European Parliament softens stance on crypto assets proof-of-work mechanism

The ECON Committee’s Approach to PoW

As part of the finalization of the first draft regulation on crypto-asset markets (MiCAR), the European Parliament’s Economic and Monetary Affairs Committee (ECON Committee) was considering a ban on crypto-assets using “proof of work”. (PoW) as a consensus mechanism to validate their underlying transactions. Notwithstanding the use of this technology by some of the most popular cryptocurrencies (including Bitcoin and Ethereum), EU institutional concerns are mainly based on the high energy consumption of the mechanism, which is in conflict with environmental objectives. of the EU. However, in line with the positions of some market players, the ECON committee has taken a “softer” approach in recent meetings by generally allowing the use of PoW, subject to additional disclosure requirements to be included in the relevant white papers. on crypto-assets.

Context: MiCAR – Where are we?

MiCAR is the envisioned regulation on crypto-asset markets, first drafted in 2018 as part of the digital finance package. MiCAR was initially proposed in response to the remarkable increase in investments in Bitcoin and other cryptocurrencies to create a legal environment that is more favorable to investors and protective against the market risk associated with investments in assets. unregulated virtual transactions that fall outside the scope of MiFID and other financial services legislative regimes.

To this end, MiCAR aims to: (i) establish certain harmonized definitions on the subject, including “crypto-asset”,¹ “asset-referenced token »² and “utility token”³; (ii) provide legal certainty for crypto-assets that are not considered financial instruments and therefore not covered by current EU financial services legislation; and (iii) establish a common framework of binding rules on “crypto-asset service providers (CASPs)”⁴ (and corresponding authorization and passport regime) and issuers based or operating in the EU area.

The above objectives are ultimately aimed at removing barriers to the establishment and improving the functioning of the internal market for financial services, including the current inability of crypto-asset market participants in the EU to “fully benefit from the benefits of the internal market, due both to a lack of legal certainty regarding the regulatory treatment of crypto-assets and the absence of a dedicated and coherent regulatory and supervisory regime at EU level. EU.”⁵

The approval of MiCAR follows the ordinary legislative procedure provided for in Article 294 of the Treaty on the Functioning of the European Union. This means that, following the Commission’s first proposal, the Council and the Parliament must finally approve the final text of MiCAR. Following the meeting of 30 June 2022 between certain representatives of the ECON committee and the Council, the European Parliament issued a press release⁶ announcing an interim political arrangement on some outstanding issues, including, among others, a final position on PSAPs’ disclosure obligations on the environmental and climate impact of their operations.

The above political arrangement is now reflected in an updated draft MiCAR, which must be approved first by the ECON committee, then by the European Parliament (after a plenary vote) and the Council. The entire legislative process, and therefore the entry into force of MiCAR, is currently expected to be completed in 2024.^seven

Proof of work – a definition and its environmental impact

In article 3, paragraph 1, point (28a) of the last draft of MiCAR, the ECON commission defines the PoW as “a consensus mechanism that forces all miners participating in DLT to solve complex mathematical puzzles to validate a new transaction, adding a block to the chain and permanently and irreversibly recording a new transaction.In particular, PoW (i) incorporates a decentralized consensus mechanism requiring members of a network to solve an arbitrary mathematical puzzle to prevent anyone from messing with the system; and (ii) process peer-to-peer cryptocurrency transactions securely and without the need for certification or other comfort from a trusted third party. Bitcoin became the first cryptocurrency to adopt this technology and was followed by Ethereum and other cryptocurrencies with the same goal of achieving secure and decentralized consensus of each of these transactions.

In addition to its strengths in terms of secure consensus around crypto-asset transactions, PoW brings a significant and unsustainable environmental impact, particularly in terms of increased electricity consumption, growth of mining equipment and generation of waste. electronics. For these reasons, a massive application of this technology, if allowed by EU legislation and not challenged by other more environmentally friendly consensus mechanisms, could ultimately undermine the EU’s mission. achieve the climate and sustainability goals set out in the Paris Agreement (see new Recitals 5(a) and 5(aa) of the amended MiCAR draft).

The PoW regime under the new draft of MiCAR – handle with care

As a compromise between, on the one hand, the commercial interest of opening the EU market to the most well-known crypto assets that use PoW and, on the other hand, the preservation of the EU’s commitments in In terms of the environment and sustainability, the revised MiCAR project ultimately provides for:

• no specific restrictions or prohibitions on the use of PoW in the EU crypto-asset arena;

• a highlight on the importance of limiting consensus mechanisms that could pose a threat to the environment on a small scale, while encouraging the deployment of more environmentally friendly solutions (new recitals 5(a) and 5(a)(a)); and

• additional disclosure requirements for issuers of crypto-assetsas to the inclusion in the relevant white paper of (i)”an independent assessment of the probable energy consumption of the crypto-asset when the proof-of-work model is used(article 5.1, point (bb)), and (ii) “information on sustainability indicators related to the issuance of the crypto-asset, including whether it was mined in accordance with the EU Sustainable Finance Taxonomy(article 5.1, point (bc)).

The above information must be complied with by duly completing the applicable standard forms, formats and models of white papers which will be developed by ad hoc technical standards which the European Securities and Markets Authority will publish separately after consultation with the European Banking Authority (article 5 (11) MiCAR).

Conclusion

Although the ECON committee’s approach may seem consistent with MiCAR’s scope of expanding and harmonizing the crypto-asset market in the EU area, environmental concerns have become a key factor in shaping of this new legislation. In addition to the current controversy over the unsustainability of bitcoins, operators and investors in crypto-assets must assess, address and disclose the impact of their trades and services in the EU area, with the aim of prioritizing and developing new new sustainable technologies.

Click here to see MiCAR’s latest project (which reflects the most recent proposed changes in “track changes” format).

FOOTNOTES

¹ “A digital representation of value or rights that can be transferred and stored electronically, using distributed ledger technology or similar technology.”

² “A type of crypto-asset that claims to maintain stable value by reference to the value of multiple legal tender fiat currencies, one or more commodities, or one or more crypto-assets, or a combination of these assets.”

³ “A type of crypto-asset intended to provide digital access to a good or service, available on DLT, and which is only accepted by the issuer of that token.”

⁴ MiCAR defines “crypto-asset service providers (CASPs)” as “any person whose profession or activity is the supply one or more crypto-asset services to third parties on a professional basis“, these “crypto-asset services” to include, in accordance with the same MiCAR, a wide range of activities related to the crypto-asset environment, including, among others, custody, exchange, operation of trading platforms, order execution, placement and advisory.

⁵ See there “Explanatory memorandumattached to the original MiCAR proposal from the European Commission.

⁶ See the Press release.

^seven See also the “Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee on a Digital Finance Strategy for the EU”, 24 September 2020.