MiCA can deliver different outcomes in a post-FTX world

The collapse of FTX

In November 2022, FTX, then one of the world’s largest cryptocurrency exchanges, and its founder and former chief executive Sam Bankman-Fried, applied for bankruptcy. The move came after an article published by CoinDesk exposed that customer funds were being held in accounts controlled by another company Bankman-Fried had founded, Alameda Research, which was heavily dependent on FTT, FTX's digital token.

Subsequently, Bankman-Fried was extradited to the US from the Bahamas where he was indicted by the US District Court in Manhattan on seven counts, including securities fraud, money laundering and conspiracy. Following a five-week trial from October to November 2023, Bankman-Fried was found guilty on all seven counts and faces a maximum possible sentence of up to 110 years in prison. A tentative sentencing date is set for 28 March 2024.

The introduction of MiCA

Currently, the degree to which cryptoassets are regulated varies greatly across jurisdictions. Earlier this year, EU law makers moved to harmonise the rules that apply across member states. The regulation on markets in crypto assets (MiCA) was published in the Official Journal of the EU on 9 June, introducing a new pan-EU regulatory framework for cryptoassets for the first time.

From December 2024, MiCA will apply new rules for cryptoassets service providers (CASPs) in the EU. MiCA defines a CASP as a “legal person or other undertaking whose occupation or business is the provision of one or more crypto-asset services to third parties on a professional basis and are allowed to provide crypto-asset services”. MiCA will bring issuers of certain types of cryptoassets into the EU regulatory framework and will establish new rules for stablecoins, including asset-referenced tokens, e-money tokens, and utility tokens.

At a high level, MiCA will impose organisational, conduct and prudential requirements on CASPs in the EU. CASPs will be subject to requirements around governance and safeguarding of client assets. The new framework will also introduce new rules aimed at preventing market abuse relating to cryptoassets or services. Ireland is set to play a leading role in shaping cryptoasset regulation and enforcement given that some of the world’s largest cryptoasset exchanges, such as Coinbase, Gemini, and Kraken, among others, have chosen the country as their main operational and regulatory base within the EU.

Following the collapse of FTX, debate has raged on whether the collapse could have been prevented had more robust regulation of cryptoassets been in place, or whether it simply arose out of a classic case of fraud.

The collapse of FTX highlights obvious red flags that are often associated with traditional frauds. For example, a lack of good corporate governance and a failure to properly ringfence client assets undoubtedly contributed to the mishandling of client cryptoassets. In addition, external failings by the exchange, such as inaccurate representations regarding the exchange’s audited financial statements and a failure to properly register cryptoassets with the relevant regulatory authorities, increased the risk of fraud. The audited financial statements released by FTX were produced by two sperate audit firms, but no red flags were raised about FTX’s internal controls over financing or audit reporting.

The introduction of MiCA will provide clarity on the regulatory status of cryptoassets and protection for cryptoasset holders in the EU because it will establish a set of common rules around the supervision of cryptoassets and cryptocurrencies for the first time. It will also require CASPs to act honestly, fairly and professionally in accordance with the best interest of their clients and perspective clients, and to provide clear information and not mislead clients. Therefore, from a regulatory enforcement perspective, the safeguards in place in MiCA will go some way to detecting and preventing crypto frauds in the EU in the future – national competent authorities (NCAs) will be tasked with ongoing monitoring and supervision of CASPs in order to assess any risks to consumer protection and financial stability.

Looking forward

It is clear that under MiCA, FTX would have been classed as a CASP and subject to the supervision and enforcement of EU NCAs. This would have gone a long way to highlighting and addressing the internal and external red flags at the exchange and would likely have ensured more robust investor protection and supervision from a relevant NCA. It is also clear that, as things stand, existing rules still apply and there is no substitute for due diligence investigations and good corporate governance at the outset for crypto businesses, which will face increasing challenges to scale up their compliance functions with their growing business to meet the regulatory demands under MiCA.

MiCA will be welcomed by most in the cryptoasset ecosystem as it will provide much needed clarity regarding regulatory expectations of NCAs and regulatory oversight in an area notorious for lack of regulation, together with passporting rights for CASPs within the EU. This regulatory clarity is essential for the mainstream adoption of cryptoassets.