European Union: New Strict Rules on Cryptocurrencies

virconlegal

April 18, 2022

News

The European Union (the “EU”) has always been strict about tracing money flow and regulating anti-money laundering, terrorist financing, and other crimes. Undoubtedly, it also aims to control cryptocurrency activities, which has been a grey area within different jurisdictions. Although it was argued that the EU would ban cryptocurrencies that are proof of work-based last month, the EU has rejected this proposal and set draft rules to govern digital assets. (1)

Proof of Work-Based Activities

On March 14, the Parliament issued a press release (2) to inform the citizens about new rules which aim to ensure uniformity, safeguards against financial crimes and manipulations, protection of customers, and environmental sustainability to reduce carbon footprint in mining activities. Additionally, the Members of the European Parliament (the “MEPs”) agreed upon critical provisions of the draft regarding transparency, authorization and supervision of transactions, a legal framework for the financial stability of crypto assets, and measures to avoid market manipulation and prevent criminal activities such as money laundering and terrorist financing.

To prevent environmental threats, it was also announced that the Commission would present a proposal regarding crypto asset mining activities, video games, and the entertainment industry for including them in the EU taxonomy,(3) which is a classification system that establishes a list of sustainable economic activities in order to achieve the European green deal's goals. (4) When the Markets in Crypto Assets (the “MiCA”) was firstly introduced in 2020, the aim of the framework for digital assets was argued and objected to by the industry players as the initial draft had explicit wording which would ban proof of work-based cryptocurrencies such as Bitcoin because of the energy concerns. (5)

As the public raises such concerns, the process has been slower and debatable. The Parliament voted for an extended version of the MiCA without the explicit ban on proof of work-based cryptocurrencies. (6) Dr. Stefan Berger, a member of the Parliament from Germany, recommends the crypto-assets be included in the Taxonomie area, just like all other financial products, to address the critical debate regarding sustainability. He further states that there would not be a separate discussion about Proof-of-Work in the MiCA. (7)

Strict KYC and AML Rules

Instead of banning the Proof-of-Work, the Parliament voted on April 1 in favor of the Know Your Customer (the “KYC”) and Anti-Money Laundering (the “AML”) rules for cryptocurrency service providers, which would require them to verify the identity of persons who use unhosted wallets and to report any transaction higher than € 1,000 to the authorities. (8) This would even require identifying a small crypto transaction’s parties, thus raising data privacy concerns.

A press release on the dangers of cryptocurrencies and the EU legislation’s benefits was published on the Parliament’s website. According to the release, new rules are required to ensure legal certainty, encourage innovation, and protect consumers and investors. (9)

Opinions From the Industry

Following this news, Brian Armstrong, the CEO of Coinbase, wrote that Coinbase would have to report any person to the authorities if he receives €1,000 or more in crypto from a self-hosted wallet regardless of the suspicious activity indicated. (10)

Pascal Gauthier, the CEO of the Ledger, also reacted to this decision on his Twitter account by stating that the EU Parliament has chosen fear rather than freedom, since legislation has been enacted to lead a massive surveillance regime over Europe's financial landscape. (11)

Paul Grewal, the Chief Legal Officer of Coinbase, emphasized that account holders cannot withdraw money from their bank account until the financial institution has verified their identity and shared their personal data. Moreover, verifying non-customers is almost impossible, and imposing this requirement contradict with the core principles of the EU data protection, such as minimization and proportionality.

Other Developments in Cryptocurrencies

On April 8, the EU also banned high-value cryptocurrency services to Russia as one of its sanctions imposed following Russia’s invasion of Ukraine. In the fifth round of sanctions, Russia's crypto wallet, account, or custody services are banned if the value exceeds €10,000. (12) The Union states that “In view of the gravity of the situation, and in response to Russia’s military aggression against Ukraine, it is appropriate to introduce further restrictive measures. In particular, it is appropriate to extend the prohibition on deposits to crypto wallets.“ (13)

What’s Next?

The new regulation (the “Regulation”) will be negotiated among the EU institutions and is expected to be enacted in July. If the Regulation will be adopted, industry players must take all actions to comply with the new rules within 18 months. (14)

Unhosted wallets are software or hardware (hot or cold wallets) that enables storing and transferring crypto assets that are not hosted by a centralized party and are managed directly by individuals. If the proposal will be approved, only the wallets qualified for the KYC standards and regulatory approval may be used within the EU. This would lead to a decrease in decentralized autonomous organizations operating in the EU, and it would be difficult for the crypto service providers to verify identities for each transaction exceeding €1,000. Some players would want to block transactions to avoid monitoring and tracking activities. Small and mid-scale companies might be forced to leave the market as it would be difficult to comply with the new regulations in terms of costs. These events may make the market centralized by more prominent and dominant players, contrary to the idea of decentralization and freedom.

As Vircon Legal, we'll keep you updated regarding the crypto-related news in the EU and other developments about blockchain.