Crypto Under the Lens: EU Strategies for Regulating Digital Currencies and Technologies PDF

Crypto Under the Lens: EU Strategies for Regulating Digital Currencies and Technologies Nicola Coden (N. 905736), Evelyn Colaci (N. 904619), Alice Comastri (N. 904580), Alice Comino (N. 904720), Aran Confalonieri (N. 904726), Elia Cristian (N. 905479), Benedetta Crosera (N. 905704...

Crypto Under the Lens: EU Strategies for Regulating Digital Currencies and Technologies Nicola Coden (N. 905736), Evelyn Colaci (N. 904619), Alice Comastri (N. 904580), Alice Comino (N. 904720), Aran Confalonieri (N. 904726), Elia Cristian (N. 905479), Benedetta Crosera (N. 905704), Lucia dal Colle (N. 904549), Marco dal Mas (N. 886663), Marco Franco de Bosis (N. 905426), Dave Prem (N.907181), Riccardo de Agostini (N. 904344) 19 November 2024 Abstract The EU and especially the Markets in Crypto-Assets Regulation (MiCA) is attempting to change the cryptocurrency and blockchain technology space. MiCA is primarily concerned with consumer protection, financial stability and transparency. This creates problems for GDPR compliance as it clashes with the data protection and “right to be forgotten” prin- ciples. The purpose of these regulations is to reduce the risk of money laundering and tax evasion. In this paper, we will check out both implications of these frameworks for the crypto market, getting into some of the challenges regarding en- forcement while also discussing how they can help create a more secure and transparent financial ecosystem in Europe. 1 Introduction to Cryptocurrencies A cryptocurrency is a digital form of money that exists only online and isn’t controlled by any central authority, like a bank or government. Instead, it relies on a technology called blockchain, which keeps a secure, public record of transactions. People can buy, sell, and trade cryptocurrencies, like Bitcoin or Ethereum, using special online platforms. Cryptocurrencies are often used as investments, and their value can change a lot in a short time. They’re also known for being private, as transactions don’t need personal information attached. 1 2 EU Regulatory Frameworks and Global Ap- proaches 2.1 MiCA: (Markets in Crypto-Assets Regulation) Markets in Crypto-Assets Regulation, or MiCA in short, is the key initiative of the European Union to set clear legal standards for the markets of cryptocur- rency and digital assets. This will not only create harmony among member states in their respective domains but also ensure consumer protection against significant risks and a robust legal framework for businesses operating with crypto assets. MiCA fills in the lacunae left by existing EU financial legisla- tion, which largely ignores digital assets, by providing one single regime for the issuance and circulating of cryptocurrencies, utility tokens, stablecoins, and e- money tokens. Consumer and investor protection, along with protection of financial stability and market integrity, are the focuses of MiCA. The regulation will force crypto service providers like exchanges and custodians to obtain licences from national regulators and comply with strict standards on risk management, cybersecurity, and transparency. Stablecoins will fall under even more stringent requirements because of their systemic risks; their issuers will be obliged to maintain suffi- cient reserves and adhere to strict management policies in order to protect users’ funds. For example, MiCA regulates stablecoins, such as one pegged to the euro. In this respect, MiCA requires the issuer to hold an amount of cover equivalent to the amount issued, ensuring that one can always redeem a stablecoin, thereby protecting users’ assets and building market trust 2.2 Comparisons to Global Frameworks Governments and international organisations try to reconcile the process of in- novation with the process of regulation in different ways. There are, however, a lot of differences between the region and global regions, in this case regulation of currency, their advantages, disadvantages and future prospects through the analysis of the future. United States: A fragmented regulatory landscape where the SEC, CFTC, and FinCEN regulate different types of cryptocurrencies. Such decentralisation may result in inconsistencies and regulatory deficiencies. United Kingdom: A more unified model where the FCA along with the HM Treasury works together. The UK seeks to foster growth rather than excessive regulation, so it seeks to be favourable to crypto businesses. European Union: The MiCA framework provides market-wide measures for the legal regulation of crypto assets at the community level such as prevention of market abuse, customer protection, and protection of the environment as well. 2 2.3 Global Systems - Financial Stability Board (FSB): The FSB leads cross country efforts to curtail the threats cryptocurrencies, and their underlying factors especially stable coins present. However, in as much as they lead, they have little power to influence others as they have no enforcement authority. - International Monetary Fund (IMF): The IMF enjoins countries to collabo- rate and provide direction on AML policies and central banks’ digital currencies (CBDCs). - Basel Committee on Banking Supervision (BCBS): The BCBS developed guidelines for standards of prudence which are to be practised by banks en- gaging in crypto related activities as means of reducing the arising risks. - Financial Action Task Force (FATF): The AML/CFT standards of the FATF including the “Travel Rule” strive to improve transparency and integrity of the financial system. On the other hand, there are some concerns about privacy regarding these laws and most face issues in terms of implementation. 2.4 Challenges and Future Directions Regulatory arbitrage, inconsistent enforcement, and environmental impact are major challenges of cryptocurrency regulation. Important steps to resolve these issues include stronger international collaboration, common regulatory approaches, and environmentally friendly practices. 3 Cryptocurrencies and Anti-Money Launder- ing (AML) Compliance 3.1 EU AML Directives Anti-Money Laundering (AML) Compliance has lately become very necessary in the Bitcoin world, considering its recent uses in criminal activities. While Bitcoin transactions are done transparently on the blockchain, most of them are pseudonymous addresses, which is usually a big challenge to identify. This anonymity is what criminals aim for when engaging in money laundering services used by criminals to obscure funds’ origins and chain switching, where they convert Bitcoin into other cryptocurrencies on different blockchains to ba- sically avoid detection. These risks are being somewhat countered by regulatory authorities such as the Financial Action Task Force through guidelines that Virtual Asset Service Providers, including crypto exchanges, should implement. That would include identification of the users of their platform through documentation such as IDs and proof of address or residence. Another key component is Enhanced Due Diligence, where high-risk transactions, for example large transfers of funds linked to dubious activities, need to be reviewed. 3 The European Union has implemented normative frameworks such as the Mar- kets in Crypto Assets (MiCA), that will compel cryptocurrency service providers to implement strict measures of AML compliance. In addition, real time blockchain analytics applications track Bitcoin transac- tions in search of patterns indicative of illicit activity. Such tools can help identify suspicious transfers by digging into transactions history and flagging the ones that involve illicit addresses. However, challenges persist, especially with the larger DeFi platforms that have no central authority to watch above their operations. Though, further im- provements have been made in regulations and international cooperation to tighten AML measures, increasing safety and transparency of Bitcoin transac- tions within the financial space. 4 Taxation and Cryptocurrencies in the EU 4.1 EU Taxation Policies Taxation of cryptocurrencies is a very complex subject in the European Union due to the decentralized nature of the digital currency, which makes them hard to be accommodated into conventional systems of taxation. Each EU country has its own way of classifying and taxing cryptocurrencies, leading to differences across the region. Most countries don’t treat cryptocur- rencies as actual money but rather as assets. This means they are subject to capital gains tax upon sales or exchange thereof. Meanwhile, in Germany, if you hold a cryptocurrency for more than one year, it is exempt from capital gains tax, which will encourage them to make invest- ments that are long-term. While in France, cryptocurrency gains are treated as income for frequent traders and income taxed at a flat 30% rate for occasional users. Crypto gains over €2,000 are taxed at 26%, while smaller gains are exempt in Italy. The EU has just introduced a new directive known as the DAC8, which now seeks to make crypto taxation more transparent and coherent between the dif- ferent member states. Under DAC8, crypto platforms would be forced to report transaction data to tax authorities with an eye toward helping close loopholes and reducing tax evasion. It is part of the broader push meant to ensure crypto is treated somewhat like other financial assets. This initiative is expected to start by 2026 and aligns with global efforts like the OECD’s Crypto-Asset Reporting Framework. However, there are still issues. Because cryptocurrencies are variously treated as either property or commodi- ties, depending on the country, it’s hard to develop coherent rules. If that were 4 not enough, the technology is changing at such a rapid pace that tax laws can’t often keep up with the pace. For the EU, what will be key is finding a balance between developing reason- able policies on taxation and fostering innovation in this growing crypto market. While DAC8 is in the right direction, the extent of its success will depend on how well EU countries can effectively cooperate and adapt to the swift pace at which cryptocurrencies are evolving. 4.2 VAT and Income Tax The application of VAT and income tax to cryptocurrencies is complex, espe- cially in transactions across EU borders. Cryptos are decentralised and incon- stant, making them very hard to fit into the concepts of the Tax Rule framework. From a European Court decision in 2015, the Hedqvist case, cryptos trades with regular currencies were ruled to be exempt from VAT across the EU. This is because cryptos are considered, for all intents and purposes, as a means of pay- ment rather than as a good or service for VAT purposes. In the payment of goods or services when paying with cryptocurrency, VAT is always applied to the particular good or service, not to the cryptocurrency. Rules on mining and staking differ, but most countries tax this kind of income. With cryptocurrencies, it is sometimes difficult to tell in which countries taxes should be paid because they can easily be stored and used across borders. For example, a resident of one EU country receiving crypto income from another might be viewed as experiencing double taxation or some other confusion about the rules. Partial anonymity in crypto transactions is also a challenge for tax authorities in determining who earned how much. The EU has pursued the development of stricter rules, such as MiCA, in order to provide greater transparency in respect of cross-border tax rules that contribute toward curtailing tax evasion. How- ever, the particular nature of cryptocurrencies continues to create challenges for tax laws and management. 5 Consumer Protection in Cryptocurrency 5.1 Consumer Rights Directive The cryptocurrency’s market is regulated by a new European regulation, called MiCA (Markets in Crypto-Assets Regulation). The MiCA was officially approved by the Council on 16 May 2023 and it aims to regulate the market in cryptocurrencies and related financial products, establish- ing a legal framework in all EU member states, increasing consumer protection from scams or misleading offers, transparency and financial stability. 5 The regulation consists of three kinds of crypto-assets: - Asset-referenced tokens: they are pegged to a stable value of multiple curren- cies that are considered legal tender. They are currencies to pay for goods and services and store of value. - E-money tokens: they have a stable value as compared to only one fiat cur- rency and are basically electronic equivalents of banknotes and coins. They are primarily meant to be used as currency. - For other crypto-assets (e.g., utility tokens). MiCA establishes obligations for issuers of crypto-assets and service providers in relation to: - Transaction oversight and authorization - Transparency - Environmental impact disclosure of crypto-assets Thanks to the MiCA, crypto-asset service providers require an authorisation to work in the EU. They must abide by stringent criteria to safeguard their clients and will be responsible if they misplace the crypto-assets of investors. To protect consumers, EBA will keep a public database of non-compliant crypto- asset service providers. Overall, MiCA represents a significant move towards establishing a safer and more regulated landscape for the cryptocurrency market in Europe, offering consumers and investors increased protection and reassurance in this evolving sector. 5.2 Market Manipulation and Misleading Advertising The EU has gone far towards consumer protection in the crypto market by re- vising existing frameworks, such as the Consumer Rights Directive, Directive 2011/83/EU, to include virtual transactions. The aforementioned Directive ini- tially targeted traditional goods but now is extended to online and cross-border transactions in cryptocurrencies. It calls for transparency of information and a non-abusive contract from platforms. However, the enforcement of such mea- sures are erroneous to carry out in uncentralized and tumultuous crypto markets. The Unfair Commercial Practices Directive, Directive 2005/29/EC, under the crypto advertisement area, prohibits deceptive marketing, including inflated re- turns and downplayed risks. This perhaps could hint at holding the crypto platforms to truthful advertising standards to help ward off consumers from losing financially because of false claims. It also protects against insider trading, ”pump-and-dump” manipulative schemes, and unauthorised disclosures under MAR-Regulation (EU) No. 596/2014. Al- though it was first established for traditional markets, these needed to be up- dated to the new digital assets, prohibiting market manipulation and ensuring 6 market integrity, thereby giving confidence to more consumers. The Digital Services Act or DSA, under EU Regulation 2022/2065, requires transparency in digital advertising by ensuring that platforms clearly indicate what is a paid promotion. This already provides indirect protection to con- sumers against crypto ads lacking risk disclosures and, in effect, protects them in informed decision-making. Through these adaptations, the EU proves its at- tachment to consumer protection within the scope of digital finance. However, in respect of the unique set of risks that come with cryptocurrency, a constant update of such laws is quite necessary for full consumer protection. 6 Privacy and Data Protection Laws The GDPR of the European Union has placed strict guidelines with respect to data collection, processing, storage, and deletion that guarantee privacy, trans- parency, accountability, and control of personal information within the EU and EEA. However, blockchain technology, which records transactions of cryptocurrencies, presents unique challenges for GDPR compliance due to its resistance to data modification and deletion: 1. Data Immutability and the Right to Be Forgotten: Immutability of blockchain technology, as it guarantees a secure and transparent record of all transactions conducted, provides challenges to GDPR compliance. Rights of individuals under GDPR include the right to correct inaccuracies and ask for the erasure of personal data, that is, the ”right to be forgotten.” The im- mutable records on blockchain make performing these obligations difficult, thus posing challenges of compliance by firms processing or storing personal infor- mation on a blockchain. Although potential pathways exist with such solutions as off-chain storage and encryption, full GDPR compliance remains complex. 2. Anonymous and Pseudonymous Data: Transactions on a blockchain are usually pseudonymous, tied to a public key rather than an identity in the real world. This provides some level of privacy, al- though for GDPR, it will continue to treat pseudonymous data as personal data if indirect identification of individuals is possible. Fully anonymous data falls outside of the GDPR protection, but true anonymity is very rare on blockchain networks, and transactions can usually be linked to a specific individual with sufficient contextual or additional information. 3. Cross-Border Data Transfers: The GDPR limits personal data transfers outside the EU/EEA to countries with strong data protections. However, public blockchain networks replicate data across nodes globally, so data flows beyond the EU/EEA are hard to control or restrict. This makes compliance challenging, as blockchain’s decentralised 7 structure means data may be stored on servers in regions without adequate GDPR protections. Conclusion Intermingling cryptocurrency into systems does hold both colossal opportunity and challenges. 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