Blockchain world is full of pitfalls. Not only is the complexity of the technology and the associated possibilities still not obvious to the masses, there is another complicating factor that is slowing down the adaptation of the technology. The unclear regulatory framework regarding blockchain and crypto tokens.
With the emergence of smart contract-capable blockchain systems and the possibility of creating own tokens, questions have been repeatedly raised about how such tokens need to be treated in terms of regulation, what rights are associated with them and what obligations the token issuer must fulfill. In this blog article, we break down how crypto tokens can be categorized in regulatory terms and use current regulatory developments to show which obligations token issuers should meet when issuing a token.
Security & Utility Token
When a Web 3 company decides to issue a crypto token, in addition to the underlying crypto token use case, they must also determine the type of token with regard to regulatory requirements. In practice, different types of tokens can be distinguished, depending on the use case they pursue: Governance Token, Access Token, Payment Token or Community Token. However, these subcategories of tokens can be assigned to two main categories. Security tokens and Utility tokens.sich jedoch zu zwei Hauptkategorien zuordnen. Die Security Token und die Utility Token.
Als Utility Token bezeichnet man digitale, in der Blockchain gespeicherten Token, die dem Nutzer Zugang zu einem Produkt oder einer Dienstleistung gewähren. Diese Token können zum Beispiel als Belohnung in Treueprogrammen vorkommen oder Rabatte gewähren. Weiterhin können sie auch Zugänge zu bestimmen Funktionen innerhalb eines Video Spiels ermöglichen oder Utility tokens are digital tokens stored in the blockchain that grant the user access to a product or service. Such tokens can be used as rewards in loyalty programs or to grant discounts. They can also be used to provide access to certain functions within a video game or grant co-determination rights for a project. Utility tokens therefore have the primary purpose of enabling users to receive benefits in the form of services and should not be issued with the intention of generating a profit for the customer.
Security tokens can be understood as tokens that are viewed as a company share, a security or an investment. Security tokens therefore always have the goal of generating profits at a later date. Be it through a resale at a higher price or through the distribution of derivatives in the form of profit sharing or staking rewards.
The distinction between utility and security tokens is not always entirely clear, as there are also projects that cannot be assigned exclusively to one of these categories. One way to determine whether a project is a security or utility token is to use the Howey test.
Web 3.0 Regulation in Europe
Once the category of token has been determined with the help of the Howey test, the next step is to find out what regulatory requirements token issuers must meet. At the European level, two regulatory initiatives can be identified that regulate the obligations of token issuers. MiFID II and MiCA.
MiFID II (Markets in Financial Instruments Directive) is the regulatory framework responsible for regulating the financial markets in Europe. The goal of MiFID is to create transparency in the European financial markets by creating guidelines for security issuers to which every registered actor in Europe has to comply. Security Tokens that have been classified according to the Howey Test are all subject to MiFID II regulations, which means that token issuers must comply to the rules of the financial regulatory authority and even require a license and a securities prospectus for their issuance.
MiCA (Markets in Crypto-Assets), on the other hand, is a regulatory approach that is intended to regulate all types of crypto assets and services in the area of crypto assets, and thus create a set of rules that will apply throughout the European market. The MiCA was finally signed in spring 2023 and is expected to be implemented in 2024. The MiCA covers both utility tokens and stablecoins. According to the MiCA, crypto asset providers will need to meet certain minimum requirements in future, such as the obligation to comply with the Anti-Money Laundering Act and the related mandatory disclosure obligations. At the same time, it also increases the requirements for token issuers by setting standards for the publication and content of a white paper.
With MiCA and MiFID II, two European regulatory requirements have been introduced, which will apply depending on the type and purpose of the token and in some cases are linked to highly different requirements.
Regulatory Framework - Development Outlook
The blockchain and web 3 area has made great progress in recent years. Not only has this field seen developments in terms of technology, but also in terms of regulation. Although there is still a lack of clear national legislation, the European Union has at least created an initial regulatory framework for the issuance of crypto assets.
In future, crypto token issuers will have to consider more carefully what specific benefits the token issue should bring for the end user. The Howey test offers an initial opportunity to determine whether the token is a security or utility token. Depending on the outcome of this test, Web 3 Startup will have to comply with the requirements of two different European regulations.
MiFID II and MiCA serve as the two central regulatory frameworks that specify the requirements and obligations of a web 3 startup issuing its own tokens in order to be able to operate as a player in Europe. Both MiFID and MiCA impose requirements on startups that should not be underestimated and create better investor protection on the one hand, while on the other hand slowing down the innovation process with additional bureaucratic requirements, as web 3 startups not only have to deal with the technology but also with the regulatory framework.
A necessary evil to put an end to the Wild West in the crypto sector and promote its adaptation. However, it remains to be seen how the MiCA will look in practice until it is fully implemented and the national states have to take care of its concrete form.