Paving the way for the future of digital asset innovations

Having been in the public consciousness since 2019, digital assets and innovative technologies have moved past the hype stage and are now at a stage where they can become one of the fastest-growing and unique industries in Ireland over the next few years.

From that comes greater scrutiny on compliance and risk management, and the focus will only increase as said assets become prominent.

“Ireland is a location of choice for international digital assets clients as it’s underpinned by a friendly, agile and collaborative business environment,” said Dominic Conlon, head of corporate, Ogier Leman. “There’s a well-educated workforce and attractive corporate tax system, all within easy access to European markets”.

Ireland boasts a significant presence in this field, hosting 60 per cent of the world’s top financial service companies – including half of the world’s top 50 banks – as well as major companies like ConsenSys, Mastercard Labs, Citi Bank’s Innovation Lab, and more who deal with digital assets.

While recognised as having a robust financial services sector and technology hub, crypto-assets regulation is being driven at an EU level. On the positive side, while many jurisdictions have been slow to keep up, Europe has been on the ball.

“Giving credit where it’s due, the EU commission is reacting quickly to recent developments in the sector,” said Conlon. “It’s acknowledged the urgent need for an EU-wide regulation and response.”

“It appears MiCA will better protect Europeans who have invested in these assets and hope to curb their misuse while being innovation-friendly to maintain the EU’s attractiveness.”

“The challenge for these regulations is whether they will be successful in not hampering the innovation that the sector has largely been built on”.

It’s perhaps a good thing considering how complex the industry is and how it continues to evolve. Broadly, crypto-assets are classified as security tokens, e-money tokens, utility tokens, exchange tokens and stablecoins.

Currently, existing regulations do not cover utility or exchange tokens, yet certain activities concerning them do. For example, some crypto-assets have attached rights similar to existing types of investment instruments, therefore falling within the definition of a financial instrument under the second Markets in Financial Instruments Directive (MiFID2).

Similarly, a crypto-asset can only qualify as e-money if it satisfies all criteria under the second Electronic Money Directive (EMD2). And that’s before you bring in other recent directives like GDPR, which cryptocurrency exchanges and blockchains may be subject to, or PSD2, which crypto-asset service providers that offer regulated payment services may require authorisation as a payment institution under it.

In short, digital assets can fall into a middle ground where it’s not officially recognised and therefore not covered under existing regulations. Yet the EU Commission has made inroads on this, having released its Digital Finance Package in September 2020, and opens up interesting possibilities for how regulations will develop.

It includes a proposal for a new EU legislative framework for the Markets in Crypto-assets (MiCA), which can help shape how they’re managed in Ireland.

The goal of MiCA is to protect consumers against some of the risks associated with the investment in crypto-assets, and help them avoid fraudulent schemes.

“MiCA will provide regulatory obligations and requirements in respect of a broad range of services,” said Conlon. “This includes trading platforms for crypto-assets and the exchange of crypto-assets for fiat currency or other crypto-assets.

“The regulations will apply to anyone providing any of the above activities within the EU. In July 2022, it was agreed that MiCA will come into force in 2024 – its transposition into Irish law will likely follow after that.”

Currently, consumers have limited rights to protection or redress, especially with non-EU transactions, but with the new rules, Crypto-Asset Service Providers (CASPs) will have to respect substantial requirements to protect consumers and will be liable if they lose investor assets.

The industry will also be required to declare information on their environment and climate footprint, which The European Securities and Markets Authority will develop draft regulatory technical standards for.

That’s not to mention the 5th Anti-Money Laundering Directive (5AMLD), which requires member states to impose registration and AML requirements on fiat-to-virtual and virtual-to-virtual cryptocurrency exchanges and crypto asset custodian wallet providers operating in Europe.

Those subject to 5AMLD must apply due diligence to prevent money laundering and terrorist financing.

“Any CASPs whose parent company is located in countries listed on the EU list of third countries considered at high risk for anti-money laundering activities, as well as on the EU list of non-cooperative jurisdictions for tax purposes, will be required to implement enhanced checks in line with the EU AML framework,” said Conlon.

“Tougher requirements may also be applied to shareholders and to the management of the CASPs, notably about their localisation.”

There’s no regulatory sandbox in operation here in Ireland, nor are there any plans to establish one. The closest to one is a fintech innovation hub operated by the CBI since 2018, which engages with fintech firms involved in developing and deploying new technologies such as blockchain.

Yet considering how quickly the EU Commission is moving, steps are being taken for a more robust and protected industry that will allow innovation to flourish.