How Europe’s finance hubs are implementing crypto regulation
Born out of the 2008 financial crisis, bitcoin was designed to be censorship-resistant. However, demand has surged to such an extent since – possibly beyond the expectations of pseudonymous creator Satoshi Nakamoto – that regulators have been forced into action.
Although Satoshi may disagree, the benefits of regulating crypto are manifold:
- Gary Gensler, chair of the US Securities and Exchange Commission, previously described the ecosystem as the ‘wild west’, so regulations are necessary to protect investors from illicit activity such as fraud and market manipulation
- Regulations ensure that participants like exchanges behave responsibly and reduce the threat to global financial stability caused by the growing interconnectedness between the old world and the new
- Regulations legitimize digital assets and encourage institutional participation
The authorities responsible for supervising Europe’s financial hubs — the EU, Switzerland, and the UK — are at different stages with their crypto regimes. Here’s a summary of where these key players stand.
Crypto regulations and taxation in Europe
The EU’s Anti Money Laundering Directives are the main regulations governing crypto in Europe. The fifth directive, which came into force in January 2020, subjected crypto exchanges to the same rules as other financial institutions for the first time, meaning they have to verify customers and submit reports of suspicious activity. The sixth and latest directive followed in December 2020, expanding the list of predicate offenses (a component of a more serious crime) to include cybercrime which sometimes relies on crypto.
Member states diverge on the taxation of digital assets. Among the most favorable regimes is Portugal’s, which doesn’t levy capital gains. At the other end of the scale, Spain taxes crypto investments at a rate of 52% if they’re bought and sold within 12 months.
The EU submitted another proposal in July 2021, the Transfer of Funds Regulation, which hasn’t been voted into law yet. This proposal would require crypto service providers to verify the identification details of owners of non-custodial wallets and report transactions over €1,000 to the relevant authorities.
Finally, a brief spotlight on Germany, where Finoa is based. BaFin, the country’s financial authority, was the first among its EU peers to classify crypto as a financial instrument in March 2020. BaFin is also responsible for authorizing custodians. Further regulations introduced in 2021 allow certain funds to allocate 20% of their portfolio to digital assets. In 2022, the Ministry of Finance confirmed that the sale of crypto is tax-free after one year even if the holder uses the coins for staking and lending.
A summary of the EU’s MiCA Regulation
Markets in Crypto-assets (MiCA) is considered the stepping stone for creating a comprehensive regulatory framework for digital assets in Europe. The need for such a framework arose when European regulators realized that most of the crypto-assets were out of the scope under the current legislation, leaving customers and market participants vulnerable to malice practices.
Developed in 2018, MiCA aims to systemize the issuance and trading of various crypto-assets. It plans to oversee the operations of CASPs (Crypto-assets service providers) and provide uniform regulation across all EU member states.
Some of the main components are:
- MiCA will extend the validity of the home member’s licensing across all EU states, ending the fragmented legislative framework.
- Issuers will be required to release a whitepaper describing the asset and its potential risks. In cases of hacks or preventable operational failures, the liabilities will fall on CASPs and other wallet custodians.
- MiCA requires CASPs to release data on their environmental impact. A previously proposed ban on proof-of-work mining wasn’t approved by the committee.
- Stablecoins need to maintain a sufficient liquid reserve to meet claims during mass withdrawals, and large stablecoins have a limit of 200 million euros in transactions per day.
The provisional agreement was recently reached in late June. It will now go to the EU Council and European Parliament for approval. The legislative process is expected to be done by the end of this year. Following that, it will take 18 months for MiCA to go into effect in 2024.
The evolution of crypto tax and regulation in Switzerland
Switzerland was a relatively early adopter of crypto- in 2016, the town of Zug started accepting bitcoin for government services. This progressive approach is reflected in its regulatory regime.
In March 2019, the Swiss National Assembly, the country’s legislative body, approved a motion instructing the Federal Council to adapt current financial regulations so they apply to crypto. The motion also requested clarification into how the risks posed by the anonymous nature of digital assets could be contained.
The Blockchain Act followed in September 2020, updating existing laws to cover crypto and setting out rules to combat money laundering and oversee exchanges (which must be licensed by FINMA, the Swiss Financial Market Supervisory Authority). At the time, Heinz Tännler, President of the Swiss Blockchain Federation, believed this act put Switzerland’s regulatory regime ‘among the most advanced in the world’.
Switzerland then introduced the Distributed Ledger Technology (DLT) Act in 2021. The DLT Act was implemented in two stages: from February 2021, blockchain platforms could issue ledger-based securities, and from August exchanges had to apply for a license to trade these securities.
The Swiss Federal Tax Administration classifies crypto as assets, so investors must pay wealth tax on their holdings and declare them on annual returns.
UK crypto regulation to focus on stablecoins
At the start of April, the UK’s Chancellor of the Exchequer, Rishi Sunak, set out plans that he hopes will turn the country into ‘a global hub for cryptoasset technology’.
One of the headlines was the regulation of stablecoins. Mr. Sunak believes that stablecoins could provide a more efficient medium of exchange than some of the options currently available in the UK and offer consumers a wider choice. The government intends to introduce legislation that subjects stablecoins to the same rules as other payment methods.
Following Switzerland’s lead, Mr. Sunak also wants to explore the potential use cases for blockchain technology. The government will launch a testing environment known as a ‘sandbox’ to allow firms to experiment with ways it could enhance the UK’s financial infrastructure.
Temporary Registration Regime closing in
Earlier in 2022, the deadline for the Temporary Registration Regime (TRR) for crypto service providers instated by the Financial Conduct Authority (FCA) officially came to a close, on March 31st.
The FCA is the UK’s principal anti-money laundering and counter-terrorist financing (AML/CTF) supervisor of UK crypto-asset businesses and requires all crypto businesses to register before commencing their activity.
According to Finextra, response to the regulation has been mixed, with only about a quarter of the applications proving successful, and many companies moving their headquarters or quietly withdrawing applications out of a fear of “running into issues with partners elsewhere in the world”.
The FCA has, in the meantime, extended its registration deadline for "a small number of firms where it is strictly necessary to continue to have temporary registration". The regulator specified that the concerned firms may be pursuing an appeal or have special "winding-down circumstances".
Crypto tax rules in the UK
Her Majesty's Revenue and Customs (HMRC) has to date only published guidelines on the taxation of crypto. HMRC recognizes that most individuals hold digital assets as an investment, so they should pay capital gains tax on any profits. However, the plans announced in April included a call to explore how the UK tax regime could become more crypto-friendly, such as the treatment of interest received from loans issued on decentralized finance applications.
To reiterate, regulations are necessary to protect investors from illicit activity like fraud, maintain global financial stability, and ultimately bring legitimacy to crypto. They also ensure industry participants behave responsibly, which is why it’s important to store assets with a custodian based in a country with regulatory clarity.
To learn about Finoa’s BaFin-regulated custodial services, get in touch today.