated dreamers.


The Froth and Scams

The crypto market started bubbling. The market demanded the emergence of exchanges. Alongside well-functioning and still-existing exchanges, projects like FTX emerged. That FTX collapsed in November 2022. Its founder, Sam Bankman-Fried, was subsequently charged with fraud by the U.S. Department of Justice. The exchange was valued at over $30 billion before its collapse. And this is just one of many episodes.

Separately lies the valley of scams, a field where blatant fraudsters play their game. They come up with new whitepapers, declarations of intentions for allegedly innovative crypto-financial projects. Naturally, the intentions described in those whitepapers are not planned to be realized by the scammers. They simply collect money from gullible investors and disappear into the blue yonder. At best, scammers accompany the news of their failure with complaints about the severity of financial regulators, the next global financial crisis, or something else.

Another source of sleeplessness for investors and regulators is the so-called stablecoins. This type of cryptocurrency has significantly increased its share in the crypto market in recent years. Their essence lies in pegging the value of the cryptocurrency to, for example, the U.S. dollar or another traditional currency (or even an ounce of gold, anything can be declared an anchor). They are actively used in cross-border transactions and for speculating on the prices of other cryptocurrencies.

However, the existence of such stablecoins is only possible if their issuers have an equivalent amount of the underlying currency (e.g., dollars) in reserve for the amount of stablecoins in circulation. And here, the issuers of stablecoins face a strong temptation: to issue more of their cryptocurrencies than the dollars held in reserves. And to spend a portion of the actual dollars received in exchange for stablecoins on Lambos and real estate in Bermuda.


Regulate can't be let go

The main dilemma for regulators is "How should we approach cryptocurrencies?" Over the past few years, there have been fluctuations between two approaches. The first approach is to tightly regulate cryptocurrencies, similar to how securities are regulated in developed financial markets. The second approach is to let them run wild but build a high wall between cryptocurrencies and the traditional financial system to make the flow of money in and out of the crypto market extremely challenging.

What do authorities and financial regulators fear? They fear two phenomena: tax evasion and money laundering. Some of their concerns are justified, but more often than not, they are not. Especially now, after so-called anonymous cryptocurrencies have been effectively banned in most jurisdictions. Non-anonymous cryptocurrencies, on the other hand, can be easily traced if desired.

The European Union (EU) has taken a compromise approach. The recently enacted MiCA (Markets in Crypto-assets) grants cryptocurrencies a much softer status compared to traditional securities. For instance, creators of a crypto asset will not require prior approval from regulatory bodies to publish an official document for investors (a white paper). So, the EU has taken a third path—cryptocurrencies will not be treated as securities in the 27 member states, but they won't be left entirely unregulated either.

This decision has already received applause from the crypto market, although there are also pessimistic voices. What happens next? MiCA is not a directly applicable law for specific EU countries. Instead, it serves as a framework within which individual EU countries will issue their own laws and regulations for the crypto market. They have a maximum of 18 months to do so, until December 2024, which allows crypto projects to adapt to the new conditions.

Moreover, it will be possible to take advantage of national regulatory peculiarities in individual countries. Because MiCA is a framework law, it leaves some freedom for EU members to create their own national laws. And the freedom of capital movement within the EU has not been abolished either.

There are still two financial centers that will compete with the EU in terms of convenience for crypto finance — Switzerland and the United Kingdom. They are currently tuning their national laws and regulations regarding crypto assets, so European citizens will have choices.


As a side note, here are the three key rules of MiCA:

The most important requirement of MiCA is that cryptocurrency transfers, like any other financial transaction, must always be traceable, and suspicious transactions must be blocked. Information about the source of the asset and its beneficiary will travel with the transaction and be stored on both sides.

The MiCA law applies to transactions of over 1000 euros from autonomous wallets (the private user's cryptocurrency wallet address) when they interact with crypto asset service providers. The rules do not apply to peer-to-peer transfers(between private persons).

The MiCA law includes measures against market manipulation, money laundering, terrorist financing, and other criminal activities. As usual, sure. The European Securities and Markets Authority (ESMA) will create a public registry of crypto asset service providers that are illegal in the European Union.

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