Markets in Crypto-assets Regulation: What Happens when Issuers are Unknown?
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Introduction
The European Parliament is set to approve the Markets in Crypto-assets Regulation (MiCAR) in April, thereby launching the European framework for crypto-assets. The final compromise text of MiCAR was published on 5 October 2022. For a detailed analysis of the requirements introduced by the regulation and their implications, please consult our comprehensive “Road to MiCAR” guide.
The regulation lays down rules for the issuance of different types of crypto-assets and for services exercised by different crypto-asset service providers (CASPs). However, the fact that MiCAR will regulate the issuance of crypto-assets, creates a need to ensure regulatory clarity for those crypto-assets, which do not have an identifiable issuer. These include the native assets of some of the largest decentralised blockchain protocols, such as Bitcoin.
Below we discuss the potential regulatory implications for CASPs who intend to offer services related to these assets.
Classification of crypto-assets
MiCAR defines a crypto-asset as a “digital representation of value or rights, which may be transferred and stored electronically, using distributed ledger or similar technology” (Art. 3(1)(2), MiCAR compromise text). Beyond the general definition, MiCAR also creates three sub-categories of crypto-assets, split into three groups, namely: Asset Referenced Tokens (ARTs), which are tokens the value of which is pegged to a basket of other assets, e-money tokens (EMTs), the value of which is pegged to a single fiat currency and a catch-all category for crypto-assets other than ARTs and EMTs. The latter category includes utility tokens, defined separately as a token “which is intended to provide digital access to a good or service, available on DLT, and is only accepted by the issuer of that token” (Art. 3(1)(5), MiCAR compromise text).
Based on the above categories, it can be determined that assets without an identifiable issuer such as Bitcoin and the native assets of other decentralised blockchain protocols will fall into the third, catch-all group. This raises several questions regarding liability for the regulatory requirements applicable to these assets under MiCAR, as they often have no identifiable issuer or the issuers (often a non-associated team of core developers) do not exercise economic control over the asset, and do not reap profits from their activity, which amounts to maintenance and development of the underlying blockchain infrastructure.
To address this issue, Recital 12a was added to the MiCAR compromise text stating that: “Where crypto-asset services as defined in this Regulation are provided in a fully decentralised manner, without any intermediary, they do not fall within the scope of this Regulation. This Regulation covers the rights and obligations applicable to issuers, offerors and persons seeking admission to trading of crypto-assets and to crypto-asset service providers. Where crypto-assets have no identifiable issuer, they do not fall within Title II, III or IV of this Regulation. Crypto-asset service providers providing services to such crypto-assets are, however, fully covered by this Regulation.”
Normally, under MiCAR, offerors of crypto-assets other than ARTs and EMTs are required to publish a white paper with respect to the issued token, before that token is offered to the public. The white paper must be drafted by a legal entity, notified to competent authorities and must include, amongst other things, information on the offeror and the issuer (if different from offeror), the underlying project, its risks, rights and obligations attached to the asset, the underlying technology and its environmental impacts (Art.5, MiCAR compromise text). Smaller offerings may be exempted from the obligation to publish a white paper (Art. 4(2)(b), MiCAR compromise text).
Recital 12a clarifies that these obligations do not/cannot apply to crypto-assets without an identifiable issuer. However, platform operators providing services in relation to these assets must comply with all requirements laid down with respect to the list of crypto-asset services included in MiCAR.
Crypto Asset Services Under MiCA and obligations of trading platform operators
Art. 3(1)(9) of the MiCAR compromise text provides a list of crypto-asset services regulated by the text. These include:
- custody and administration
- the operation of trading platforms
- the exchange of crypto-assets for funds (on-ramps/off-ramps)
- the exchange of crypto-assets for crypto-assets
- the execution of crypto-asset orders for third parties
- placing crypto-assets
- transfer, reception and transmission of crypto-assets
- providing advice and portfolio management with respect to crypto assets
As Bitcoin is the largest crypto-asset by market capitalisation (USD value of total floating supply of Bitcoin), most providers of the above crypto services will have exposure and will offer services linked to Bitcoin.
From the above list, regulatory clarity is the most needed for operators of trading platforms who seek to admit crypto-assets without an identifiable issuer on their exchanges. Art. 4a of the MiCAR compromise text states that anyone asking for admission of a crypto-asset, other than an ART or an EMT, must have “drafted a crypto-asset white paper in respect of those crypto-assets in accordance with Article 5”. Furthermore, under Art. 123(1a)(b) of the MiCAR compromise text, it is the responsibility of operators of trading platforms to publish a white paper for crypto-assets, other than ARTs and EMTs, which were admitted to trading on a trading platform before the entry into force of MiCAR.
In the case of crypto-assets without an identifiable issuer there is no consensus whether platform operators are the ones offering the crypto-asset to the public, or if there is simply no offeror. In either case, platform operators will fall under the Article 4a obligation to draft a white paper if they want to admit the given crypto-asset without an identifiable issuer to trading on their platform. Otherwise, this responsibility could potentially fall on the shoulders of a single holder of Bitcoin, which could not have been the intention of the legislators behind MiCAR.
It will therefore be considered the responsibility of the trading platform operator to draft, notify, and publish a white paper, either as offeror of the crypto-asset, or as the person seeking its admission to trading. This poses an interesting legal and technical challenge, as so far, we can only speculate what form a potential MiCAR approved white paper for Bitcoin may look like. It is probable that exchange operators will rely on more or less standardised templates across the sector.
Liability
a. Under MiCAR:
Art. 14 of the MiCAR compromise text clarifies that holders of crypto-assets can claim damages from the entity that was responsible for issuing the white paper, in case there was an infringement of the requirements established by Art. 5. Actors operating a trading platform who want to list a crypto-asset without an identifiable issuer will, therefore, be required to comply with the white paper requirement contained in Article 4a and could be held liable in disputes arising from those white papers with consumers who hold those assets on the given trading platform.
b. Liability for on-chain activities and decentralised finance (DeFi):
i. To explore another interesting aspect of the regulatory treatment of crypto-assets without an identifiable issuer, we must look at the treatment of DeFi from a regulatory perspective. For the moment, DeFi does not fall under the regulatory umbrella of MiCAR. This is demonstrated by the exemptions afforded to on-chain staking and mining activities and non-custodial digital wallets.
When talking about DeFi, it needs to be clear that regulators might qualify this term differently from the market. Depending on the control and intervention powers of the developers or others, there might be no real DeFi (but only so called “decentralization theatre”).
According to Recital 59 of the MiCAR compromise text, hardware and software providers of non-custodial wallets will not fall under the scope of the Regulation and according to Art. 4(2)(b) of the MiCAR compromise text, Title II shall not apply to the crypto-assets that are automatically created as a reward for the maintenance of the DLT or the validation of transactions (i.e. staking and mining activities).
Within 48 months after the application of MiCAR, the European Commission will complete an assessment of the development of DeFi in the crypto-asset markets and of the adequate regulatory treatment of decentralised crypto-asset systems. The report will assess the adequate regulatory treatment of decentralised crypto-asset systems without an issuer or crypto-asset service provider.
ii. In this regard, liability for on-chain activities on permissionless blockchains is a potentially decisive regulatory debate. Bird & Bird has advised on Tulip Trading Ltd v Bitcoin Association for BSV and others, a case that could represent a turning point in determining whether fiduciary/tortious duties are owed to users of the Bitcoin blockchain by the developers of the underlying software infrastructure.
Tulip Trading Ltd. sustained a loss of over USD 4.5 billion when the private keys to the fund’s digital wallet were stolen. The fund in turn sued the core developers of the Bitcoin blockchain, who are split into different associations and networks of developers, for breach of a fiduciary duty owned to the users of the Bitcoin blockchain.
However, the High Court of England and Wales in its summary judgment ruled that it is not realistic for Tulip Trading ltd. to claim that the developers owe a fiduciary duty to all users of the Bitcoin blockchain, as the users are a group which is by definition an “anonymous and fluctuating class with whom the defendants have no direct communication, and certainly no contractual relationship” and the developers themselves are a “fluctuating body of individuals. As a general proposition it cannot realistically be argued that they owe continuing obligations to, for example, remain as developers and make future updates whenever it might be in the interests of users to do so.”
Tulip Trading Ltd. has appealed the decision and the appeal has been upheld, with the Court of Appeal stating that the facts of the case merit more extensive treatment than the summary judgment. Nonetheless, the court stated that for Tulip’s case to succeed “a significant development of the common law on fiduciary duties" would be needed.
Conclusion
While MiCAR provides some insight on the obligations regarding crypto-assets without an identifiable issuer, in the long-run, strong industry standards for white papers will have to be developed, and the question of liability for on-chain activities will have to be examined by the European Commission taking into account international developments such as the outcome of the Tulip Trading Ltd. case.
Regarding the regulatory timeline, MiCA enters into force on the twentieth day following its publication in the Official Journal (OJ) of the EU, and it will apply from 18 months after the date of entry into force. Title III (on ARTs) and Title IV (on EMTs) will apply from 12 months after MiCA's entry into force.
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