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The Long and Winding Regulatory Road to MiCA

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By Javier Hernani, Head Securities Services, SIX.

As we witness a collapse in cryptocurrencies, it is clear nowhere is regulation needed more than in the burgeoning crypto-asset marketplace. Especially in the digital asset class with the largest market capitalisation (estimated to be in the region of $2.3 trillion) – cryptocurrencies.

Dominated by the likes of Bitcoin and Ethereum, institutional participation has accelerated despite the recent price crash. According to a recent study by Fidelity Digital Assets, over half (52%) of investors globally have exposure to digital assets, while 9 in 10 said they found digital assets to be attractive.  Appetite for crypto is clearly on the ascent.

Even though Bitcoin has seen a 15% price decline in recent times, there has still been over $25 million of net inflows into Bitcoin products and global assets under management (AUM) for Bitcoin products still stands at $30 billion. That said, it is important to note that cryptocurrencies are not a risk-free asset. Price volatility aside, economists highlight the problems with crypto as a store of value and investors highlight the absence of sound fundamentals as being off-putting. The lack of transparency in terms of the valuation methodologies for many cryptocurrencies is a crucial problem, especially when looking at post-trade processing of digital asset transactions.

The good news is that there are more concrete moves by rule makers to address the issue of transparency. As a case in point, the EU is taking a nuanced approach through the Markets in Crypto-assets (MiCA) Regulation. Last month, an agreement in principle was struck in the European Parliament on MiCA, which aims to bring about a pan-EU regulatory framework overseeing crypto-assets not currently covered by existing securities rules – namely crypto-currencies and StableCoins. The rules will apply to those issuing and servicing crypto assets, in what should hopefully bolster investor protection and safeguard market integrity.

But as the industry awaits more details around MiCA, it is important to note that digital assets are not just about cryptocurrencies and StableCoins. The technology that underpins digital assets can and will have an important role to play in financial markets.  Asset fractionalisation or tokenisation is gaining significant traction too and, as a consequence, will need to be carefully considered under MiCA, or through broader regulatory directives. Through tokenisation, the investment process will be democratised by creating digital, divisible tokens representing tangible assets. The need for custody in case of digital assets is also increasing significantly. New players are entering the market in order to answer this need and large traditional players are now entering the digital custody market through agreements with leading technology providers. As you can see, the number of new players in the sector increased six times in the past six years.

Elsewhere, Central Digital Bank Currencies (CBDCs) are also on the rise. Unlike crypto-currencies, which are issued by private institutions – CBDCs – as the name suggests are issued by Central Banks. The most recent BIS Annual Economic Report, while damning of cryptocurrencies, sees great potential in the use of CBDCs and their role in financial markets. The truth is that neither CBDCs nor security tokens will usurp traditional securities overnight. In fact, they will most likely co-exist with each other for a prolonged period. As regulatory frameworks such as MiCA evolve; more and more institutional investors will gradually become more comfortable trading these new asset classes and using this technology as part of the trading and post-trade process.

In short, there will not be a sudden Big Bang adoption. Nonetheless, the post-trade industry cannot afford to ignore these new digital trends – and not just the ones relating to cryptocurrencies and StableCoins. A failure to fully consider asset fractionalisation, tokenisation and burgeoning CBDCs, will open incumbents up to disintermediation or at best, a loss of market share. Ultimately, the end of the road has to be a regulatory sound and sustainable market structure that covers the entire digital asset ecosystem. While the end is far from in sight, it is nevertheless important to start the crypto regulatory journey off on the right foot.

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