crypto-asset regulation in europe

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Crypto-Asset Regulation in Europe Cleveland, July 27th 2018

Nikolas Guggenberger

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Outline

1. Tokens as financial instruments

2. Broader Context – CMU

3. Proposal for a future EU Token Framework

Crypto-Asset Regulation in Europe

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Financial Instruments - point of referenceArt. 4 (1) 44 MiFID (Markets in Financial Instruments Directive )

‘transferable securities’ means those classes of securities which are negotiable on the capital market, with the exception of instruments of payment, such as:

(a) shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares;

(b) bonds or other forms of securitised debt, including depositary receipts in respect of such securities;

(c) […];

[Art. 4 (1) 15 MiFID Financial Instrument -> Annex 1 Section C(1): ‘transferable securities’ = financial instruments]


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Transferable Securities[Ultimate definition in national laws]

1) Transferability

2) Negotiability on Capital Market [Fungibility/Ease of Transfer]

3) Standardization4) Not Instrument of Payment

5) Categorical Comparability [“such as”]

- BaFin: „embodiment of rights in the token, i.e. either shareholder rights or creditor claims or claims comparable to shareholder rights or creditor claims, which must be embodied in the token”

- „Howie“-Test?


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Categories of TokensAsset/Equity/Security Tokens [certainly covered]

Utility Token [unclear – likely covered, depending on specific functions]

• Voting, registration, counting etc.

Payment/Currency Tokens [potentially exempt, but meaning of ‘payment’ in Art. 4 (1) 44 MiFID unclear]

Hybrids [unclear – likely covered, depending on specific functions]

• Main characteristic/focus• Partial investment component suffices


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Practice

2) Investor perspective/reality check

- Why do investors buy the tokens? Why do they buy millions worth of them?

- What is the tokens’ perceived utility? What is the general market expectation?


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Adhami et al., Why Do Businesses Go Crypto? An Empirical Analysis of Initial Coin Offerings

1) Rights attached to Tokens





SEC selected decisions/statements25 July 2017 – The DAO

• Howey-Test applicable to ICOs; DAO Tokens were securities• SEC „has determined not to pursue an enforcement action in this matter.“

1 November 2017 – Warning against celebrity endorsements

11 December 2017 – Munchee [food review]• Cease and desist ICO proceedings

11 December 2017 – Warning by Chairman Jay Clayton30 January 2018 – Arise Bank [„first decentralized bank”] - misinformation

• preliminary and permanent injunctions, disgorgement of ill-gotten gains plus interest and penalties, prohibit co-founders from serving as officers or directors of a public company or offering digital securities again in the future.


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ESMA/ESAs statements

ESMA, 13 November 2017• Investor warning• Alerting firms involved in ICOs: „Firms involved in ICOs must

give careful consideration as to whether their activities constitute regulated activities.“

ESAs, 12 February 2018• Consumer warning


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BaFin statements

15 November 2017 - ICO consumer warning• Tokens - case-by-case assessment: ICO could be regulated activity

20 February 2018 – Advisory Letter • Tokens - case-by-case assessment: ICO could be regulated activity• Labeling token as utility token is irrelevant

21 February 2018 - Parliamentary Question• 23 pending proceedings to determine jurisdiction of BaFin in 2017• 13 pending investigations for illegal activities in 2017 • Hardly any communication by BaFin


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Dichotomy in Europe’s Securities Framework

Regulatory Potential

Market Expectation of Concequences


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Oliver Wendell Holmes Jr. (1897):

- “[I]f we take the view of our friend the bad man we shall find that he does not care two straws for the axioms or deductions, but that he does want to know what the [European authorities] are likely to do in fact.”





5th AMLD

Extension of scope:

- Exchange Platforms: providers engaged in exchange services between virtual currencies and fiat currencies

- Custodian Wallet Providers: entity that provides services to safeguard private cryptographic keys on behalf of their customers, to hold, store and transfer virtual currencies.

Requirements: KYC, licensing or registration, reporting of suspicious behavior, fit and proper standard


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Connecting the Dots ICapital Markets Union

- Landmark project to create a single market for capital

- Unlock funding and spur cross-border capital allocation

- Jobs and Growth Agenda / second wave reaction to financial crisis

- Regulatory roll-back („Proportionality“) + legal harmonization

- So far: partial regulatory roll back + visions, ambitions, and intentions

Unique regulatory window of opportunity

- European entities have collected more than € 1 bn via ICOs in 2017; 2018 set to break records

- No legacy structures, no specific legacy regulation, and no legacy supervisory customs on a Member State


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Connecting the Dots IIRegulatory best practice: Principles based, risk adequate, and technologically neutral

- Is technologically neutral regulation possible?- Is the present framework for financial markets technologically neutral?

- Do ICOs pose technologically specific risks?

Regulatory options1. Base line scenario (no changes); will inevitably lead to 2)

2. Various national initiatives + further fragmentation

3. EU-Framework for ICOs

4. Full-blown overhall and harmonization of securities and insolvency laws


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Proposal for Future ArchitectureSingle market for capital through backdoor of technological specific regulation

Optional, ICO-specific, fully harmonized legal framework w/ EU-level single supervisor (comparable to SSM)

- Product regulation: ensuring transparency, accountability, and market integrity; modularly expandable (insolvency law, corporate law, depository)

- Relative attractiveness would dry out regulatory race to the bottom

- Politically fesable

- Close to zero costs; mitigation of downsides of tech-specific regulation

European ICOs as first truly European IPOs; Positive vision for Europe – a union that is worthy of joining.


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EU-Regulatory Priorities

1) Enforcement of existing rules: Create, publish, and communicate decisions

2) Provide clear guidance on present regulation

3) Develop optional, harmonized EU-level framework for future ICOs entrusted with single regulator

4) Clarify/potentially revise new AMLD

5) Transition tokens of past ICOs into new framework


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Thank you.






Regulating decentralized networks I

Centralized Elements?

Yes

New Intermediaries?

Yes

Adressing Gateways?

Yes

Incentives-based

Regulation?


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Regulating decentralized networks II

Law abiding citizens

Limited Anonymity• „Chainalysis“ + Metadata + Uncertainty of Future Procecution• Spending

Collective Incentives: Threat of Prohibiton• Transaction Costs• Impact on Price of Token [Network Effects]


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Scope of Trust by BlockchainOn-chain, not

Off-chain.

Ability, not legality.

Validity, not truth.

Form, not content.

Transaction, (as of now) not identity.

Technological, not

institutional.

Factual and technical, not

right or wrong.


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Prospectus Regulation

Art. 1(1) This Regulation lays down requirements for the drawing up, approval and distribution of the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market situated or operating within a Member State.

Art. 2(a) ‘securities’ means transferable securities as defined in point (44) of Article 4(1) of Directive 2014/65/EU with the exception of money market instruments as defined in point (17) of Article 4(1) of Directive 2014/65/EU, having a maturity of less than 12 months;


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Switzerland

‚SAFT‘-Approach

- exisitng Tokens vs. Future Tokens

- Function of Token

Minimum information requirements in Annex


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