What is ESMA?
Before discussing the contents of this 110-page reportBefore we talk about ESMA, let’s remind ourselves of what ESMA is. The European Securities and Market Authority (ESMA) is a supervisory authority of the European Union, independent of any political power. Its headquarters are in Paris.
ESMA’s remit covers financial markets and their legislation. Its aim is to improve the functioning of these markets, to enhance investor protection and to strengthen cooperation between the competent national authorities, including the Autorité des marchés financiers (AMF) in France.
In short, ESMA is to Europe what the AMF is to France. However, it has an additional role, which is to regulate rating agencies such as Standard & Poor’s, which made such a splash after the subprime crisis. So much for paying attention to an ESMA report mentioning cryptocurrencies.
ESMA sees cryptocurrencies as an innovation in their own right
First appearing in 2009 with the Bitcoin protocol (BTC), crypto-assets are young compared to other financial assets regulated by ESMA. For this reason, according to the authority, crypto-currencies still represent a mere “innovation” and have apparently not yet passed the stage of being considered as mainstream assets.
In the chapter on financial innovations, ESMA considers that blockchain technology, known as Distributed Ledger Technology (DLT), has interesting use cases.
Indeed, it could ” improve the efficiency of businesses and the outcome expected by consumers “. In fact, the European authority sees DLT as a significant innovation in the same way as artificial intelligence and machine learning.
The report is rather complimentary towards central bank digital currencies (MNBC), which would attract even more institutional investors. Put another way, ESMA wants central banks to appropriate blockchain technology in order to issue MNBCs under their control, unlike Bitcoin and other cryptocurrencies.
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Cryptocurrencies in ESMA report: decentralised finance (DeFi) gets a pretty good look
DeFi is the surprise of the ESMA report. Indeed, the European authority acknowledges that it has attracted many investors and sees its principles in a positive light (for those interested, go to page 56 of the report).
For ESMA, DeFi allows access to financial products built on peer-to-peer networks, all in a decentralised manner. Most importantly, DeFi extends the use of blockchain to a wide variety of products, from simple transfer ofiquidities to complex use cases through decentralized applications and smart contracts alone.
Even better, the report considers that:
“ DeFi offers the same benefits as the blockchain technology on which it is built, namely disintermediation, round-the-clock availability and resistance to censorship. “
With the emergence of MNBCs and stablecoins, which we will come back to elsewhere, we could see the boundaries between traditional finance and DeFi shrink. However, without rejecting it, this possibility does not reassure ESMA. Indeed, a totally positive opinion would not have been possible from the European agency.
If the innovation is appreciated, the DeFi remains feared by ESMA
If ESMA is rather positive towards decentralized finance, the authority nevertheless believes that it presents the same risks as blockchain regarding resilience, scalability and the sacrosanct governance. We know that governance is vital for the financial system, which wants to maintain effective control over everything related to money.
However, as it is constructed, the DeFi prevents this, which is not to the liking of ESMA. For ESMA, which is responsible for maintaining financial stability, an innovation like DeFi is both revolutionary and dangerous.
The last paragraph on decentralised finance is unequivocal:
“ Although the size of the DeFi market is not yet large enough to be considered a risk to financial stability, the fact remains that regulators and supervisors need to accurately monitor its development and analyze its activities […]. In this context, ESMA will continue to monitor the development of DeFi, which could lead us towards specific regulation and the beginning of a response to the supervisory issue. “
ESMA’s opinion on DeFi therefore seems ambivalent. On the one hand, it is an innovation and its development should not be prevented; on the other hand, an overly large market could threaten financial stability and it should therefore be regulated in a specific way. This brings us back to the notion of lack of control, which still worries the authorities.
Cryptocurrencies: ESMA is concerned about the environmental issue
The positive side of digital assets takes a back seat to the negative, which is not surprising coming from an institution in charge of keeping the financial system going. Of course, the environmental issue, the main argument of cryptocurrency opponents, could not be left out by ESMA.
According to the report, sustainable finance is growing in Europe. In particular, the report states that there is a 20% growth in funds related to corporate social responsibility (CSR), which is a contribution to sustainable development issues. In addition, there has also been a 40% increase in debt securities linked to sustainable development.
Behind this term of sustainable finance lie many points of discussion and even rupture. In essence, finance consumes energy and therefore cannot be sustainable. Moreover, it may be a matter of hedge funds and carbon neutrality through project financing and not of reducing greenhouse gas emissions. In a word, this is more about greenwashing than environmental protection.
It is therefore not surprising that ESMA is concerned about certain DLT protocols. More specifically, it is mining that is in the sights of the European agency. The latter even allows itself a comparison between the Bitcoin network and the pressure put on world leaders and large institutions to fight climate change.
Acknowledging that estimates on the carbon footprint of cryptocurrencies vary, they are nevertheless ” far from negligible.” According to ESMA, the environmental consequences of cryptocurrencies, and mining in particular, need to be mitigated through regulation. In other words, the report implies that the solution cannot come from the sphere of digital assets and therefore needs to be regulated as soon as possible.
ESMA proposes some solutions to improve the cryptocurrency sphere
In the cryptocurrency sector, discussing numbers, estimates, the source of energy or even the difference between consumption and pollution is no longer meaningful as the debate is so partisan.
Nevertheless, we’ll conclude this topic on a more positive, or less negative, note, depending on. The ESMA report tries to provide solutions, such as abandoning the consensus proof-of-work (PoW) and encouraging the use of renewable energy.
While the abandonment of PoW by the Bitcoin protocol seems impossible, the use of renewable energy is a reality that is unfortunately not highlighted enough by the mainstream media who prefer to tackle the Bitcoin network.
Moreover, this is forgetting that PoW is a consensus that is used less and less, if not at all, by new projects
On the same subject – How does Bitcoin (BTC) enable the development of green and renewable energy?
Volatility and stablecoins, major problems for cryptocurrencies according to ESMA
Any investor in crypto-assets knows or should know: they are highly volatile assets. A 20% rise or loss in the same day is not something uncommon. Unsurprisingly, this negative point is therefore cited by ESMA, along with the lack of a legal framework. There is no point in revisiting these points.
On the other hand, a particular focus is put on stablecoins, which is reminiscent of the MiCa regulation proposal. Often opposed to centralized MNBCs, stablecoins present a double problem for a regulator like ESMA. In addition to suffering the aforementioned supposed difficulties of other cryptocurrencies, they also have the ” claim to replace ” a fiat currency.
Thus, a mass adoption of stablecoins could generate a much stronger impact on the financial system and, ipso facto, they need to be scrutinized by the regulators.The Commission has also demonstrated how its wedges are guaranteed to be safe and secure.
In recent weeks, stablecoin issuers have been trying to show their credentials. Tether (USDT) has The Commission also demonstrated how its corners were secured. and Circle, issuer of the USD Coin (USDC), has made its composition public.
However, Tether’s transparency was not to everyone’s liking, as 49% of its reserves came from marketable debt securities. Most recently, Christine Lagarde, President of the European Central Bank (ECB), who has returned to the chargewho said that stablecoins were pretending to be currencies when they are actually assets.
What does this mean? Probably that MNBCs, issued by central banks, have much more credence in the eyes of ESMA than stablecoins, which seem to be the ultimate competitors. One thinks in particular of the digital euro, currently in the testing phase..
In summary, this report does not tell us much new about the classic fears of financial regulators in relation to cryptocurrencies (danger to financial stability, environment). Nevertheless, it confirms the focus of European regulators on stablecoins and is surprisingly positive on DeFi.
We will see in the coming months if this report will be followed by effects, namely a regulation going in the direction of the proposals timidly issued by ESMA.
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About the author: Benjamin Allouch
Formerly a lawyer specializing in personal data and digital law, I quickly became interested in Bitcoin, blockchain technology and their legal implications. I am now a freelance consultant and writer in the field of cryptocurrencies and blockchain.
All articles by Benjamin Allouch.