The EU Moves on the Cryptocurrency Regulation Bill

In the 1990s, the cypher punks (such as Eric Hughes, Timothy C. May, and John Gilmore) defined an agenda where public key encryption would…
Photo by Omid Armin on Unsplash

The EU Moves on the Cryptocurrency Regulation Bill

In the 1990s, the cypher punks (such as Eric Hughes, Timothy C. May, and John Gilmore) defined an agenda where public key encryption would change our world, and free our society from the control of governments, large corporate banks, and the state. Satoshi Nakamoto then crystalized this vision with the implementation of Bitcoin — and which has run without stopping since 2009.

For some, Bitcoin gives cryptocurrency a bad name, as its proof of work methods consumes so much energy, and that it has generally been used as an investment/gamble, rather than replacing our current financial infrastructure. But, cryptocurrency is only one small part of a much larger opportunity in creating a tokenized economy. Whichever country/region of the world can make best use of this new economy, is likely to be the one that benefits the most in terms of governance and economic development. Our old paper world — of paper money and wet signatures — will fade into the past.

Law makers finally catch up

Since the time of the cypher punks, we have seen some of the greatest ever advancements in computer science, such as digital signing, blockchain, distributed ledgers, zero-knowledge proofs, smart contracts, and so on. This has built a new world of trust and privacy, and researchers have continually strived to improve the way that we conduct our transactions. But, this has brought the opportunity for those who prey on vulnerable people, the scammers, the money launders, the fake companies, and all the rest of the faceless fraudsters who have used cryptocurrency as a shell for their own benefits.

It has taken two decades for governments and lawmakers to wake up to the new work, but eventually, cryptocurrencies had to meet reality. Perhaps, it's a sign of their acceptance as a financial instrument, and that they only exist for a while before lawmakers (and tax gathers) caught up with them.

And it is to the European Union that we see the first real step in providing some type of control on “crypto”:

Regulation

At the core of this regulation is to put in place the types of controls that are applied to our finance industry, such as money laundering, accountability and consumer protection. But with it comes a focus on the energy consumption of some of the cryptocurrency methods — especially those that focus on proof of work.

An interesting focus is on stablecoins, too, and the methods that are used to create these. For many, stablecoins would provide a core foundation of a future economy, as they could be properly tethered to fiat currency. If they were, for example, backed by the bank which issues the fiat currency, they would provide a convenient way to trade with a digital version of the currency. But, there have been problems with some of the tethered cryptocurrencies, which were tethered to other cryptocurrencies — and when the reserve of this is depleted, the tethered cryptocurrency can crash.

The new regulation has been passed by the European Council and will go for full approval on 10 October by the European Parliament, and be implemented in 2024.

But, the new regulation is rather light on the general usage of cryptographic assets, and mainly just focuses on cryptocurrency. For this, the Liechtenstein Blockchain Act possibly comes the closest to defining proper regulation within cryptographic token use.

The Liechtenstein Blockchain Act

The consultation document [here] defines trusted technology transaction systems (VT systems). For the first time, we see blockchain methods being translated into legal speak, with a token being defined as:

enable the transformation of the ‘real’ world to blockchain systems while ensuring legal certainty, thereby opening up the full application potential of the token economy.

The Act also defines methods which aim to protect client interests from scam agents, and these are at the core of cleaning up the cryptocurrency marketplace. It defines “legal certainty” for blockchain implementation and projects a world where our existing assets are added onto blockchain, and then traded there. Our centralised economic trading models may thus disappear, and a fully distributed and more trusted model replaces old-fashioned practices.

The tokens that are likely to be defined are:

  • Payment tokens (currency coins). This includes cryptocurrency coins.
  • Utility tokens. This allows for a spend against a service.
  • Security tokens (equity and assets). These could define the ownership of an asset.

Overall the Act aims to properly define the key legal consequences of the ownership, possession and transfer of tokens:

The Act defines:

  • Subject and purpose (Art. 1 VE-VTG): This defines that the main focus is around the protection of users, and to thus build confidence in tokens.
  • Trusted technologies (Art. 3 VE-VTG): This defines the technology that is required to build a VT.
  • Definitions (Art. 5 VE-VTG): This defines a token as something that defines the claims of a person to the rights to goods.
  • Rights of disposal (Art. 6 ff. VE-VTG): This defines the rights to transfer tokens, and is normally defined by the owner of a private key signing the transaction. A disposition is defined as the transfer of the disposition authorization on the token. Within the Act, it is defined that a buyer has the right to dispose of a token, even if the seller was not authorized to dispose of the same token.
  • Requirements for VT service providers (Art. 13 ff. VE-VTG): This defines the entities that will perform services within the VT. These entities must provide an organisational structure, control mechanisms and a minimum amount of capital.
  • Basic information on the issuance of tokens (Art. 28 ff. VE-VTG): This defines the assurance in the issuing of tokens and their legal requirements. They must provide a minimum amount of information, such as the technology used, the purpose of the token, and any risks. There should be at least 10 years of issuance, and to also prevent token cloning, along with prevention of a token not being released with the same rights.
  • Obligation to register (Art. 36 ff. VE-VTG): This defines that service providers must register with the Financial Market Authority (FMA) before starting their commercial operation.
  • Supervision (Art. 42 ff. VE-VTG): This defines that the FMA implements the Act.
  • Penal provisions (Art. 49 ff. VE-VTG)

A token protector is defined as someone who holds the token in their own name, and on behalf of the owner. Custodians are then defined as a person who can provide custodial services for the private keys of a third party. Overall the custodian should be able to operate without disruption. They should also provide strong controls against the loss or misuse of private keys, and provide separation between business assets and the private keys of their customer.

In order to clean up on those to operate within the token economy, the Act requires the following entities to register with the FMA: Token issuers; token service protectors; token service custodians; token service exchange platforms; physical validators; and token service identity service providers.

The Act then defines that tokens held by a company will not be part of their estate in the case of bankruptcy, and must be held separately from the company's other assets. A fine for breaches of the Blockchain Act will range from CHF20,000 (around 20K) to CHF30,000 (around $30K).

Conclusions

At, the core of any new regulation must not be the suppression of innovation and freedom to investigate new methods, but where there should the protection for citizens, and in a way, we might expect for our normal financial transactions. Basically, we just scale our existing financial regulations onto a more trustworthy infrastructure for trading.

We must strike a balance between innovation, building new economies, and protecting our citizens from fraud and abuse. The EU regulation is a baby step towards this. There’s a feeling that those who make the laws, really don’t understand the underlying technology, and how much it could transform our world. Unfortunately, Bitcoin has not provided a good role model and has generally been used as an investment, rather than a new way to transform our financial infrastructure. Stablecoins, though, do have great potential but need to be carefully regulated.

The EU regulation is truly a baby step towards the future, and there needs to be much more debate about creating more trusted economies, as cryptocurrencies are just the tip of the iceberg.