How regulation is shaping the future of markets in digital assets

First came the hype surrounding blockchain technology, and the emergence of crypto securities and other digital assets. Fluctuations in prices mirrored surging or waning investor enthusiasm for these pioneering assets.

Then, a few failures rattled the market. Simmons’ partner Jochen Kindermann observes: “We were coming from an environment in which there were no rules, and that led to market abuses and fraudulent behaviours. Now, regulations are being introduced, albeit slowly, to establish a framework, standardise practices and legitimise the market.”

At cryptocurrency custody and brokerage platform Copper, Matthias Winter notes how the emergence of stablecoins — cryptocurrencies pegged to a fiat currency — were the catalyst that triggered global regulators and governments to take note. “The realisation that big tech players, like Facebook, could actually issue a cryptocurrency, meant there was definitely something that needed to be regulated.” Where Facebook led, others would surely follow.

Regulation enacted in the EU

In April 2023, the European Parliament adopted The Markets in Crypto Assets (MiCA) Regulation. By early 2025, a unified regulatory regime will be in place across the EU for crypto instruments.

MiCA will offer a comprehensive regulatory framework, aimed at ensuring proper safeguarding and protection of consumers and investors. It will enhance transparency over digital assets, maintain financial security and deter market abuse. It is a significant step towards harmonising and legitimising the crypto industry in the EU. To support clients, Simmons and Simmons has released its own guidance to mastering MiCA.

Parallel developments are now underway in other jurisdictions too, including in the UK and Switzerland. Digital assets may be ringfenced, as in the EU, or integrated into existing financial regulation. Matthias describes the EU stance to issuing financial instruments on blockchain as “technologically neutral. A security is a security, irrespective of whether it is issued on blockchain or not.”

However, due to the lack of a global standard, regulatory authorities have limited jurisdiction. Even if MiCA had been in place in 2022, it might not have adequately protected European investors from the US$8bn bankruptcy of Bahamas-based crypto exchange FTX, simply because cryptocurrency services are delivered cross-border via apps.

Matthias highlights growing institutional demand for global standards and professionalisation of the industry. He believes, regardless of the specific crypto or trading app used, that regulation or oversight is needed.

How effective will MiCA be?

We’re barely into MiCA 1.0 but discussions about MiCA 2.0 are already underway. That’s because the current version of MiCA has limited scope. It focuses primarily on asset-referenced tokens, electronic-money tokens and other crypto assets not caught by existing financial services regulation. Even so, some assets, like non-fungible tokens, are not yet covered by MiCA 1.0��s provisions.

MiCA applies to the issuance, trading and management of crypto assets. The traditional securities’ prospectus is replaced by a white paper, approved by a competent authority. These white papers serve to ensure market integrity and boost investor confidence in the adequacy of funding on the blockchain for immediate token settlement.

The effectiveness and evolution of MiCA hinges on a shift in mindsets. Incumbent systems and long-standing practices must evolve so that institutional investors can follow the lead of retail investors in embracing blockchain technology and participating in the cryptocurrency markets.

To support MiCA’s objectives, organisations must implement internal processes, systems and databases to detect insider trading or market abuse by employees. Additionally, marketing, compliance and communications functions must adapt to the new operational landscape to keep pace with technology developments and regulatory requirements.

What next?

Within the next two to three years, Jochen anticipates a gradual shift in market infrastructure, from paper-based to fully technology-based processes for buying and trading digital securities over blockchain. It will, he says: “happen imperceptibly and users will barely notice that it exists. There won’t be any big hype; it will simply become the new norm.”

For Matthias, transformation in financial markets infrastructure will come from technology-led service providers that are willing to work with established structures, laws and regulations, and incumbent financial institutions, which are ready to embrace new technology. “I think we will see these two players move closer together and change the way that investors interact with the crypto markets. Working hand in hand, being prepared to experiment and take the lead, they will bring about a revolution.”