Title: Analysis of the Evolution and Future Trends of EU Cryptocurrency Regulation

Author: TaxDAO

As one of the world's largest economies, the EU plays an important exemplary and leading role in the regulatory policies for cryptocurrency assets. Studying the historical evolution and future trends of EU cryptocurrency market regulation is of theoretical significance and practical value for understanding the legislative thinking and practical experience of the EU in this field, analyzing the different regulatory models and their effects in various countries worldwide, and exploring future cryptocurrency regulatory measures.

This article will analyze the EU government's historical, current, and future development direction of the nature identification and regulatory policies (exchange regulatory system, licensing system, tax policies, etc.) for cryptocurrencies, in order to provide reference and inspiration for policy formulation.

1. How the EU Improves the Cryptocurrency Definition Framework

1.1 Initial Regulation (2014)

As early as 2014, the European Central Bank (ECB) issued a report clarifying the definition of cryptocurrency as "a digital token not issued or supported by a central authority or public institution, the value of which depends on market supply and demand, and can be traded peer-to-peer through specific network protocols." This was the EU's first formal assessment of cryptocurrencies, laying the foundation for subsequent regulatory policies.

1.2 Challenges of Terrorism and Supra-Sovereign Currency (2015-2019)

1.2.1 Fifth Anti-Money Laundering Directive (5AMLD)

In the evening of November 13, 2015, a series of terrorist attacks occurred in seven locations in central and northern suburbs of Paris, the most serious violent event in France since World War II and the deadliest terrorist attack in Europe since the Madrid train bombings in 2004. Similar terrorist attacks also occurred in Brussels in March 2016. These two disasters exposed the loopholes in the EU's Fourth Anti-Money Laundering Directive (4AMLD), especially its neglect of the risks of financing channels such as cryptocurrencies.

To strengthen the fight against money laundering and terrorist financing, in 2016, the European Commission proposed a series of legislative proposals, including the 5AMLD. Subsequently, the 5AMLD was adopted by the European Parliament and the Council in May 2018, and came into effect in January 2020, aiming to increase the transparency of financial transactions to combat money laundering and terrorist financing. One of the main contents of the 5AMLD is that virtual currency exchange platforms and custodian wallet providers will be considered "obliged entities" and subject to EU regulations. This means that they will face the same regulatory requirements as banks and other financial institutions, such as implementing customer due diligence controls, monitoring virtual currency transactions regularly, and reporting suspicious activities to government entities.

However, since the 5AMLD is a "directive" type of EU secondary legislation, it does not have direct applicability and requires member states to amend domestic laws to ensure implementation. Therefore, although the 5AMLD brings cryptocurrency service providers into the regulatory scope, it does not establish a unified and coordinated legal framework. As a result, EU countries have different definitions, classifications, and regulations for cryptocurrencies, which is not conducive to cross-border collaborative regulation.

1.2.2 Challenge of Diem

Diem stablecoin is a global payment project proposed by Facebook in June 2019. Unlike conventional cryptocurrencies, Diem relies on Facebook's global 2 billion users and is pegged to a basket of currencies, posing a significant challenge to financial sovereignty and stability. In addition, the issuance location of Diem in Geneva, Switzerland, may have a significant impact on the future financial stability, monetary sovereignty, and public interests of the EU, and has been cautioned by EU experts and institutions since its proposal.

Due to the fact that the regulatory framework of 5MALD cannot effectively address "supra-sovereign currencies" like Diem, and the loose definition of existing cryptocurrencies has also brought difficulties for cross-regional regulation, a new cryptocurrency definition framework is urgently needed.

1.3 MiCA's Cryptocurrency Definition Framework (2020 to Present)

Under the pressure of cross-border regulation and the direct stimulation of Diem, the European Commission's draft of the Markets in Crypto-Assets Regulation (MiCA) proposed in 2020 classifies crypto-assets into three categories to unify regulation across EU countries. These categories include: electronic money tokens (EMT), asset-referenced tokens (ART), and other crypto-assets (other than asset-referenced tokens or e-money tokens). The draft has been approved by the European Parliament and is expected to come into effect in 2024.

• Electronic Money Tokens: Cryptographic assets pegged to a single legal tender, intended as electronic substitutes for cash, and can be used for payments or transfers. For example, tokens pegged to the euro fall into this category.

• Asset-Referenced Tokens: Cryptographic assets pegged to multiple legal tenders or other assets, intended to maintain stable value, typically referred to as "stablecoins."

• Other Crypto-Assets: Any cryptographic assets not belonging to the first two categories, including most cryptocurrencies and utility tokens. Bitcoin, Ethereum, etc., fall into this category.

According to MiCA's classification, stablecoins like Diem fall under EMT or ART and are subject to stricter regulatory requirements, such as white paper approval, reserve management, liquidity assurance, and information disclosure. However, MiCA does not cover other regulated instruments such as DeFi, NFTs, and security tokens.

2. Historical Evolution of EU's Major Regulatory Policies

After reviewing the development of the EU's cryptocurrency definition, let's take a look at the historical evolution of its major regulatory policies. These regulatory policies are based on the cryptocurrency definition framework, and the time periods are generally similar.

2.1 Inception and Exploration (2014)

2014 was the "year of cryptocurrency regulation" in the EU. Prior to this, the EU did not have specific regulatory rules for cryptocurrency exchanges, only some generally applicable financial laws and directives, such as the Fourth Anti-Money Laundering Directive (AMLD4); whether these financial laws applied to cryptocurrency exchanges was also vaguely defined.

2.2 Initial Integrated Regulation (2015-2019)

In 2015, the European Court of Justice made a ruling on whether Bitcoin transactions should be subject to value-added tax, determining that Bitcoin payments are considered a service payment and are subject to value-added tax provisions. At the same time, according to Article 135(1)(e) of the EU VAT Directive, it was ruled that the exchange of cryptocurrencies and legal tender is exempt from value-added tax. This ruling provided some tax advantages for cryptocurrency exchanges in the EU.

In 2018, AMLD5 brought cryptocurrency exchanges into the scope of anti-money laundering and anti-terrorist financing regulations, requiring them to conduct customer identity verification, record transaction information, and report suspicious activities. This set certain compliance requirements for cryptocurrency exchanges operating in the EU. In the same year, the European Central Bank issued an opinion, suggesting that the EU should establish a unified regulatory framework for crypto-assets to address their potential impact on financial stability, consumer protection, and market integrity. This guidance opinion is also one of the origins of MiCA.

During this stage, several important judicial and legislative measures marked the EU's beginning of partial regulation of cryptocurrency services. However, the EU still did not form a unified and comprehensive regulatory framework.

2.3 Unified Regulatory Framework of MiCA (2020 to Present)

The upcoming MiCA proposes licensing, registration, information disclosure, and behavioral norms for entities providing crypto-asset services (including exchange services), and grants regulatory functions to the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA). The introduction of MiCA will provide a clear and consistent regulatory framework for cryptocurrency exchanges within the EU and will also impact cryptocurrency legislation worldwide, accelerating the transition of the global cryptocurrency market from the "wild growth" phase to the "legal era."

MiCA sets detailed admission licensing requirements for crypto-asset traders. Specifically, traders need to obtain a CASP (crypto-asset service provider) license from the competent authorities of EU member states. All CASPs need to comply with governance, asset custody, complaint handling, outsourcing, wind-down plans, information disclosure, and permanent minimum capital requirements. Different CASPs have specific regulatory requirements to meet, such as:

• Custodians: Need to develop custody policies and regularly inform clients of their asset status.

• Trading platforms: Need to implement market manipulation detection and reporting systems, or publicly disclose current buying and selling prices and trading depth.

• Exchanges and brokers: Need to establish non-discriminatory policies and execute orders with the best possible results and prices.

3. EU's Regulatory Approaches to Stablecoins, DeFi, and NFTs

3.1 Stablecoins

MiCA has clear regulatory standards for stablecoins. It requires stablecoin issuers to establish sufficient liquidity reserves in the form of deposits at a 1:1 ratio to protect consumers and apply for a license and registration with the European Banking Authority (EBA). MiCA also limits the daily number of transactions and trading volume of stablecoins not backed by the euro to no more than 1 million transactions and 200 million euros.

3.2 DeFi

MiCA has not yet included DeFi in its regulatory scope because the information structure of DeFi differs from traditional finance, making standard policies ineffective for regulating DeFi. However, MiCA has not completely ignored the development of DeFi but is piloting an "embedded regulation" scheme for DeFi, which uses DLT technology to achieve automated supervision and enforcement of DeFi projects and participants. In 2022, the EU has issued a public tender for "DeFi Embedded Regulation Research" on Ethereum, with an estimated bid amount of 250,000 euros, and the research is expected to take 15 months to complete.

3.3 NFTs

While MiCA does not specifically use the term NFT, its specific textual description does refer to NFTs. MiCA defines NFTs as cryptographic assets that are unique and non-fungible with other crypto-assets. MiCA's regulation of NFTs is relatively lenient, requiring compliance with general rules such as marketing communication, information disclosure, and technical security, without the need to submit a white paper or apply for a license. However, if NFTs involve copyright, intellectual property rights, or other legal issues, they must comply with relevant legal provisions.

4. Future Development Trends

The EU's cryptocurrency asset regulatory policies have undergone a process from inception to exploration, and then to integration over the past few years, and are currently at a crucial turning point with the introduction and implementation of MiCA. MiCA will provide a unified and coordinated regulatory framework for the cryptocurrency asset market within the EU and will have far-reaching implications for the global cryptocurrency asset market. Based on this, we can anticipate several trends in the future development of the EU's cryptocurrency asset regulatory policies:

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Proactive Regulation: The EU's regulatory attitude towards cryptocurrency assets is open and proactive. The EU's regulatory principles are based on risk, technological neutrality, market-driven approaches, and international coordination. This means that corresponding regulatory measures are taken for different types and scales of crypto-assets, without discrimination or favoritism towards specific technologies or business models. It encourages market competition and innovation, as well as cooperation and communication with other countries or regions. The EU will also support research and pilot projects in the cryptocurrency asset field, such as the DeFi Embedded Regulation Research, to explore more advanced and adaptive regulatory solutions.

Detailed Rules: The EU's regulatory goal for cryptocurrency assets is to ensure their safety, reliability, transparency, and effectiveness, and to prevent negative impacts on financial stability, monetary policy, payment systems, and consumer interests. Any cryptocurrency assets seeking to enter the EU market must comply with the rules of MiCA. With the implementation and enforcement of MiCA, the EU will continuously refine and specify its regulatory standards and measures for cryptocurrency assets to address the rapid changes and diversification of the cryptocurrency asset market.

Integration Trend: The EU's regulatory framework for cryptocurrency assets is a unified and coordinated framework aimed at eliminating regulatory differences and uncertainties among EU member states, and promoting the integration and development of the EU internal market.

The EU has made significant progress and achievements in the regulation of cryptocurrency assets. The EU needs to continue refining its regulatory framework for cryptocurrency assets to adapt to the rapid changes and diversification of the cryptocurrency asset market, and to coordinate and cooperate with other countries or regions in an effort to achieve consistent global regulation. The openness, proactivity, balance, and flexibility demonstrated by the EU in the regulation of cryptocurrency assets provide valuable references and insights for other countries or regions.

References

[1] European Court of Justice. (2015). Skatteverket v David Hedqvist.

[2] European Council. (2018). Fifth Anti-Money Laundering Directive (5AMLD).

[3] European Commission. (2020). Markets in Crypto-Assets Regulation (MiCA) draft.

[4] Fabio Panetta. (2022). How to Avoid a Wild West Era in the Crypto Market.

[5] Patrick Hansen. (2023). A Comprehensive Analysis of the EU's MiCA Regulatory Framework: The Prelude to the Era of Cryptocurrency Unification.

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