Today's Recommendation | JD Research Report: In-depth Discussion on Key Points and Impacts of EU Encryption Asset Regulation

Author: Shen Jiangguang, Chief Economist of JD Group; Zhu Taihui, Senior Research Director of JD Group

Introduction

In June 2023, the European Union officially released the Markets in Crypto-Assets Regulation (MiCA), which will come into full effect on December 30, 2024, applicable to 27 EU member states and an additional 3 European Economic Area countries (Norway, Iceland, Liechtenstein). It addresses the fragmentation and regulatory arbitrage issues in the regulation of crypto assets in the EU and EEA countries, making it the most widely applicable cryptocurrency regulatory framework globally.

MiCA provides detailed regulations on the classification and use of crypto assets, the licensing of crypto asset issuers and service providers, the operational management of crypto asset issuers and service providers, the reserve and redemption management of crypto asset issuers, and anti-money laundering supervision of crypto asset trading activities. It is the most comprehensive regulatory framework for crypto assets globally to date.

MiCA not only sees the role of crypto asset development in improving the efficiency of financial services, improving financial inclusion and promoting economic growth, but also pays attention to the challenges brought by crypto asset development to the operation of the payment system, the stability of the financial system and the transmission of monetary policy (monetary sovereignty), and has found a balance between supporting financial innovation and fair competition, maintaining financial stability and consumer rights. Starting from 2025, with the gradual implementation of MiCA in European countries, it will play a great role in promoting the compliance development of the global crypto asset market, and will also lead the formulation of crypto asset regulatory policies in other countries and the construction of a global governance coordination system.

1. Classify and define cryptocurrency assets, and clarify usage and trading requirements.

2. In terms of asset classification, MiCA divides regulated crypto assets into three main categories.

According to whether crypto assets attempt to stabilize their value by referencing other assets, MiCA categorizes regulated crypto assets into three main types: Electronic Money Tokens (EMT), Asset-Referenced Tokens (ART), "Utility Tokens" (UTs), and other crypto assets. Fully decentralized crypto assets are not regulated by MiCA.

Among them, EMT is a payment method that maintains the value of assets by referencing an official currency (i.e., fiat-backed stablecoin). The issuer of EMT is prohibited from paying interest on EMT (including compensation, discounts, etc., similar to domestic requirements for non-bank payments).

ART maintains a stable value by referencing another value or right, or a combination of both, including one or more values or rights, commodities, fiat currencies, or crypto assets. It serves as a means of transaction and an investment tool. Issuers and service providers should not pay holders interest related to the length of time ART is held when providing services related to ART.

The difference between EMT and fiat-currency supported ART lies in the right of redemption; EMT holders can and have the right to redeem EMT at face value at any time, while ART holders do not have such strong guarantees regarding the redemption time and redemption value.

UTs and other cryptocurrencies provide digital access to certain goods or services, offered on distributed ledger technology, and are only accepted by the issuer of the token. They serve non-financial purposes related to the operation of digital platforms and digital services, representing a specific type of cryptocurrency. Additionally, non-fungible tokens (NFTs) and central bank digital currencies (CBDCs) are not within the regulatory scope of MiCA, and security tokens are also not regulated by MiCA but are governed by securities regulations.

Table 1: Regulatory Requirements of MiCA for Crypto Assets and Their Issuers

2. In terms of usage and trading, limits have been set on the daily trading volume of crypto assets and the use of foreign currency stablecoins.

MiCA requires that the daily trading volume of a single ART or EMT must not exceed 5 million euros, and when the market value of ART or EMT exceeds 500 million euros, the issuer must report to the regulatory authority and implement additional compliance measures.

MiCA allows the use of EMT (stablecoins) for cryptocurrency trading and decentralized finance (DeFi) activities, but imposes distinctions and restrictions on the use of EMT for payment for goods and services. Only euro stablecoins can be used for everyday goods and services payments to protect the monetary sovereignty of the European Union and prevent the development of foreign currency stablecoins from impacting the EU's monetary system.

In addition, MiCA has imposed strict limits on the daily usage scale of ART. When the usage volume exceeds 1 million transactions or a transaction amount of 200 million euros (quarterly average) within a single currency area, the issuance of that ART must be halted.

2. Clarify the licensing requirements for cryptocurrency issuers and service providers, and implement differentiated regulation.

3. Implement different access and licensing requirements for the issuance of different types of cryptocurrency assets.

MiCA believes that ART may be widely used by holders to transfer value or as a means of exchange, and has imposed stricter requirements on ART issuers to protect the interests of holders (especially retail holders) and market integrity.

MiCA clarifies the access authorization requirements for ART issuers: ART issuers must establish themselves as legal entities in the EU, must first obtain authorization from their home country's designated regulatory authority, and such assets must be traded on a crypto asset trading platform. However, under circumstances where the ART issuer is already a credit institution, the outstanding ART is below 5 million euros, or the ART is issued to qualified investors, access authorization may be exempted.

For EMT issuers, MiCA requires that they must be authorized as credit institutions or electronic money institutions and comply with the requirements of the Electronic Money Directive (EMD2) regarding electronic money institutions. In cases where the amount of EMT does not exceed 5 million euros, EMT issuers can also obtain an exemption from access authorization, but they need to publish a white paper as required.

For issuers of crypto assets other than ART and EMT, the requirements of MiCA mainly focus on disclosure rules, but the white papers of these crypto assets need to be registered with the European Securities and Markets Authority (ESMA).

2. Clarify the scope of cryptocurrency asset services and the licensing requirements for cryptocurrency asset service providers.

MiCA defines the scope of services related to crypto assets quite broadly, mainly covering the following ten areas of business activities: providing custody and management of crypto assets on behalf of clients, operating crypto asset trading platforms, exchanging crypto assets with fiat currencies, swapping crypto assets with other crypto assets, executing crypto asset orders on behalf of clients, investing in crypto assets, receiving and transmitting crypto asset orders on behalf of clients, providing advice on crypto assets, offering portfolio management for crypto assets, and providing transfer services for crypto assets on behalf of clients.

On this basis, MiCA classifies any individual or entity that provides crypto asset services commercially as a Crypto Asset Service Provider (CASP). Service providers intending to offer crypto asset services must register an office in one of the EU member states and apply for CASP authorization from the competent authority of the member state where their office is registered. It is important to note that crypto asset services provided in a fully decentralized manner without any intermediaries are not subject to MiCA regulation.

3. Clarify the operational requirements for issuers of crypto assets and service providers, with a focus on capital regulation.

4. Make capital regulation a top priority in the operational supervision of cryptocurrency issuers.

MiCA has clear requirements for ART issuers regarding information disclosure, honest operation, corporate governance mechanisms, internal control mechanisms, risk management procedures, reserve asset management, and redemption. It also requires that all types of crypto asset issuers publish a white paper (except for UT and small cryptocurrencies). For EMT issuers, they must comply with the operational regulatory requirements for electronic money and payment instrument institutions.

At the same time, in order to address the potential impact of the widespread issuance of ART on the stability of the financial system, MiCA has set specific capital requirements for ART issuers (essentially following the principle proportional to the scale of ART issuance), requiring them to always have at least the higher of the following amounts of their own funds: first, €350,000; second, 2% of the average amount of reserve assets/token issued as described in Article 32 of MiCA; third, one-quarter of the fixed indirect costs from the previous year (if the ART issuer is a credit institution, it must comply with the capital regulatory requirements for credit institutions); the capital requirement for EMT issuers is no less than 2% of the circulation scale of EMT issued, and they must also meet the capital regulatory requirements for credit institutions or electronic money institutions.

In addition, MiCA also refers to the regulation of "systemically important financial institutions" and evaluates whether ART and EMT are "important crypto assets" based on factors such as the number of customers, market capitalization, trading volume, and the degree of association with the traditional financial system, while imposing additional risk and capital requirements on issuers of important crypto assets.

2. Implement differentiated regulatory requirements for service providers of encrypted assets in different ranges.

MiCA sets differentiated minimum capital requirements for different types of crypto asset service providers, to be executed at no less than the following standards or one-quarter of the fixed management fees from the previous year: the minimum permanent capital (own capital) that trading platforms need to maintain is €150,000; the minimum permanent capital for crypto asset custodians and brokers is €125,000; the minimum permanent capital that CASPs providing other services need to hold is €50,000, with a review of regulatory requirements conducted annually.

At the same time, MiCA has put forward targeted regulatory requirements for various CASPs. For example, MiCA requires crypto asset custodians to establish clear custody policies, regularly communicate asset status to clients, and assume responsibility for client asset losses due to network attacks/failures, among other things. Trading platforms need to implement monitoring for market manipulation and disclose buy/sell prices and trading depth, while brokerage firms need to develop non-discriminatory policies. Advisors and portfolio managers need to assess whether to engage in crypto asset investments based on the client's risk tolerance and knowledge.

Table 2: MiCA Differentiated Capital Requirements for Crypto Asset Service Providers

4. Strengthen the management and supervision of issuer's reserve assets; isolating custody and timely redemption are key points.

5. Clear requirements have been set for the custody and investment of reserve assets.

In order to protect the reserve assets of ART from claims by creditors of the issuer and the custodian, MiCA requires that the reserve assets of ART be completely segregated from the issuer's own assets at all times. The issuer must entrust the reserve assets to a qualified credit institution, investment company, or crypto asset service provider for safekeeping. The reserve assets must not be used by the issuer as collateral or as guarantees. In the event of a loss, the custodian must return crypto assets of the same type or equivalent value as the lost assets to the ART issuer, unless the custodian can prove that it can be exempted from repayment obligations.

When the issuer faces bankruptcy or is unable to fulfill its obligations to the holders, the reserve assets should be prioritized for ensuring the redemption payments to ART holders. However, regarding the principle that should be followed to ensure the redemption rights of all holders when the reserve assets cannot guarantee the redemption at face value for all holders, MiCA has not yet provided specific requirements.

For the reserve asset management of EMT, MiCA requires issuers to comply with the safeguarding requirements of the EU's Electronic Money Directive (EMD2) and Payment Services Directive (PSD2): reserve assets must not at any time be mixed with the funds of any natural or legal persons other than payment service users; reserve funds should be invested in assets denominated in the same currency as the currency referenced by the electronic money token to avoid cross-currency risk; and if funds are held by payment institutions and are not used for payments by the end of the next business day, they should be deposited in a separate account with a credit institution or invested in safe, liquid, low-risk assets determined by the competent authorities of the member state; EMT issuers must isolate reserve assets from the claims of other creditors to ensure that EMT holders are prioritized for repayment in the event of issuer bankruptcy.

In addition, MiCA has strict requirements regarding the allocation and structure of reserve assets for issuers of crypto assets: general ART and EMT issuers are required to deposit 30% of their reserve assets in credit institutions (banking institutions), while significant ART and EMT issuers must deposit 60% of their reserve assets in credit institutions.

2. Focus on ensuring the asset redemption rights of holders.

For ART, MiCA requires issuers to establish a liquidity mechanism and develop an orderly redemption plan for tokens to ensure asset liquidity and meet customer redemption requests. If the market price of ART significantly deviates from the value of the reserve assets, ART holders have the right to redeem ART directly from the issuer, even if the issuer has not granted this right through a contract. However, MiCA does not specify a timeframe for the funds to be credited upon the holders' redemption of ART, and further follow-up is needed on the specific implementation requirements of the EU member states.

For EMT, MiCA requires that issuers must be able to redeem the currency value of EMT held at par value at any time, either in cash or by credit transfer. The redemption conditions must be specified in the cryptocurrency asset white paper, and no fees should be charged for redemption. If the issuer of EMT does not fulfill the redemption requests of EMT holders within 30 days, holders can seek assistance from the custodian of the EMT assets and/or distributors acting on behalf of the EMT issuer.

V. Implement strict anti-money laundering regulations for cryptocurrencies to raise the standards for the implementation of travel rules.

Cryptographic assets are issued and traded based on blockchain technology, characterized by decentralization, globalization, anonymity, convertibility (to fiat currency), and irreversibility of transactions. Additionally, bridge technology enhances interoperability between different blockchains, making the prevention of money laundering and terrorist financing risks associated with cryptographic assets more complex. MiCA and relevant EU regulatory frameworks have made specific requirements in this regard.

1. MiCA requires that cryptocurrency asset trading be subject to comprehensive anti-money laundering regulatory requirements.

MiCA places a high emphasis on the illegal activities that stablecoins and the cryptocurrency market may generate (such as insider trading, market manipulation, etc.), requiring all crypto asset service providers to implement comprehensive anti-money laundering and counter-terrorism financing measures, including strict KYC procedures and transaction monitoring, enacting rigorous customer due diligence (CDD) procedures and monitoring suspicious transactions, and reporting to the relevant authorities to prevent money laundering and terrorist financing activities.

Although ART and EMT are tokens that operate on open systems without establishing a direct relationship with the issuer, MiCA still emphasizes that issuers should utilize chain analysis to understand the usage of the tokens. This allows issuers to view in real-time the active wallets holding their tokens, including holder behavior (i.e., exchanges with personal wallets, holding periods), overall transaction volumes across multiple blockchains, and the scale of transactions involving sanctioned entities or jurisdictions, in order to prevent the use of tokens for illegal activities.

2. MiCA has raised the anti-money laundering "travel rule" requirements for crypto assets.

The "Funds Transfer Regulation" passed simultaneously with MiCA provides more targeted requirements for anti-money laundering and counter-terrorist financing actions regarding crypto assets, requiring crypto asset service providers to include information about the remitter and the recipient when transferring crypto assets (i.e., the anti-money laundering and counter-terrorist financing "travel rule"). Without personal identification information, no amount of cryptocurrency is allowed to transfer between accounts on their crypto asset service provider (CASP). Compared to the €1,000/USD threshold set by the FATF for the implementation of the "travel rule", the aforementioned requirements of the "Funds Transfer Regulation" are undoubtedly stricter.

In addition, in December 2024, the European Banking Authority (EBA( officially announced the extension of the EU's "Travel Rule Guidelines" to cryptocurrency service providers and intermediaries, requiring the collection of information on users transferring funds or crypto assets, determining whether a transaction is related to the purchase of services, and monitoring suspicious cryptocurrency transactions; cryptocurrency service providers and intermediaries are required to declare their policies on multiple intermediaries and cross-border transfers.

6. The Impact on the Development and Regulation of Global Cryptocurrency Assets

The implementation of MiCA marks a shift in the global crypto asset market development from a phase of "free development" to one of "compliant competition", which will have a significant impact on the structure of global crypto asset market development, the direction of global crypto asset regulation, and the construction of a global collaborative governance system for crypto assets.

1. MiCA will promote the standardization and stratification of the global cryptocurrency market development.

MiCA implements differentiated licensing and operational regulations for issuers and service providers of crypto assets based on the classification of crypto asset types. It proposes differentiated capital and liquidity requirements for different types of issuers and service providers, providing standardized guidelines for the business activities of crypto asset market participants.

At the same time, considering that the regulatory requirements of MiCA are relatively strict, such as high standards for reserve asset segregation custody, minimum capital requirements, and anti-money laundering regulations, the compliance costs for operating in the cryptocurrency market will increase. This benefits leading compliant issuers and service providers (such as Circle's USDC) by consolidating market share through licensing barriers, while accelerating the exit of non-compliant cryptocurrency issuers and service providers.

In addition, MiCA exempts fully decentralized crypto assets from regulation, but decentralized exchanges (DEX) that involve fiat currency exchanges or custody services still need to be included under CASP regulation, which forces decentralized crypto asset trading platforms to restrict access for EU users, pushing decentralized platforms to the margins. For the entire crypto asset market, these will ultimately increase the concentration of the market as a whole.

2. MiCA will become a "reference framework" for the formulation of regulatory policies for crypto assets in various countries.

From the perspective of policy recommendations from international regulatory organizations, in July 2023, the Financial Stability Board (FSB) released the "High-level Recommendations on the Regulation of Global Stablecoins" and the "High-level Recommendations on the Monitoring, Supervision, and Regulation of Crypto Asset Activities and Markets." These recommendations regarding the governance framework of stablecoins, the issuers and service providers of cryptocurrencies, risk management, information disclosure, reserve asset management, and redemption of stablecoins, as well as the principles of "same activities, same risks, same rules" and technology neutrality, are also requirements of MiCA, or can be seen as reflecting the rules of MiCA.

From the regulatory practices of authorities in various countries, it can be seen that regulatory agencies in EU countries will formulate specific implementation policies based on the requirements of MiCA. The specific requirements of MiCA regarding the classification of crypto assets, the entry regulation and operational requirements for issuers and service providers, the upgraded anti-money laundering regulatory "fulfillment rules", and the restrictions on fiat-backed stablecoins from other countries in real transaction payments have also become important references for the formulation of cryptocurrency regulatory regulations in non-EU countries such as Singapore and Japan.

In this regard, MiCA has initiated the process of compliance for the development of the global cryptocurrency market, as well as the standardization of regulation in the global cryptocurrency market. Of course, during this process, it cannot be ruled out that some countries may lower regulatory requirements (regulatory competition) to promote the establishment and development of advantages in their domestic cryptocurrency markets.

3. The construction of a global governance collaborative system for crypto assets is expected to accelerate.

Cryptographic assets are global and essentially cross-border. Compared to traditional banking and financial markets, the globalization of the cryptographic asset market is at a higher level and there is a more urgent need to establish a global regulatory governance system. Since the second half of 2023, the global stablecoin and cryptocurrency market has entered a rapid development track. According to monitoring data from Triple A, by 2024, the number of holders of global cryptographic assets will exceed 560 million, and entering 2025, the total market value of cryptographic assets will remain above 3 trillion USD for most of the time, with the integration of cryptographic assets into traditional financial systems and real economy transactions advancing rapidly. The construction of a global governance system for cryptocurrencies has become even more prominent.

Currently, global cryptocurrency regulation is still in a fragmented state with each region acting independently. International regulatory organizations have not yet released a stablecoin and crypto asset regulatory standard similar to the "Basel Accords." The development of stablecoin and crypto asset regulatory frameworks in various countries also lacks a specific roadmap and timeline. With the full implementation of MiCA in the European Union, the United States is also accelerating the advancement of its regulatory framework for stablecoins and crypto assets. It is expected that international regulatory organizations such as the FSB will expedite the research and formulation of a unified regulatory standard for global crypto assets and establish a coordinated governance mechanism for global cryptocurrencies. The MiCA legislation also clearly states that the EU will continue to support the promotion of global coordinated governance for crypto assets and crypto asset services through international organizations or institutions (such as the Financial Stability Board, Basel Committee on Banking Supervision, and the Financial Action Task Force).