The MiCA chronicles, number five.

There is a popular belief that the law can solve all our social maladies. By simply enacting a piece of legislation, the system of social interaction in which we inhabit becomes safer, more predictable, and – following the ideas of Montesquieu – freer.

The problem is that the law is a general act applicable to an undefined plurality of agents. The undistinguished “mass” of legal subjects is, nonetheless, inherently plural in terms of beliefs, wills, and capacities to understand and apply the law applicable to them. In other words, the enactment of the law can bring clarity to the table of social relations (whether political, commercial, or civil in nature), but it is not the end of the story. Much will hinge on how such laws are perceived by the subjects and how they choose to follow them. More importantly, the meaning of the law shall depend on the way public authorities responsible for exercising the operational side of the legal equation (i.e., implementation and adjudication) understand the law.

This operational task is crucial for the way the law “lives” within a legal system. It is also a challenging prospect, as it produces an inevitable stand-off between its goals and objectives and the real-life cases that it is supposed to solve. Context shall play a role, as well as culture: the culture of the community, institutions, or the market. If this makes the application of the law complicated in municipal legal systems, what can we expect when discussing more complex, composite forms of legal orders where different jurisdictions share common rules and governance institutions?

This brings me to the problem of EU law, or, to put it another way, the challenges faced by EU law in guaranteeing the coherence and unity of its legal system in the face of the plurality of national legal systems where it applies and considering the local institutions responsible for its application. Many contexts, many cultures, and therefore many possibilities for debate and application.

The EU was formed to help its Member States achieve prosperity and peace through economic integration. The idea of economic integration required the establishment of a common market with common rules, whereby legal discrimination based on national criteria would be progressively eliminated as it constituted an obstacle to the functioning of the market. The objective was clear: to have single rules that would facilitate the movement of economic agents, products, and services, along with the movement of capital, between the Member States.

This objective took some time to materialize due to the difficulty in reaching a political consensus to reform national markets through a central European legislator. It took the EU almost thirty years after the Treaty of Rome to start thoroughly harmonizing national rules through legislative acts. Although legislative harmonization has never looked back since, and nowadays there is a great degree of centralization of legislative initiatives thanks to banking law, the problem of data, and competition issues related to digital service providers, the fact is that there are still significant discrepancies between Member States and their local markets. Ask any businessperson, particularly in the banking and financial sectors, and they will tell you how different it is to operate in one EU Member State compared to another, even if the rules applicable are the same.

The common/single/internal market (pick your favorite) is still fragmented in many aspects, and it is unlikely to change dramatically in the future. There are many legal embedded “glitches” in the matrix of the single market to protect the legal orders of Member States, such as clauses protecting public order and public security. Furthermore, even if regulatory requirements are enacted by the EU legislator, there is the problem of their implementation, which falls under the competence of national public authorities, more precisely the national public administration and national courts (and sometimes the national legislator as well, particularly when the EU opts to legislate through directives instead of legislating through regulations). Different bureaucratic and legal cultures lead to different applications and consequent "localization" of what are supposedly “common” rules.

Another reason for this level of regulatory fragmentation has to do with the way Member States decide to position themselves within the internal market. Despite the goal of building a single market among them under EU auspices, national governments try to hold on to some of their regulatory “traits” and to install innovative normative features in their legal orders to see if they can become more attractive for businesses. Of course, the political center of governance (aka the EU) holds an important position in the application of EU law by supervising Member States’ actions and having administrative and judicial mechanisms in place to review national compliance with EU rules, limiting the political action of Member States. However, this action is not always quickly effective, which means that, all in all, the building of the single market did not kill the game of jurisdictional competition but rather limited the margins of its playing field.

What makes a jurisdiction attractive for business is a combination of many factors, most of them straightforward: stability (political and economic), appealing levels of taxation, regulatory expertise and transparency, business opportunities, the size of the market, language, possibilities of growth and expansion with access to financing, credit, and partnerships, and, importantly (but not always so decisively as thought), the costs of starting an operation. Of course, not all factors exist in the same way in all jurisdictions of a common market, and different businesses (different companies, operating in different sectors, with different plans) shall have naturally different preferences and consider the specific “cocktail” of criteria that each jurisdiction has on offer. The point is that the scope for arbitrage is wide, although some jurisdictions – particularly the biggest and richest ones – will be in the first place for most businesses wishing to operate in Europe.

Before MiCA, the market in crypto-assets was highly fragmented from a regulatory perspective, with some Member States enacting rules for crypto companies, such as Malta, while others did not. The implementation of the fifth AML directive (where the EU first imposed the obligation on Member States to start regulating virtual asset service providers for anti-money laundering and counter-terrorism financing purposes) improved this situation, but the legal instrument chosen by legislators was a directive and therefore provided some normative leeway for Member States in its transposition. Also, the regulatory purpose of the directive was not crypto per se. Fragmentation remained a feature of the market to a large extent; there were certain jurisdictions considered by market players to be more favorable for crypto businesses than others. For example, Portugal became attractive because of its tax regime for non-habitual residents and the fact that the tax authorities decided not to tax crypto, while Malta and Estonia were attractive because of their regulatory environment. Switzerland, not being part of the EU, benefited from regulatory clarity and political support for web3 and blockchain businesses.

MiCA brings some important changes to the current scenario because it is the first centralized (no pun intended) piece of legislation regulating crypto specifically. MiCA establishes normative definitions, lists regulated activities, presents rules for licensing businesses, and imposes prudential and conduct requirements (together with supervisory powers for national and EU institutions) that shall be applicable all over the EU. Harmonization beckons in the crypto sector and should eliminate a good part of the market fragmentation witnessed beforehand.

Or not. It is true that some market fragmentation shall be eliminated, but other cracks in the harmonized regulatory tissue will appear because of MiCA rules and the implementation dynamics it can give rise to.

I base my considerations on the following three reasons. The first reason is that MiCA, like all forms of EU law, must be implemented by national authorities and requires national authorities (legislative and executive, specifically) to make important decisions, particularly regarding how the law shall be applicable in their territory. The two most obvious questions concern, on the one hand, the grandfathering of current VASP regimes to new MiCA licenses, since the scope of services to be regulated under MiCA is more developed than the previous regime set under the 5th AML directive; and, on the other hand, the distribution of supervisory competence to local regulatory institutions. These changes may take some time, and which jurisdictions position themselves first in the race of implementation may sow important gains from the likes of current companies searching for the best jurisdiction to establish their business.

The second reason concerns the inclusion of the provision of services or activities with crypto assets within the broader financial regulatory framework, with the application of rules that are equivalent (and, in some cases, outright similar) to existing rules for banking and financial institutions, such as rules on prospectus guidelines, the exercise of financial intermediation activities, or prudential and conduct requirements of payment and credit institutions. Most importantly, the application of the passport scheme for the provision of services across different EU Member States, similar to what currently exists in the banking and payments sector, risks creating, like the case of former specialized jurisdictions for the registration of CASPs that will then start providing their business in other EU States. It is not hard to see how certain countries will try to become “hubs” for CASPs. It is true that passporting schemes have their limitations – see, for example, what happens with credit institutions that try to passport their licenses to other Member States and end up setting their operations and businesses in those jurisdictions because they see how complicated it is to deal with local regulators without a fixed corporate structure in the receiving jurisdiction. However, they will inevitably lead to the flocking of companies to bigger jurisdictions that can easily passport into other smaller jurisdictions.

The third and final reason concerns what MiCA has left out of its scope, like fully decentralized organizations or NFTs, and the everlasting problem of security tokens. There is still so much out there to regulate – or at least to regulate specifically, without recourse to existing laws of general application – in the field of DLT and crypto that some Member States can look at the opportunity to establish rules and practices protecting the enactment of such products. MiCA took some time to enact, and although people already speak about a “MiCA 2” law as inevitable to cover what has been left out of MiCA 1 (basically, DeFi), that legislative process is still some time away, and it will invariably be affected by the way MiCA is implemented, and the next crypto market cycle pans out. Until then, the opportunities for regulatory arbitrage remain very open.

Do not get me wrong: I believe that market competition is healthy within a common market. However, I believe there should be limits to this competition so that a race to the bottom in the criteria for posting the best regulatory forum to shop out there does not occur. Limits on this competition should be clear and allow for every Member State to throw its hat in the ring and present a good solution to its local businesses, thus enabling economic development. However, I think we are far from seeing that in the crypto markets, and the next years will see some jurisdictions doing better than others in this respect.