The EU is hoping to create one of the most innovation-friendly regimes for blockchain

In September 2020, the European Commission proposed a comprehensive legislative package for crypto assets and blockchain technology as part of its broader European Digital Finance Strategy. Pēteris Zilgalvis, one of the key contributors to the proposal, provides insightful context to the current draft and makes a bold invitation for industry participants to contribute and provide feedback.

Lakestar Partner Nicolas Brand in conversation with Pēteris Zilgalvis, Head of the Digital Innovation and Blockchain Unit at DG Connect within the European Commission. Pēteris has been working for over 25 years at the European Commission, the Council of Europe and the World Bank. Originally with a background in environmental law, he started covering financial markets, cryptocurrencies and blockchain innovation in 2013, when he was a Visiting Fellow at the University of Oxford. He is also co-chair of the European Commission’s Fintech task force.

Nicolas Brand: Pēteris, do you own any Bitcoin?

Pēteris Zilgalvis: In 2013 I was part of the virtual currencies working group at the University of Oxford that had people from many of the colleges, who were mostly younger than me. I said publicly at the time that I thought Bitcoin was for speculation and not useful as a payment token. I didn’t realise how good it was for speculation though: one Bitcoin then was around €8 so I should have bought a whole bunch of them.

I wasn’t at that point convinced that the speed and the throughput was sufficient for Bitcoin to really succeed as a new credit card or in some of the ways that people envisaged at that time. However, I was very impressed with it as a proof of concept and its appreciating value was evidence of its popularity.


Today we want to talk about two legislative packages recently proposed by the European Commission. First, regulation on Markets in Crypto Assets – or MiCA – and second, a pilot regime for market infrastructures based on distributed ledger technology.
Both proposals together are 206 PDF pages full of content and thought leadership. Can you give us an idea of the amount of resources that went into drafting them?

There is a joke going around that there are more Google lobbyists looking at the digital services act than there are people drafting it in Brussels. With MiCA in reality it’s a couple of colleagues under the leadership of a head of unit in DG FISMA, as well as myself and two colleagues contributing on the decentralised ecosystems and utility tokens. We spent only a share of our time on it on my side so it’s probably equivalent to two or three full-time roles altogether, however not taking into account the discussions by the Commissioners and the time now being spent in the European Parliament. We are quite efficient I believe.


When did you start with the actual drafting of the proposals?

At the time of the fintech action plan, going back to 2016, we saw crypto assets and digital assets as a high-potential innovation but with some issues and risks that needed to be addressed but in a pro-innovation approach. It was probably in 2019 that we started in earnest drafting this.

We are looking for an approach that is pro-innovation but does not expose the consumer or the investor to more risks than with traditional financial products.

How do the proposals fit in with other relevant European legislation such as the Digital Finance Strategy overall?

We see the whole Digital Finance Strategy as tackling fragmentation in the digital single market and giving the EU a framework that facilitates digital innovation. We also want to address new challenges and risks and in particular give crypto assets legal certainty.

We want to support innovation as well as consumer protection and this is where we are in agreement with our colleagues across the Atlantic in the Securities Exchange Commission: we don’t have a mandate to get rid of protection for consumers or investors. We are also focused on market integrity, financial stability and mitigating risks to monetary policy transmission and monetary sovereignty.  

The approach is pro-innovation but one that does not expose the consumer or the investor to more risks than with traditional financial products.

We are creating a taxonomy of crypto assets. Those that are qualifying as financial instruments, we clarify that they are covered by existing rules. Those crypto assets that are not covered by the existing rules are subject to MiCA.”

It is remarkable that you are in effect creating a new asset class that gets its own legislative treatment, crypto assets, and a set of new actors, such as Crypto Asset Service Providers. What are you hoping to achieve with this current package?

We are creating a taxonomy of crypto assets. Those that are qualifying as financial instruments, we clarify that they are covered by existing rules. Then you see the pilot on distributed ledger technologies for market infrastructures which is also firmly within existing financial markets. Then there are the crypto assets that are not covered by the existing rules and are subject to MiCA. These are the utility tokens and the asset reference tokens, including e-money tokens.

With this we make sure there are no more grey areas. We want innovation but we also want regulation and certainty. After MiCA in combination with MIFID, the Markets in Financial Instruments Directive, there won’t be tokens any more that are in an unknown space. Everything is covered with a regime that is risk based. Where there are less risks there will be a much lighter level of regulation.

You are, in effect, legitimising an entire asset class. Could you share with us the process unfolding now before this becomes law?

It follows the usual EU legal process. We produced this proposed regulation and the civil servants prepared the draft, which was adopted by the Commission’s political leadership, the College of Commissioners. Now it has been submitted to the European Parliament, the Council and the member states for adoption. Nothing is adopted without the consent of the member states and if there is disagreement between the parliament, the Council and the member states, it goes into conciliation procedures. This is an important message for people in the community who feel that a definition or a provision could have been better drafted – they can contact their Members of the European Parliament and their national representatives and propose adaptations. This negotiation and debate is going on right now.

We invite the community who feel that a definition or a provision could have been better drafted to contact their Members of the European Parliament and their national representatives and propose adaptations.

Do you know how long it might take?

It usually takes about a year or more because it is a democratic process. During the financial crisis, a lot of legal texts were adopted very quickly because we needed to do something, sometimes in the space of a week. But this is something that will hopefully be future-proofed and will remain in force and not need to be changed frequently in the coming years. It requires a full democratic debate in the parliament and between the member states and that takes some time. On top of that, we have the corona situation which almost eliminates face to face meetings. That slightly slows things down but it shouldn’t be a major problem.


What do you think are the key issues that member states will quarrel about?

As a civil servant I cannot claim to know what member states might think but I can point to three things.

First, I think the overall atmosphere is very much for innovation: I don’t think any member state wants to turn back the clock.

Second, our consumers and investors need to be protected and not in a retrograde way. We have to make sure that we don’t reduce protection or transparency of information through the change of technology.

Third, there is some concern about globally significant asset-based tokens, more popularly known as stablecoins. These could impinge on monetary policy and monetary sovereignty. While Europe is open for innovation it has to make sure that there is a supervision difference between something that’s used by 18,000 people or even 18 million people and something that might be used by 5 billion people across the world. Massive use does require certain supervision. We know that from the banking sector and the concept of too big to fail. There could also be massive influence on markets.

These are the things that member states will be looking at very closely. They may also be critical of the Commission feeling it was too liberal or too open but we will see this in the debates.


You have previously described this regulation as being a combination of light touch regulation for the vast majority of crypto assets and more stringent regulation for systemically relevant stablecoins. Can you first of all describe the light touch regulation?

We are making sure that the regulatory and supervisory level is based on the level of risk or the level of a possible disturbance to markets and monetary sovereignty. With things are proportionally less risky there is the possibility to experiment more.

The vast majority of crypto assets covered by MiCA are not subject to securities laws. There are no prospectus requirements for issuance. Instead, a much less onerous whitepaper requirement means that issuers have to register their whitepaper with the relevant national authority which has a certain time period in which to review it and raise any objections. If no objections arise, the issue can proceed across the entire EU. That requirement doesn’t apply for the smaller ones under €1 million.


You are creating a new actor to be regulated, Crypto Asset Service Providers. Could you describe briefly what regulation is planned to apply?

Crypto Asset Service Providers offer services such as custody, the operating trading platform, exchange services, execution and placing of orders, reception and transmission of orders and advice. They will be authorised to provide their services in the EU and will be able, via passporting, to operate in all the EU countries. The authorisation can be withdrawn, which is important: this underlines that consumers and investors are protected.

Providers are obliged to act fairly, honestly and professionally in the best interest of clients. These principles have arisen from previous Commission regulation of financial services based on prudent requirements, organisational requirements, safekeeping of clients’ crypto assets and funds and complaint handling procedures. Just because we are using a new technology does not mean that complaints are over. We also need to prevent conflicts of interest and supervise certain degrees of outsourcing.

Crypto Asset Service Providers will be obliged to act fairly, honestly and professionally in the best interest of clients.

In the blockchain industry there has long been a feverish debate when to distinguish between custody by a provider and self-custody by the user. How would software services such as wallet providers that allow for self-custody be treated?

You don’t have to use a custodian as a consumer but if you do, they are covered by MiCA. The dividing line I believe is whether a service provider takes the private keys to the crypto assets into custody versus you keeping custody yourself of the key, for example in a software or hardware wallet. The latter is not a crypto asset service under MiCA.


Shifting back to the crypto asset issuers – you mentioned that they are required to form a legal entity in one of the European member states. How can decentralised projects that do not have such a legal entity fit in?

We would like to have decentralised systems in general and decentralised finance flourishing in Europe. But there have to be ways to address things like complaints, like capital adequacy when it comes to globally significant asset backed tokens, including certain investor protections.

We are open to other forms of structures, such as foundations or cooperatives. Addressing this is possible and we have tried to make sure that there is no discrimination in favour of the traditional systems, but we don’t want to remove safeguards for the individual or the client just to allow this. We also need to consider the answer of who is responsible if a client has a problem or if the system stops working and consider cybersecurity risks.

We have to be innovative in our thinking and be open to these new decentralised systems. But at the same time we can’t say it's a completely new world and it’s every man or woman for him or herself. A radical version of libertarianism is not what citizens have voted for.

If a group from the ecosystem has a specific concern, make it concrete. Even for a sympathetic member of parliament it can be hard to understand what exactly needs to be changed. Please come with specific points and specific solutions.

It seems that politicians, regulators as well as practitioners in the technology ecosystem will have to have a conversation around decentralisation. What would be your advice to the tech ecosystem to make itself heard when this is discussed?

If there are certain provisions that entities and people find problematic, I would encourage those people to join the discussion for example via their members of parliament.

In general, be organised and get together in large groups and pass on a unified message of your group with a specific concern and make it concrete. Even sometimes for a sympathetic member of parliament it can be hard to understand what exactly needs to be changed. Please come with specific points and specific solutions. There is great innovation, technical and legal thinking out there. So if you come up with a solution to a problem that you see, there is going to be openness. But let’s not be naïve, there are also other stakeholders who are very concerned about money laundering, ransomware and consumer protection. The result is likely going to be balanced.


On the second aspect, “more stringent regulation for systemically relevant stablecoins” - what does this entail?

They’re not called stablecoins in the legislation but asset-referenced tokens. The Member States didn’t like the term stablecoins because they felt it indicated that in all cases these would be stable, which of course really depends on the quality of the underlying asset. 

Assets that are considered significant can either be classified as such by the European Banking Authority or at the request of the issuer. The classification criteria depend on the size of the customer base, the value of the asset reference token’s market capitalisation, the size of its reserve, the significance of the cross-border activity and interconnectedness with the financial system.

The criteria will be specified by a delegated act and the commission cannot set thresholds that are lower than those specified right now in Article 39-6. With something like Libra, that would have a great impact on markets and on monetary sovereignty, this leads to a political reaction and hence a closer level of supervision under MiCA. But on this point, there will probably be a lot of debate in the Council and in the parliament.


The ECB is pushing forward in their understanding of a digital euro, or put otherwise ‘central bank digital currency’. Do you expect the ECB to move forward with this?

It’s dangerous for me as a civil servant to predict what the ECB governing board will do so I highly recommend their report to anybody who’s interested in this. There you’ll see their criteria for introducing a central bank digital currency.

We had a workshop on central bank digital currencies at the end of October and you can see the video on YouTube and on my Twitter account.

We had all kind of players and stakeholders there, including the ECB, Bank of Japan, Bank of Canada and Libra. In my industrial policy part of the Commission we do see potential for a central bank digital euro to act as programmable money. We see this as something that can be a vital part of the digital economy and Manufacturing 4.0.

We’re following this very closely, both publicly and talking frequently to our colleagues and the ECB. It will be their decision to introduce it but once that decision is taken, we do see possibilities for a token-based system, a programmable euro, and that is something that is being anticipated by members of the ecosystem.


The package’s goal is to enhance the EU’s competitiveness globally. How do you view this proposed regime in comparison to what is happening in the US and China?

Our blockchain strategy or broadly defined emerging technologies convergence strategy is based on evidence and knowledge, such as in the European Blockchain Observatory and Forum. We have the European blockchain partnership where all 27 member states and Norway and Liechtenstein are building a European Blockchain Services Infrastructure deploying use cases for RegTech, self-sovereign identity, audit document certification, diplomas, and SME bonds on the blockchain. We have an AI blockchain investment fund and are trying to ramp up venture capital and other private investors to make sure that the investment climate is great in Europe. We are also establishing the legal framework as well with the digital services act and the digital markets act, which cover the ecommerce and platform side. This may include provisions on smart contracts. We’re also working on digital standardisation as we have a convergence vision of AI, IoT, data and blockchain working together in our future economy.


We’re trying to listen and engage with the private sector. We want to help build this producer ecosystem in Europe that has the investment, the frameworks and the ecosystem support to take a globally leading role.

Are there any other aspects of the European blockchain strategy that you'd like to highlight?

We are working with the investor community about providing funding and meeting with people like you. We are also bringing together the International Association for Trusted Blockchain Applications (INATBA), which includes a governmental advisory board with representatives from Canada, the United Nations, World Bank, the ECB and others to hear the views of blockchain providers and users and what they need. I think they also have a working group that will provide inputs to the European Parliament and the Council on crypto assets.

We’re really trying to listen and engage with the private sector and when it comes to the European Blockchain Services Infrastructure, really have a public-private partnership in the future as foreseen in the Declaration.


What contributions would you like from venture capitalists and the technology ecosystem?

The European Blockchain Partnership is informally working as a regulatory sandbox allowing for innovation and experimentation. All of what we talked about is going into building an even more vibrant ecosystem in Europe but what we are still missing in Europe is the massive number of scale-ups. Where we do have scale-ups, we’re proud of them: we know and cherish the likes of Spotify, Transferwise and Klarna.

But what would be great from both start-ups and investors is to tell us what you still need from us so that we can build this producer ecosystem in Europe. Then we can make sure that at least some of the really significant scale-ups in this new part of the digital economy come from Europe and hopefully go global. They will have the investment, the frameworks and the ecosystem support to really grow and take a globally leading role.

Thank you, Pēteris.


About the speakers

NICOLAS BRAND

Nicolas is Partner at Lakestar. He invests in and builds businesses at the intersection of finance, blockchain and technology. His sector expertise comprises the digitisation of finance and banking, insurtech and blockchain infrastructures.

Nicolas is a fundraising and M&A specialist and a frequent adviser to our portfolio companies on financial and fundraising matters. He spends most of his time across the European technology hubs and is part of the Lakestar team that has taken up coverage responsibility for Paris as an emerging region. He is responsible for our investments in Aglet, Avrios, Bellman, Blockchain.com, Crosslend, Holded, Passbase, ShapeShift, Solarisbank and Zebedee.

Before joining Lakestar, Nicolas was an investment banker. As Vice-President for J.P. Morgan in London, he led mergers and acquisitions for technology and industrial companies and was responsible for debt and equity capital raisings. Over the years, Nicolas has raised more than $25 billion on behalf of clients.

Nicolas holds a Master of Science in Finance and Business Administration from WHU – Otto Beisheim School of Management – and studied in Germany, the US and France. He is an active member of the European FinTech community and speaker at key industry events.


PĒTERIS ZILGALVIS

Pēteris is Head of Unit for digital innovation and blockchain in the digital single market directorate of the European Commission, DG Connect. He is also co-chair of the Fintech Task Force alongside Jan Ceyssens from the financial market side.

He has a doctorate in environmental law and comes from the policy side as he has worked for the environment and foreign affairs ministries in his home country of Latvia. He then moved to the World Bank, where as Regional Environmental Specialist, he was responsible for areas like biotechnology and environmental law. At the Council of Europe in Strasbourg he worked as Deputy Head of the Department of Bioethics in the directorate-general of legal affairs.

In 2013, Pēteris started researching and publishing on innovation policy at the University of Oxford as visiting EU fellow at St. Anthony’s college. He was also invited to discussions with the Financial Conduct Authority when they were developing Project Innovate, which became their regulatory sandbox just as the fintech scene was exploding.

This is where he ended up looking closely at Bitcoin and blockchain payments innovation, peer to peer lending and investing, and crowd funding. When he returned to the European Commission, he was joined by other people who were also looking at blockchain and fintech at the time. This was the genesis of the fintech task force, which was set up by Commissioner Oettinger and vice-president Dombrovskis, and Pēteris became its co-chair.