European Crypto Regulation Risks Liquidity, Lack Of Innovation

The European Union (EU) will introduce on January 1 the Markets in Crypto-Assets Regulation (MiCA). This regulation will establish a unified legal framework for crypto assets across the 27-member bloc to protect consumers, foster transparency, and ensure market stability.

"MiCA is a significant step in ensuring the responsible evolution of the crypto market," Ari Redbord, Head of Legal and Government Affairs at TRM Labs, said. "It represents the EU's commitment to creating a balanced environment that encourages innovation while safeguarding stakeholders."

Under MiCA, crypto firms will face new compliance demands, including licensing requirements, anti-money laundering (AML) standards, and strict oversight for stablecoins. Although impressive on paper, MiCA risks a negative impact on competitiveness and innovation.

MiCA Framework in Detail

MiCA primarily aims to create a secure and transparent environment for crypto-assets. Central to its framework are stablecoins, cryptocurrencies pegged to fiat currencies like the euro or US dollar.

Stablecoin issuers must secure e-money licenses and maintain reserves primarily in low-risk assets, a rule designed to ensure stability, with at least 60% of reserves held in liquid, safe assets.

Total Stablecoin Market Cap, 2021-2024, Source: CCData

These measures are seen as a double-edged sword. While they protect consumers and prevent financial instability, they raise concerns among stablecoin issuers. 

For example, cryptocurrency exchanges Binance and Seychelles-based OKX have preemptively delisted Tether (USDT) in anticipation of compliance issues, while Circle's USDC has already adapted to the requirements.

"MiCA's stringent reserve requirements pose profitability challenges for retail-focused stablecoins," fintech entrepreneur Anton Golub noted. He pointed to Revolut's struggles as an example of difficulties within this regulatory landscape.

MiCA will also introduce a passportable licensing system, enabling crypto firms to operate across the EU with a single authorization. However, critics argue that the regulation could stifle innovation by imposing burdensome requirements, making it harder for startups to thrive.

US Liberal Regulations Pushes Bitcoin Higher

In anticipation of Donald Trump’s second term, the situation is starkly different in the United States. Crypto-friendly policies and appointees have spurred innovation as Bitcoin's value soared past $100,000, and venture capital funding in blockchain technology has seen a resurgence.

Trump's choice for the "crypto czar" is former PayPal's COO David Sacks, while crypto advocate Paul Atkins will become the new boss of the SEC.

Bitcoin Price 2019-2024, Source: TradingView

Stablecoins, particularly those backed by the US dollar, have flourished in this environment. Without stringent reserve requirements, dollar-backed stablecoins dominate global markets, providing liquidity and hedging against crypto volatility. 

The US approach has facilitated rapid growth and adoption, leaving euro-backed stablecoins struggling to compete.

"The market for euro-backed stablecoins is minuscule compared to dollar-backed ones, and MiCA's hurdles only widen the gap," Golub said. This divergence could drive European crypto firms to seek opportunities in more accommodating jurisdictions, potentially undermining the EU's ambitions to be a global crypto hub.

MiCA Ramifications for Crypto Market

The removal of Tether (USDT), the most traded stablecoin, will certainly reduce liquidity for traders as they switch to alternatives. Erald Ghoos, CEO of OKX, noted a shift to using fiat trading pairs. "I was quite surprised by that," he said. 

The larger backdrop of EU's regulation could discourage VC capital funding in the region. Both 2023 and 2024 saw a notable decline in European crypto funding, as a spillover from the 2022 bear market. While the overall VC market tanked in contrast to a record 2022, North America still saw growth this year.

Global crypto venture deals, 2018-2024, Source: PitchBook/Bloomberg

In a way, MiCA regulation is the sign of a crypto market maturity and a "seal of approval" from the European Securities and Markets Authority (ESMA), recognizing crypto as an asset class. 

Although the regulators claim it positively affects innovation, it is unlikely that more regulations will reverse the downward funding trend. Regulations can be burdensome from a legal perspective, boosting project costs and requiring capital buffers.

BCB Group, an institutional digital asset solutions provider, compared MiCA to the Markets in Financial Instruments Directive II (MiFID II) regulation, legislation the EU rolled out in 2018 to increase transparency for trading costs and improve record keeping. 

Eventually, this legislation caused turmoil in the sell-side research market that the Financial Conduct Authority proposed its reversal earlier this year.

Disclaimer:

Any opinions expressed in this article are not to be considered investment advice and are solely those of the authors. European Capital Insights is not responsible for any financial decisions made based on the contents of this article. Readers may use this article for information and educational purposes only.

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