This paper aims to explain the current stage of blockchain and virtual currency regulation in the EU.
The paper explains the current state of blockchain and virtual currency regulation in the EU, presenting the EU institutions’ main policy and regulatory initiatives on, and approaches to, blockchain and virtual currency.
Though the EU is looking seriously at the potential of blockchain and distributed ledger technologies, many European institutions are of the opinion that it is still too early to regulate in this field. As far as virtual currencies are concerned, Member States’ central banks do not consider them to be equivalent to money or legal tender. However, with the current high profile of and interest in virtual currencies, one can expect the European Commission to at least consider what regulation might be called for.
This study provides practical guidance on and introduction to the current regulatory and policy landscape of blockchain and virtual currency in the EU.
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Emerald Publishing Limited
Copyright © 2018, Covington & Burling LLP.
The European Commission (EC) has stated that the almost limitless list of potential use cases of distributed ledger technology (DLT) makes it both very promising and challenging and has expressed its support for blockchain and DLT. However, many European institutions are still of the opinion that the technology is at its early stage of development, and it is therefore too early to regulate it. They rightly see a risk that early regulation could limit its further development and potential. Moreover, too early regulation could fail to regulate the relationships appropriately and reduce the risks associated with the use of blockchain technology.
The EC also indicates that it needs to “be able to make the distinction between a hype and a true opportunity to improve the lives of our citizens and businesses. That’s why we [the EU] need to launch more proof of concepts and pilots in different domains and according to different use cases”. On this basis, the EU is currently exploring various applications of blockchain technology and its possible benefits both for public and private sectors.
As far as virtual currencies like bitcoin are concerned – which are based on blockchain technology – it seems that the EU has more concrete views. Central banks of the EU Member States do not consider virtual currencies as equivalent to money, and they are not treated as legal tender. The European Central Bank (ECB) typifies virtual currency as a digital representation of value, not issued by a central bank, credit institution or e-money institution, which in some circumstances can be used as an alternative to money. In many Member States, there is no specific virtual currency regulation, and in many cases, only a series of opinions and warnings have been issued by central banks or regulators. Germany has the most elaborate rules and considers virtual currencies as units of account – which does not confer them the status of legal tender.
Moreover, the surge in interest in bitcoin and similar virtual currencies, as well as their price fluctuations, has recently attracted the attention of the EC. In December 2017, the EC’s Vice President, Valdis Dombrovskis, wrote a letter to the European Supervisory Authorities asking them to urgently update their warnings from a financial stability and investor protection perspective to address bitcoin’s price volatility. In addition, in his speech in January 2018, Vice President Dombrovskis said that the EC wants “Europe to embrace the opportunities of blockchain, the technology underlying cryptocurrencies. But to do so, we [the EU] must be vigilant and prevent cryptocurrencies from becoming a for unlawful behaviour”.
In February 2018, Vice President Dombrovskis brought together key authorities and the private sector in a high-level roundtable to assess the longer-term significance of cryptocurrencies beyond the current market trends. At this roundtable, Vice President Dombrovskis concluded that the EU needs “to assess further under what circumstances crypto-currencies and related services are covered by existing regulation” and that, “based on the assessment of risks and opportunities and the suitability of the existing regulatory framework for these instruments, the Commission will determine if regulatory action at EU level is required”.
Cryptocurrencies and the related regulatory questions are clearly a focus of the EU’s attention and may be subject to regulatory action in the year to come. This gives a brief overview of the main EU-level initiatives on, and approaches to, blockchain and virtual currencies.
The European Commission
Virtual currency legislation relating to anti-money laundering and terrorist financing
In December 2017, the Council of the EU confirmed that an agreement had been reached between the European Parliament (EP) and the Council of the EU on the amendments to the 4th Anti-Money Laundering Directive (4AMLD). In January 2018, EC Vice President Dombrovskis welcomed this agreement, saying that the new rules mean “less anonymity and more traceability, through better customer identification, and strong due diligence”. These amendments bring custodian wallet providers (CWPs) and virtual currency exchange platforms (VCEPs) within the scope of the 4AMLD as obliged entities. VCEPs and CWPs will be obliged to put in place policies and procedures to detect, prevent and report money laundering and terrorist financing. The amendments only cover exchanges between virtual and fiat currencies; consequently, virtual-to-virtual currency exchanges fall outside the scope of the amended 4AMLD.
The above mentioned amendments have been approved and the 5th Anti-Money Laundering Directive (5AMLD) entered into force on July 9, 2018. Though Member States of the EU will have to implement these new rules into their national legislation by January 10, 2020, the EC urged them to introduce these tightened measures as early as possible.
Blockchain Observatory and Forum
On February 1, 2018, the EC officially launched the EU Blockchain Observatory and Forum. Originally created as the EP-led pilot project, the EU Blockchain Observatory and Forum is intended to support the EC’s fintech work. The Commission intends that it should highlight key developments of the blockchain technology, promote European actors and reinforce European engagement with multiple stakeholders involved in blockchain activities. It hopes to make the EU Blockchain Observatory and Forum into a knowledge hub on blockchain, so that it may serve as an important communication tool setting out EU’s vision and ambition for DLTs on the international scene. The EC selected ConsenSys as a partner to support the Observatory’s outreach in Europe, following a call for tenders launched in 2017.
European Commission fintech task force
In November 2016, the EC set up an internal task force on financial technology with three clear objectives: first, to make sure that all policy work across the board is informed by and takes account of technological innovation; second, to assess whether existing rules and policies are fit for purpose in the digital age; and third, to identify actions and proposals that could harness the potential opportunities fintech offers while also addressing its possible risks. The EC indicates that the task force has been looking at the existing frameworks within EU Member States, talking to relevant stakeholders and considering the case for a coordinated European response.
European Commission fintech action plan
In March 2018, the EC published a communication entitled “FinTech Action Plan: For a more competitive and innovative European financial sector”. Its intention is that “Europe should become a global hub for FinTech”; to this end, the action plan proposes 19 actions to enable the European financial sector to make use of fast-developing new technologies, such as blockchain, artificial intelligence and cloud services. These include hosting an EU FinTech Laboratory, creating a strategy on DLT and blockchain, presenting best practices on regulatory sandboxes and helping develop more coordinated approaches on standards for fintech.
Proposed new rules on crowdfunding
Alongside its FinTech Action Plan, the EC also presented new rules on crowdfunding platforms, the proposed regulation on European Crowdfunding Services Providers. If adopted by the EP and the Council of the EU, instead of having to comply with different regulatory regimes, platforms will have to comply with only one set of rules, when operating in both their home market and other EU Member States. Investors on crowdfunding platforms would then “be protected by clear rules on information disclosures, rules on governance and risk management and a coherent approach to supervision.”
The European Parliament
A recent EP report on virtual currencies stressed that virtual currencies and DLT have the potential to contribute positively to citizens’ welfare and economic development, including in the financial sector. It also acknowledged their increased risks and suggested that addressing these risks will require enhanced regulatory capacity, including technical expertise and a sound legal framework that keeps up with innovation, ensuring a timely and proportionate response if and when the use of some DLT applications becomes systemically relevant. However, the EP called for a proportionate regulatory approach at the EU level, so as not to stifle innovation or add superfluous costs to it at this early stage – while taking seriously the regulatory challenges that the widespread use of virtual currencies and DLT might pose.
The European Central Bank
The ECB is keeping a careful eye on innovative fintech solutions, including DLT. The ECB acknowledges the potential advantages of DLT and has even created a special DLT task force which brings together market experts on financial innovation and cybersecurity. The ECB also conducted a study on DLT that concluded that the ECB cannot yet consider basing its market infrastructure on a DLT solution because, at this stage, DLT is not mature enough to meet its high requirements in terms of safety and efficiency. However, ECB indicated that it will continue to explore DLT opportunities – and it has, for example, launched a joint research project with the Bank of Japan to study the possible use of DLT for market infrastructure services.
Its 2015 paper on virtual currencies indicates that the ECB does not consider these to be a fully fledged form of currency as defined in economic literature. However, the ECB noted that it will continue to monitor payments-related developments in virtual currency schemes. In addition, in its opinion on 4AMLD, the ECB warned that “the Union legislative bodies should, however, take care not to appear to promote the use of privately established digital currencies, as such alternative means of payment are neither legally established as currencies, nor do they constitute legal tender issued by central banks and other public authorities”. Finally, in September 2017, the ECB’s President criticized a proposal by the Estonian Government to launch a state-managed digital currency.
The European Securities and Markets Authority
In 2017, the European Securities and Markets Authority (ESMA) published a report on “Distributed Ledger Technology Applied to Securities Markets.” This acknowledges that there are benefits to adopting DLT and indicates that as DLT applications are still at a very early stage, they do not require regulation. ESMA also identified a number of challenges of DLT applications, including interoperability and the use of common standards, access to central bank money, governance and privacy issues and scalability. ESMA also noted the absence of major impediments in the EU regulatory framework to the emergence of DLT in the short term. It said, it would continue to monitor market developments around DLT to assess whether a regulatory response may be needed.
In November 2017, ESMA also issued two statements on initial coin offerings (ICOs), one on risks of ICOs for investors and another on the rules applicable to the firms involved in ICOs. In its statement on the risks of ICOs for investors, ESMA warned investors of the high risk of losing all of their invested capital, describing ICOs as very risky and highly speculative investments. ESMA also warned investors that “ICOs may fall outside of the scope of EU laws and regulations, in which case investors cannot benefit from the protection that these laws and regulations provide”. In its second statement on the rules applicable to firms involved in ICOs, ESMA indicated that in cases where ICOs qualify as financial instruments, “it is likely that firms involved in ICOs conduct regulated investment activities, in which case they need to comply with the relevant legislation,” such as the Prospectus Directive, the Markets in Financial Instruments Directive, the Alternative Investment Fund Managers Directive and the Fourth Anti-Money Laundering Directive.
The EU is looking seriously at the potential of blockchain and DLTs. Its principal regulatory focus for blockchain and DLTs is on transparency and cybersecurity. To date, it has taken a pro-innovation approach to blockchain technology and DLT, as a number of EU initiatives show, and many European institutions are of the opinion that it is still too early to regulate blockchain technology. At this stage, it sees a need for more innovation, research, development, piloting and proof of concepts to facilitate uptake of the technology.
As far as virtual currencies are concerned, Member States’ central banks do not consider virtual currencies to be equivalent to money, or legal tender. This may create problems for their users in the EU – for example, in cases of loss or fraud, there is no compensation or redemption mechanism. However, with the current high profile of and interest in virtual currencies, the EU is likely to pay particular attention to them and their potential risks – and we can expect the EC at least to consider what regulation might be called for.
Available at: http://europa.eu/rapid/press-release_IP-18-521_en.htm
Available at: https://new.consensys.net/
The EC will host an EU FinTech Laboratory where European and national authorities will engage with tech providers in a neutral, non-commercial space.
The EC will report on the challenges and opportunities of crypto assets later in 2018 and is currently working on a comprehensive strategy on distributed ledger technology and blockchain addressing all sectors of the economy.
The EC will present a blueprint with best practices on regulatory sandboxes, based on guidance from European Supervisory Authorities.
The EC will help to develop more coordinated approaches on standards for FinTech by Q4 2018 by liaising and working with major standard-setting bodies, such as European Committee for Standardization and International Organization for Standardization, including in the field of blockchain.
About the author
Jurgita Misevicute is a policy advisor at Covington & Burlington LLP, Brussels, Belgium.