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Distributed ledger technology (DLT) has the potential to
fundamentally change the financial services landscape. The underlying
technology itself holds great potential for existing financial markets
including, accelerating payments, improving fraud prevention and
allowing banks to clear and settle trades much more efficiently. Both
banks and new market entrants in the Fintech space have been developing
DLT based solutions to reduce costs, transform their offerings , and
respond to growing demand by customers for the tokenisation of
traditional assets (e.g. real estate, fine art) as well as the inclusion
of the emerging asset class of crypto-assets.
Crypto-assets, such as Bitcoin, harness DLT and are seen by many to
have plausible value for future generations. As the industry looks to
implement the technology across their business lines, and crypto-asset
markets continue to expand, global regulators are also reviewing and
developing the regulations required to manage the risks arising from
these new assets to financial stability, investors, and consumers.
MiCA (Markets in Crypto-assets), the framework proposed by the European
Commission, aims to create EU-wide minimum requirements for all
crypto-assets issuers and service providers. It is currently being
discussed by the European Parliament and the Council of the EU and is
expected to be adopted later this summer.
However, while good progress is being made towards implementing a
standardised European framework that brings regulatory protection,
concerns remain.
The most critical is related to the requirements imposed on custodians of crypto assets, and, in particular, to what extent they are responsible if something goes wrong. ‘Crypto custody’ refers to the securing of crypto assets by a third party, which is important to protect investors from theft or hacks. Custodians are essential for secure crypto-asset adoption by both consumers and institutional investors. However, despite the enhanced protection that custody offers, things can still go wrong. For instance, there may be circumstances beyond the custodians control, such as sanctions.
In this respect, the drafting of MiCA causes concern, because as
currently proposed, banks providing custody services are liable for
crypto-asset losses that are outside of their control, for example, in
the event of regulatory or government action (e.g. banning or outlawing a
particular crypto-asset). This is inconsistent with current global
liability regulation for other asset classes, and would strongly
disincentivise traditional finance institutions from offering
crypto-asset custody solutions. If unresolved, MiCA may inadvertently
cause the opposite impact of its stated intent – i.e. protecting
investors from loss by driving clients to look for unregulated solutions
in other jurisdictions or self-custody in the EU. These solutions
ultimately put them at a greater risk of loss, and also outside of all
courses for redress.
As with the risks that may arise from the current drafting of the broad
liability requirements, there are other pieces of the proposal that may
inadvertently drive crypto-asset investors to conduct their business
outside of regulated providers. For example, further consideration
should also be given to risks concerning decentralised finance (known as
DeFi). The European Commission proposed MiCA in September 2020, when
other crypto-asset developments such as Non Fungible Tokens (NFTs) and
DeFi offerings (such as Decentralised Autonomous Organisations or DAOs)
were still nascent. Since then, they have evolved rapidly with billions
in DAOs globally. Policy makers are considering whether these
innovations also deserve a home in MiCA, but if DeFi and its associated
activities are in fact regulated products (such as securities) it is
critical that they are brought within the regulatory perimeter in an
appropriate way to manage risks to market integrity, financial stability
and end users.
The EU is taking a leading role in regulating crypto-assets and the
finalisation of MiCA will undoubtedly harmonise the regulatory approach
across the EU, and make it an attractive and competitive market for
crypto-assets . However, in order to implement an EU framework that
protects investors from severe losses, regulators must be mindful of the
potential unintended consequences that could arise if the framework
disincentivises banks from offering crypto-asset services and forces
clients to seek out new players outside of the protection MiCA should
guarantee them.
It is also crucial that both EU and global regulators work
cooperatively to build a balanced and harmonised framework, fit for the
digital age, where market participants can engage with crypto-assets
from within the regulatory perimeter.