Editorial of the Day: The EU’s New Crypto-Legislation

Context: The European Parliament, the legislative body of the 27-country block European Union, has approved the world’s first set of comprehensive rules to bring largely unregulated cryptocurrency markets under the ambit of regulation by government authorities. The regulation, called the Markets in Crypto Assets (MiCA), will come into force after formal approval by member states.

The EU’s New Crypto-Legislation Background

What are Crypto Assets?

• Crypto assets are purely digital assets that use public ledgers over the internet to prove ownership.
• They use cryptography, peer-to-peer networks and distributed ledger technology (DLT) – such as blockchain – to create, verify and secure transactions.
• Crypto is part of the Web 3.0 internet landscape which decentralises ownership and alters the concept of one or more big entities wielding control over everyday lives.
• Cryptocurrencies, utility coins, stable coins are some of the types of crypto assets.

The Growth of Crypto Assets around the World

• Crypto assets have grown and diversified substantially since Bitcoin was first launched in 2009 and have evolved to serve different purposes and economic functions.
• After reaching a market capitalization of $1 billion in 2010, the crypto asset market had grown to almost $3 trillion in 2021 before falling to around $1 trillion in mid-2022.
• The largest proportion of this market, by capitalization, consists of unbacked crypto assets and stablecoins.
• Current state of crypto assets in India:
  • It is estimated that India has 25 to 30 million investors with an exposure to crypto assets. This is set to grow multi-fold over the next 3-5 years.
  • According to the United Nations Conference on Trade and Development Report 2021, 7.3% of Indians owned cryptocurrency in 2021.
  • India ranked second in a list of 20 countries with the highest cryptocurrency adoption rate, according to the Chainalysis’s 2021 Global Crypto Adoption Index, with a growth rate of 641% over the past year.

Advantages of Crypto Assets

Why is it necessary to regulate crypto assets?

• Protection of investors: The crypto market can be highly volatile and subject to significant price fluctuations. By setting standards, regulation can help to protect investors by ensuring that they are provided with accurate and transparent information about crypto assets.
  • The year 2022 saw some of the biggest failures and wipeouts in the crypto industry involving bankruptcies and fraud scandals, be it the collapse of the crypto exchange FTX or the failure of Terra LUNA cryptocurrency, hurting investors across the world.
• Prevention of illegal activities: Crypto assets have been associated with illegal activities such as money laundering, terrorism financing, and tax evasion.
  • In 2021, illicit transactions using cryptocurrencies were estimated to be $14 billion, 79% increase from $7.8 billion the previous year, according to blockchain analysis firm Chainalysis.
• Financial stability: The growth of the crypto market has raised concerns about its potential impact on financial stability. Regulation can help to mitigate these risks by setting standards for the conduct of market participants.

Decoding the Editorial

This article discusses the recently approved legislation of the European Parliament, called Markets in Crypto Assets (MiCA) and its rules for issuers and investors of crypto assets, the applicability and significance of the rules and their shortcomings.

Key highlights of the Markets in Crypto Assets (MiCA) legislation

Applicability

• Applies to:
  • The MiCA legislation will apply to ‘cryptoassets’, which are broadly defined as “a digital representation of a value or a right that uses cryptography for security and is in the form of a coin or a token or any other digital medium which may be transferred and stored electronically, using distributed ledger technology or similar technology”.
  • This definition implies that it will apply not only to traditional cryptocurrencies like Bitcoin and Ethereum but also to newer ones like stablecoins.
• Does not apply to:
  • MiCA does not regulate digital assets that would qualify as transferable securities and function like shares or their equivalent and other cryptoassets that already qualify as financial instruments under existing regulation.
  • It will also for the most part, exclude non fungible tokens (NFTs).
  • MiCA will also not regulate central bank digital currencies issued by the European Central Bank and digital assets issued by national central banks of EU member countries.

Key rules under the MiCA legislation

• MiCA will impose compliance on the issuers of cryptoassets and cryptoasset service providers (CASPs).
• Requirements for CASPs:
  • The regulation prescribes different sets of requirements for CASPs depending on the type of cryptoassets.
  • The base regime will require every CASP to get incorporated as a legal entity in the EU.
  • They can get authorized in any one-member country and will be allowed to conduct their services across the 27 countries.
  • They will then be supervised by regulators like the European Banking Authority and the European Securities and Markets Authority.
  • Besides authorisation, service providers of stablecoins also have to furnish key information in the form of a white paper mentioning the details such as participants, terms of the offer etc.
• Prevention of money laundering and terror financing: Another legislation passed with MiCA requires crypto companies to send information of senders and recipients of cryptoassets to their local anti-money laundering authority, to prevent laundering and terror financing activities.

Significance and Shortcomings of the MiCA legislation

• The author contends that having a comprehensive framework like MiCA for 27 countries in Europe not only harmonises the crypto industry but also gives the EU a competitive edge in its growth compared to the U.S. or the U.K. which lack regulatory clarity.
• However, he feels that the regulation is already laggard in covering newer vulnerabilities in the crypto industry. For instance, it does not cover practices like crypto staking and lending, which led to some of the industry’s biggest failures last year.

Beyond the Editorial

An overview of crypto regulation in India

• Cryptoassets in India: In India, they are identified as Virtual Digital Asset (VDA). Under Section 2 (47A) of the Income Tax Act (1961), VDAs are defined as
  • any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;
  • a non-fungible token or any other token of similar nature, by whatever name called;
  • any other digital asset, as the Central Government may, by notification in the Official Gazette specify.
• Trade in cryptocurrencies: Cryptocurrencies as a payment medium are not regulated or endorsed by the RBI. There are no clear guidelines dealing with cryptocurrency or its trade.
  • Even though crypto currencies have not been banned, their transactions in the country are very low. Majority of them buy cryptos as an investment.
• Taxation: During the Union Budget 2022-23, the Finance Minister announced a 30 per cent tax on gains from crypto assets and an additional 1 percent TDS on the transfer of the said assets.
  • This marked the Indian government’s official regulation of cryptocurrency in the country.
• Money laundering law: The government has brought crypto currencies and such other digital assets, trading, safe keeping and related financial services under the ambit of Prevention of Money Laundering Act (PMLA).
  • It means that entities dealing with crypto assets must follow similar reporting standards and KYC norms as the other regulated entities like banks, securities intermediaries, payment system operators, etc.

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