Distributed ledger technologies (DLT) such as blockchain are not only suitable for centrally operated business models – this has already been evident for many years and is becoming increasingly interesting. Decentralized exchange platforms – i.e. without a central service provider appointed to handle the transaction – have been around since the mid-2010s. Currently, more and more experts are claiming that the bankruptcy of the crypto exchange FTX could have been prevented by more decentralization. Even if the risks such as human error, personal greed and counterparty risks, which apparently materialized in the FTX case, are rather minor problems on fully decentralized exchange platforms, it must of course not be overlooked that other risks such as operational and technical risks could lead to similarly high damages here. Ever since the EU Commission published its first draft of the new Markets in Crypto Assets Regulation (MiCAR) in the summer of 2020, there has been discussion about whether and to what extent MiCAR should also regulate providers of decentralized business models and the area of Decentralized Finance (DeFi). Since the final version of MiCAR has been agreed upon in October, this question can now be answered.
MiCAR is not Supposed to Regulate DeFi in Principle
MiCAR is designed to regulate service providers and operators. This approach seems bizarre, especially since DLT and blockchain are in fact decentralized technologies. Nevertheless, a large number of companies have established themselves in the crypto market, especially in the years up to 2020, offering their customers services such as custody and administration, exchange or trading services related to crypto assets. They provide these services on the basis of customer contracts concluded between them and the customers and thus as centrally acting providers. These crypto asset service providers are now required by MiCAR to comply with numerous obligations such as, in particular, the obligation to obtain an operating license and to fulfill due diligence obligations. Initial providers or issuers of crypto assets are likewise to be regulated by transparency and disclosure obligations. However, decentralized offerings, where there is no clearly identifiable provider, are not to be subject to the provisions of MiCAR. The legislator clarifies this in recital 12a MiCAR by stating that crypto asset services that are provided in a completely decentralized manner without an intermediary should not fall within the scope of MiCAR. Similarly, it states the same with respect to crypto assets that are not issued by an identifiable issuer.
Extent of Decentralization Decisive for Application of MiCAR
However, recital 12a MiCAR leaves a loophole open. In the last sentence of the recital, it clarifies that crypto asset service providers that offer their services in relation to decentrally issued crypto assets will of course still be covered by the MiCAR provisions. In all other respects, however, it will depend on the specific degree of decentralization of a crypto asset service as to whether MiCAR applies to an individual or a company. This is because not every service described as decentralized is a true DeFi business model. For example, if a company has the administrator rights to a smart contract executed on a blockchain through which an exchange designated as “decentralized” is operated, that company may be considered the operator of that exchange platform in a specific case. Another relevant indication will be whether a company or person receives trading fees or other benefits directly or indirectly from users of such a DeFi exchange. The assessment must be made in the individual case on the basis of the specifics of each case. If, after taking into account all the circumstances of the individual case, the service proves to be only partially decentralized, a possibly identifiable initiator or operator may nevertheless be subject to the provisions of MiCAR.
Attorney Lutz Auffenberg, LL.M. (London)
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