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The European Union (EU) is currently reviewing existing EU financial legislation, how those rules apply to cryptoassets and initial coin offerings (ICOs), and whether EU-level action is necessary. The European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) issued their respective reports on the suitability of the EU regulatory framework in January 2019. ESMA supported the introduction of EU-wide rules for cryptoassets to ensure investor protection and have a level playing field, as most cryptoassets do not qualify as financial instruments under EU financial law. EBA concluded that most cryptoasset-related activities are not covered by EU financial services regulation and that Member States apply divergent approaches, which poses risks to consumers. It therefore recommended to the European Commission the performance of a comprehensive cost-benefit analysis to determine what, if any, action is required at the EU level at this stage.

With regard to anti-money laundering legislation, the EU amended its Anti-Money Laundering Directive (AMLD) in July 2018 and brought custodian wallet providers and virtual-currency exchange platforms within the scope of the AMLD. In their reports EBA and ESMA recommended also bringing crypto-to-crypto exchanges and providers of financial services for ICOs within the scope of the AMLD, taking into account the recommendations of the Financial Action Task Force (FATF).

I. Approach to Assets Created Through Blockchain

The European Union (EU) is currently reviewing existing EU financial legislation and how those rules apply to cryptoassets and initial coin offerings (ICOs). The European Commission is carrying out this work together with the European Supervisory Authorities (ESAs), meaning the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA), and the European Insurance and Occupational Pensions Authority (EIOPA). In its 2018 FinTech Action Plan, it tasked the ESAs to assess the suitability of the EU regulatory framework with regard to ICOs and cryptoassets.[1] EBA and ESMA issued their respective reports in January 2019.[2] The Commission is also monitoring developments together with international partners such as the Financial Stability Board (FSB) and G20 as well as the European Central Bank (ECB) to determine if regulatory action at the EU level is necessary.[3]

Several laws are relevant to the regulatory treatment of cryptoassets and other assets created through blockchain, in particular the Market in Financial Instruments Directive (MiFID 2),[4] the Second Electronic Money Directive (EMD2),[5] the Second Payment Services Directive (PSD2),[6]  and the EU Anti-Money Laundering Directive (AMLD).[7]

A. Financial Regulation and Consumer Protection

ESMA’s mission is to enhance investor protection and promote stable and effective financial markets.[8] It is authorized to provide opinions to the Union institutions on all issues related to its area of competence.[9]

It achieves these objectives through four activities: 

• assessing risks to investors, markets and financial stability;
• completing a single rulebook for EU financial markets;
• promoting supervisory convergence; and
• directly supervising specific financial entities.[10]

ESMA in its report reviewed the applicability of EU financial securities laws to cryptoassets, in particular whether they qualify as financial instruments under MiFID 2.[11] It supports the introduction of EU-wide rules for cryptoassets to ensure investor protection and have a level playing field. ESMA’s Chair, Steven Maijoor, summarized the findings of ESMA’s report as follows:

Our survey of NCAs [National Competent Authorities] highlighted that some crypto-assets may qualify as MiFID  financial instruments, in which case the full set of EU financial rules would apply. However, because the existing rules were not designed with these instruments in mind, NCAs face challenges in interpreting the existing requirements and certain requirements are not adapted to the specific characteristics of crypto-assets.

Meanwhile, a number of crypto-assets fall outside the current financial regulatory framework. This poses substantial risks to investors who have limited or no protection when investing in those crypto-assets.

In order to have a level playing field and to ensure adequate investor protection across the EU, we consider that the gaps and issues identified would best be addressed at the European level.[12]

EBA “works to ensure effective and consistent prudential regulation and supervision across the European banking sector. Its overall objectives are to maintain financial stability in the EU and to safeguard the integrity, efficiency and orderly functioning of the banking sector.”[13] In addition, it is tasked with consumer protection in relation to financial products and services offered by payment institutions, e-money issuers, and mortgage credit providers.[14] Like ESMA, it is authorized to provide opinions to the Union institutions in its area of competence.[15]

The EBA opinion reviewed the applicability of financial services regulation to cryptoassets, in particular the applicability of the Second Electronic Money Directive (EMD2)[16] and the Second Payment Services Directive (PSD2),[17] and issues arising in relation to cryptoasset custodian wallet provision; the risks of money laundering and terrorism financing arising from virtual assets; and the extent to which institutions engage in activities involving cryptoassets.[18] It concluded that current cryptoasset-related activity in the EU in this area is relatively limited and therefore not a threat to financial stability.[19] However, as most cryptoasset-related activities are not covered by EU legislation in this area and Member States apply divergent approaches, risks exist for consumers. It therefore recommended to the European Commission the performance of

a comprehensive cost/benefit analysis to determine what, if any, action is required at the EU level at this stage to address these issues, specifically with regard to the opportunities and risks presented by crypto-asset activities and new technologies that may entail the use of crypto-assets. The EBA also advises the European Commission to have regard to the latest recommendations and any further standards or guidance issued by the Financial Action Task Force (FATF) and to take steps where possible to promote consistency in the accounting treatment of crypto-assets.[20]

B. Anti-Money Laundering Law

On July 9, 2018, the amendment of the EU Anti-Money Laundering Directive (5th AMLD) entered into force.[21] Member States must transpose the new rules into national law by January 10, 2020.[22] The AMLD obligates credit institutions, financial institutions, and certain other entities to fulfill customer due diligence requirements when they conduct business transactions and have in place policies and procedures to detect, prevent, and report money laundering and terrorist financing.[23] The amendment, among other things, extended the customer due diligence requirements to custodian wallet providers and virtual-currency exchange platforms that exchange virtual currencies for fiat currencies and vice versa.[24]

The amendment defines “virtual currencies” as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically.”[25] A “custodian wallet provider” is defined as “an entity that provides services to safeguard private cryptographic keys on behalf of its customers, to hold, store and transfer virtual currencies.”[26]

Both EBA and ESMA support bringing crypto-to-crypto exchanges and providers of financial services for ICOs within the scope of the AMLD, taking into account the recommendations of the Financial Action Task Force (FATF).[27]

C. Taxation

In general, collecting taxes falls within the competences of the individual EU Member States. However, the EU has some limited competences to harmonize Member States’ rules if harmonization is necessary to ensure the establishment and the functioning of the internal market and to avoid distortion of competition. An example would be the harmonization of Member States’ rules in the area of indirect taxation,[28] such as value-added tax (VAT).[29] On October 22, 2015, the European Court of Justice (ECJ) held in its Hedqvist decision that transactions to exchange a traditional currency for bitcoin or other virtual currencies and vice versa constitute the supply of services for consideration, which are generally subject to VAT, but fall under the exemption from VAT.[30] Buying or selling bitcoin is therefore exempt from VAT in all EU Member States.

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II. Custodianship of Cryptocurrencies by Financial Institutions

EU financial law does not contain a definition of safekeeping and record keeping of ownership of securities.[31] There are many different entities involved.  The rules at the issuer level are regulated in the corporate laws of the EU Member States, whereas the investor-level rules vary depending on which type of EU financial legislation applies.[32] With regard to cryptoassets, ESMA in its report defines safekeeping services as “having control of private keys on behalf of clients.”[33] These custodians would then have to ensure the safekeeping and segregation of client assets. However, ESMA points out that this requires “further consideration” as there might be other relevant factors, and the safekeeping of cryptoassets may take different forms.[34] In addition, it suggests that regulators look into the issue of multiwallet providers.[35]

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III. Regulations of Cryptocurrencies as Financial Securities

ESMA in its report reviewed whether cryptoassets qualify as financial instruments under MiFID 2. It defined “cryptoassets” as “a type of private asset that depends primarily on cryptography and Distributed Ledger Technology as part of their perceived or inherent value” and that is “neither issued nor guaranteed by a central bank.”[36] ESMA uses the term to refer to both virtual currencies and digital tokens issued through ICOs.[37] It notes that there is currently no legal definition of cryptoassets in EU financial securities laws.[38]

MiFID II defines “financial instruments” as “those instruments specified in Section C of Annex I.”[39] Among others, these instrument include “transferable securities,” defined as “those classes of securities which are negotiable on the capital market, with the exception of instruments of payment.”[40] In order to review whether cryptoassets qualify as financial instruments, in particular as transferable securities, ESMA surveyed the National Competent Authorities (NCAs) of the Member States, gave them a sample set of six cryptoassets issued in an ICO, and asked them whether they would qualify as financial instruments under national law.[41] It pointed out that the classification of a cryptoasset as a financial instrument falls within the competence of the respective NCA and varies depending on the national implementation of MiFID 2.[42] A majority of NCAs determined that cryptoassets with attached profit rights qualify as transferable securities.[43] No NCA labelled the sample case of a pure utility-type cryptoasset as a financial instrument.[44] For hybrid cryptoassets, the financial instrument features mostly prevailed.[45] Member States that defined the categories for financial instruments broader than in MiFID 2 and included instruments with an investment purpose or expectation of returns were able to capture more of the sample cryptoassets than the other NCAs.[46] The NCAs agreed that cryptoassets should be subject to some type of regulation; however, at a minimum cryptoasset-related activities must be subject to anti-money laundering laws.[47]

If a cryptoasset is qualified as a financial instrument, several legal provisions will potentially apply to them, among them the Prospectus Directive (PD),[48] the Transparency Directive (TD),[49] the Market in Financial Instruments Directive framework (MiFID II),[50] the Market Abuse Regulation (MAR),[51] the Settlement Finality Directive (SFD),[52] the Central Securities Depositories Regulation (CSDR),[53] the Alternative Investment Fund Managers Directive (AIFMD),[54] the Directive on Investor-Compensation Schemes,[55] and the 5th AMLD.[56]

A. Prospectus Directive

The Prospectus Directive (PD), which will be repealed and replaced by the Prospectus Regulation (PR)[57] in July 2019, requires that a prospectus must be published before transferable securities are offered to the public or before such securities are admitted to trading on a regulated market in the EU. Some provisions of the PR already came into force in July 2018.[58] The requirement to publish a prospectus for cryptoassets offered to the public in an ICO therefore only applies if they are qualified as transferable securities.[59] Depending on the size of the offer, some cryptoassets might be exempt from the obligation to publish a prospectus (the threshold for which is €1 million (about US$1.12 million)) and only be subject to disclosure requirements.[60] When a prospectus has to be published, it must contain the necessary information to enable an investor to make an informed decision about the financial condition of the issuer, meaning in the case of cryptoassets “detailed information on the issuer’s venture, the features and rights attached to the crypto-assets being issued, the terms and conditions and expected timetable of the offer, the use of the proceeds of the offer and the specific risks related to the underlying technology.”[61] However, there are no specific schedules for ICOs unlike for IPOs, so that existing schedules must be adapted to the ones that they mostly resemble.[62]

B. Transparency Directive

The Transparency Directive (TD) objective is to improve information supplied to investors about issuers of securities admitted to trading on a regulated market in the EU. It therefore requires the disclosure of periodic and ongoing information about issuers—for example, annual financial reports.[63] Like MiFID 2, it only applies to transferable securities, meaning that issuers of cryptoassets that are qualified as transferable securities must comply with these disclosure obligations.[64]

C. Markets in Financial Instruments Directive Framework

The MiFID II framework obligates companies that provide investment services or activities in relation to financial instruments to register as an investment firm and comply with the legal requirements set out in MiFID II.[65] According to the ESMA report, the following cryptoasset-related activities will most likely qualify as investment services: “placing, dealing on own account, operating an MTF [Multilateral Trading Facility] or OTF [Organized Trading Facility] or providing investment advice.”[66] The report focuses on the applicability of MiFID II to cryptoasset trading platforms as the most common type of intermediaries. These platforms are generally divided into three categories:

• those that have a central order book and/or match orders under other trading models;
• those whose activities are similar to those of brokers/dealers; and
• those that are used to advertise buying and selling interests.[67]

Category 1 platforms are qualified as multilateral systems and should therefore either operate as Regulated Markets (RMs) or as MTFs or OTFs.[68] Category 2 platforms must adhere to the requirements set out in Title II of MiFID 2 for broker/dealers, whereas the third category of platforms falls outside of the scope of MiFID II.[69] Cryptoasset trading platforms that are covered by the MiFID II framework must comply with several requirements—for example, minimum capital requirements, organizational requirements, investor protection provisions, rules for transparent and nondiscriminatory access to MTFs, OTFs, and RMS, pre- and post-trade transparency rules, and transaction reporting and obligations to maintain records, among others.[70]

The ESMA report identified the following gaps and issues that arise from the application of the MiFID II framework to cryptoassets:

• Disintermediated access to cryptoasset trading platforms: Checks on the reputation, sufficient level of trading ability, competence, experience, adequate organizational arrangements, and resources of members or participants “may be time and resource intensive for the platforms in the case of individual investors, because of their large number, and many individual investors may not pass those tests.”
• Pre- and post-trade transparency provisions: These rules are designed for equity and nonequity instruments and not all Member States will qualify cryptoassets as such, which would result in divergent transparency rules across Member States.
• Transaction reporting and obligations to maintain records: The rules were designed to capture traditional instruments, and standards must be adapted to cryptoassets.
• Platforms with decentralized business models: The lack of a clearly identified operator and the reliance on self-executing pieces of code raise specific issues.
• Hybrid platforms: There is a need to clarify the types of investment services they can provide.[71]

D. The Market Abuse and Short-Selling Regulation 

The Market Abuse Regulation (MAR) prohibits insider dealing and the disclosure of inside information and market manipulation (market abuse) with regard to financial instruments that are traded or admitted to trading on a trading venue, MTF, or OTF.[72] The MAR would apply to such cryptoassets, which means that several arrangements, systems, and procedures to prevent, detect, and report market abuse have to be put in place.[73] ESMA recommends that for the next revision of the MAR, the EU should look into whether the price of a financial instrument could be influenced through manipulative trading activity in cryptoassets that do not qualify as financial instruments.[74] Furthermore, it warns that “new actors may hold new forms of inside information, such as miners and wallet providers, which could potentially be used to manipulate the trading and settlement of crypto-assets.”[75]

Where a position in a cryptoasset that qualifies as a financial instrument confers a financial advantage in the event of a decrease in the price or value of a share or sovereign debt, the Short Selling Regulation applies.[76] However, the determination of net short positions is dependent on the list of financial instruments included in Annex I of the Commission Delegated Regulation (EU) 918/2012.[77] ESMA proposes to explicitly include cryptoassets in that list.[78]

E. Settlement Finality Directive and Central Securities Depositories Regulation

The Settlement Finality Directive (SFD) and the Central Securities Depositories Regulation (CSDR) apply to settlement activities.[79] The objective of the SFD is to reduce systemic risk in payment, clearing, and securities settlement systems, in particular with regard to insolvency.[80] The CSDR aims to “harmonize certain aspects of the settlement cycle, [implement] settlement discipline and provide a set of common requirements for CSDs [central securities depositories] operating securities settlement systems in order to enhance cross border settlement in the EU.”[81] The ESMA report points out various issues when the trading platform or the DLT network for cryptoassets qualifies as a securities settlement system, among them

• whether a market operator can be identified in the case of decentralized business models;
• the role of miners under the CSDR;
• that participants to a securities settlement system cannot be individuals as is the case for most cryptoasset trading platforms and DLT networks;
• potential issues in relation to settlement finality and Delivery versus Payment (DvP) in a DLT environment; and
• timeline requirements set by CSDR.[82]

F. Alternative Investment Fund Managers Directive

The Alternative Investment Fund Managers Directive (AIFMD) “lays down the rules for the authorisation, ongoing operation and transparency of the managers of alternative investment funds (AIFMs) which manage and/or market alternative investment funds (AIFs) in the Union.”[83] Several NCAs told ESMA that some of the sample cryptoassets would qualify as collective investment undertakings, most likely AIFs under national law.[84] However, ESMA states that further research needs to be conducted to determine whether the AIFMD applies to these cases.[85]

G.  Directive on Investor-Compensation Schemes

If an investment firm is no longer financially able to meet its obligations, investors will receive compensation under the Directive on Investor-Compensation Schemes.[86] The Directive applies to all MiFID firms that deal with MiFID financial instruments.

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IV. Treatment of Cryptoassets Not Considered Securities

EBA in its report reviewed whether EU financial services law applies to cryptoassets, in particular whether they qualify as “electronic money” within the Second Electronic Money Directive (EMD2) or as “funds” within the Second Payment Services Directive (PSD2).[87] It emphasized that the report did not focus solely on cryptoassets that are used as a means of exchange as earlier reports did.[88] For purposes of the report, it defined the term “cryptoasset” as

an asset that depends primarily on cryptography and distributed ledger technology (DLT) or similar technology as part of its perceived or inherent value, is neither issued nor guaranteed by a central bank or public authority, and can be used as a means of exchange and/or for investment purposes and/or to access a good or service.[89]

A. Second Electronic Money Directive

The Second Electronic Money Directive (EMD2) defines “electronic money” as

electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions as defined in point 5 of Article 4 of Directive 2007/64/EC [PSD2], and which is accepted by a natural or legal person other than the electronic money issuer.[90]

The EBA report found that, depending on their characteristics, certain cryptoassets will qualify as electronic money under the EMD2. The issuers of these cryptoassets would require an authorization as an electronic money institution, unless a limited network exception applies.[91] The following was provided as an example of a proposed business model involving a cryptoasset that was qualified as electronic money by one or more NCAs:

Company A wishes to create a Blockchain-based payment network. The network is open meaning that both merchants and consumers can participate. Company A explains that it intends to issue a token which is intended to be the means of payment in the network. The token is issued on the receipt of fiat currency and is pegged to the given currency (e.g. EUR 1 to 1 token). The token can be redeemed at any time. The actual payment on this network is the underlying claim against Company A or the right to get the claim redeemed.[92]

B. Second Payment Services Directive

The Second Payment Services Directive (PSD2) puts in place rules for different categories of payment service providers.[93] It defines “funds” as “banknotes and coins, scriptural money or electronic money as defined in point (2) of Article 2 of Directive 2009/110/EC [EMD2].” The EBA report states that if cryptoassets are categorized as electronic money and are used to provide a payment service, PSD2 would apply.[94]

C. Recommendations

EBA advises the European Commission to carry out a cost-benefit analysis and, if necessary, to develop proposals for EU-level action.[95] It recommends taking a holistic and balanced approach as well as an activities-based approach, focusing on the interconnectedness of cryptoasset activities with the traditional financial system and with consumers, and trying to achieve a coordinated international response.[96]

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V. Distinctions in Treatment of Different Categories of Cryptocurrencies

ESMA pointed out that most cryptoassets will not qualify as financial instruments or be covered by EU financial services rules, and investors will therefore not benefit from investor protection rules.[97] However, most investors will not be aware that most cryptoassets are not subject to these rules, especially when they are traded on the same venues. Instead of national regimes for cryptoassets, ESMA suggests a bespoke regime on an EU level for cryptoassets that do not qualify as financial instruments, as well as for pure utility-type cryptoassets and certain payment-type cryptoassets.[98] In addition, there is a consensus among ESMA, EBA, and the NCAs that all activities involving cryptoassets should be subject to the AMLD.[99] ESMA “advises to focus the regime for crypto-assets that are not financial instruments on warning buyers about the risks of those crypto-assets, instead of a more elaborate regime that could legitimise crypto-assets and bring them into a similar regulatory remit as the one for crypto-assets that are financial instruments.”[100]

EBA’s report states that “it appears that a significant portion of activities involving crypto-assets do not fall within the scope of current EU financial services law (but may fall within the scope of national laws).”[101] Like ESMA, it therefore sees potential issues regarding consumer protection, a level playing field, and divergent national approaches.[102]

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Prepared by Jenny Gesley
Foreign Law Specialist
April 2019

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Last Updated: 12/30/2020