Responses to crypto-assets consultations

Download the full Finance Watch responses to the:

• European Commission’s Consultation on an EU Framework for Markets in Crypto-Assets (response submitted on 19 March 2020; 106 pages)
• Basel Committee on Banking Supervision’s call for comments on its Discussion Paper on Designing a Prudential Treatment for Crypto-Assets (response submitted on 13 March 2020; 10 pages)

As a general rule, Finance Watch recommends applying the principle ‘substance over form’, which is a well-established concept in Accounting and Finance. When applied to ‘crypto-assets’ this means that their legal and regulatory treatment should be determined by the economic substance of the underlying transaction.

We would therefore advise against the use of the term ‘crypto-assets’ and recommends the use of the generic term ‘token’ as a common point of departure. ‘Crypto assets’ are not necessarily assets in their own right but primarily instruments in digital form (‘tokens’) that document a contractual agreement, or represent a claim on an underlying asset. The legal, and regulatory treatment of a ‘token’ follows its primary function and economic substance.

We broadly agree with the European Commission’s proposed classification of ‘tokens’ into three main categories:

• ‘payment tokens’ are digital payment instruments, such as ‘e-money’ and certain categories of ‘stablecoins’;
• ‘investment tokens’ are digital financial instruments, such as tradeable securities or units in collective investment vehicles; and
• ‘utility tokens’ comprise many other categories, such as vouchers or discount coupons, that enable access to a specific product or service.

There is no need for a category of ‘hybrid tokens’, in our view: ‘tokens’ that combine features of more than one category should be classified according to their prevailing function. We propose a strict separation between these three categories. Only the first two categories above should be subject to financial sector regulation, while genuine ‘utility tokens’ should be outside of its remit.

We note, however, that we propose a much stricter classification for ‘utility tokens’: any ‘token’ whose main function is to raise funds for the issuer, or to generate a financial return for the subscriber, should be treated as a financial instrument and regulated as such. We disagree with the popular, but misguided interpretation that ‘utility tokens’ represent a forward sale of a yet-to-be-developed service or good. In reality, investors in such ‘tokens’ effectively take on the equivalent of equity risk, but without proper financial compensation or governance rights.

For all ‘crypto-assets’ (or ‘tokens’) that qualify as ‘payment instruments’ or ‘financial instruments’ the corresponding regulatory requirements, including but not limited to PSD 2/EMD 2, MiFID II, UCITS IV or AIMFD, must apply. This may require amendments to the relevant legislation to accommodate a few genuinely novel instruments, such as ‘virtual coins’ (such as Bitcoin) and ‘stablecoins’ (such as Tether), and to account for the technical specificities of ‘tokens’, in particular Distributed Ledger Technology (DLT) and the ‘permissioning’ and ‘validation’ processes it involves.

In our view, it is important to bring crypto‑assets’ into the regulatory scope to close existing gaps and ensure consistency. We are skeptical therefore about any gradual approach, i.e. starting with instruments that are perceived as ‘high risk’ while continuing to assess other categories.

We would also strongly advise against the use of so-called ‘regulatory sandboxes’ or ‘safe harbour’ arrangements where “businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of engaging in the activity in question” (as defined by the UK Financial Conduct Authority). We want to underline that well-considered and consistent regulation creates the legal certainty and predictability needed to encourage investment in long-term innovation.