EU Data Act smart contract ‘kill switch’ brings uncertainty

On June 28, the European Council and Parliament achieved a political consensus on the Data Act, which moves the legislation regarding non-personal data closer to fruition.

Thierry Breton, European Union commissioner for the internal market, described the agreement in an X post as a “milestone in the reshaping the digital space.”

The Data Act complements the Data Governance Act of November 2020 by clarifying who can create value from data and under which conditions. It stems from the European Strategy for Data, announced in February 2020, which also aims to position the EU as a regulatory frontrunner in the era of data-driven society.

The Data Act is part of the European Commission’s wider data strategy aimed at making Europe a global leader in the data-agile economy. In simple terms, the Data Act proposes new rules on who can access and use data generated in the EU across all economic sectors.

For the Data Act to become law, it must be approved by a vote of the European Parliament and the Council, which represent the bloc’s 27 member states. And once again, as with the Markets in Crypto-Assets (MiCA) regulation, the crypto sector is facing a major challenge. The problem raised by the new EU data law could permanently change the use of smart contracts in the European Economic Area (EEA) –– and not for the better.

Smart contract “kill switch”

The blockchain community is largely concerned about one provision in the Data Act, namely that automated data-sharing agreements contain a “kill switch” by which they could be terminated or halted in the event of a security breach.

Many blockchain experts contend that the current definition of smart contracts in the Data Act is broad, fearing it may lead to unintended consequences for existing smart contracts on public blockchains. For example, the text of the upcoming law doesn’t distinguish between just digital contracts and smart contracts utilizing distributed ledger technology.

But above all, the Data Act supposedly doesn’t give clear details about the conditions under which safe termination or interruption kill switch should occur, and it is hard to predict the potential outcomes with a higher degree of certainty. The smart contract architecture often doesn’t allow for termination or interruption, as blockchain technology is praised for being immutable and irreversible.

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The Data Act also doesn’t say exactly what a “data sharing agreement” is, and it doesn’t explain if the smart contracts currently ubiquitous in Web3 applications follow these kinds of agreements.

“By design, most of smart contracts don’t offer a termination or interruption feature and are often un-upgradable to ensure higher levels of protection from abusive behaviors,” Marina Markežič, executive director and co-founder of European Crypto Initiative, told Cointelegraph.

“The fact that smart contracts lack such features puts their use and development at risk. They may be perceived as inconsistent with regulatory requirements.”

“The problem is if the scope of Article 30 were to be extended beyond the application of smart contracts in this narrowly defined context, and on public permissionless networks. It becomes not only problematic but almost impossible for such protocols to comply,” he said.

Per Voloder, another concern is whether these rules could spill over into decentralized finance (DeFi). “As we do not have a DeFi regulation, this is a question that will need an answer over the next 18 months as the EC prepares its position on DeFi.”

Moreover, kill switches can have errors because of human mistakes and, in smart contracts in general, “as they are rigid, bounded information environments.” This rigidity, plus an automatic feature that triggers a certain outcome following strict rules, could lead to issues like locking up assets, shutting down protocols or even losing funds and important data, said Voloder.

A lot of uncertainty

The Data Act has rules for vendors of an app using smart contracts, or for people whose business involves deploying smart contracts.

According to Markežič, the Data Act might cause such vendors and deployers to be more cautious and consider whether their smart contracts in any way contain a data-sharing agreement. Apps might need to change how they work to meet these rules if their smart contracts share data.

But first, it’s crucial to understand who exactly needs to follow these rules, Markežič said:

Erwin Voloder, head of policy at the European Blockchain Association, told Cointelegraph that Article 30 of the Data Act applies when parties agree to share data using a smart contract, and this contract follows the rules. It should be fine if it’s only for that situation, especially when used on a controlled network where the Data Act’s safety stop can be used. 

“Is the regulation even targeted toward DeFi platforms and protocols? […] It should be clarified under what circumstances the ‘access control’ is provided, what, who, why and how the ‘safe termination or interruption’ measure is triggered and how protocols prevent further abusive behavior thereof.”

Markežič stated that, in the past, some changes and terminations were made on a protocol layer as part of the overall governance mechanisms. 

A kill switch on the level of a smart contract might lump projects and individuals into “a single point of failure, prescribed by the regulators.”

Therefore, it’s critical that regulators clarify who has the power to use this kill switch.

Crypto community across the globe reacts

The crypto community has already proposed some alternative solutions to bring more legal clarity to smart contracts.

In April 2023, Polygon had already penned an open letter suggesting how to improve Article 30, sating that lawmakers could apply these rules to enterprises only, excluding software and developers, and make clear that smart contracts aren’t “agreements” in and of themselves.

More recently, the European Crypto Initiative and numerous organizations, such as Stellar, Iota, Polygon, Near, Coinbase, Cardano and ConsenSys, have signed an open letter voicing their concerns regarding the Data Act and calling on lawmakers to reconsider and clarify certain aspects.

They argued that the Data Act could potentially clash with the recently agreed MiCA regulation. MiCA, which will come into force in 2024, provides a license for crypto exchanges and wallet providers to operate throughout the EU. 

They further claim that European lawmakers deliberately sidestepped the more complex issue of decentralized financial regulation –– an issue the Commission will need to revisit in the coming years.

More harm than good?

The trialogue on the Data Act has been completed, and this means that the text has reached its final version and is likely to be enacted in its current form.

According to Markežič, the new law could affect the European crypto industry and businesses that want to operate in the EU, stating that the Data Act doesn’t give clear details about what use cases the new rules apply to, and that makes the whole industry unsure about what to expect. And this is just the first step in the direction of regulating smart contracts, setting a precedent for forthcoming actions, she said.

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The next important step for the community is to work closely with European standardization groups. These groups are responsible for creating the standards that vendors and developers of smart contracts should follow when making agreements to share data, especially given that these vendors will need to make sure their smart contracts broadly align with the scope of Article 30.

According to Voloder, if the Data Act is extended to public networks, it could mean companies leaving the EU, at worst, and “otherwise being pigeonholed into a narrow development trajectory of smart contracts in the best case.”

“The result is capital flight, stifled innovation and a floundering blockchain industry in Europe. At a time when Europe is at the vanguard of the regulatory apex, the timing of such an outcome would be most inopportune.”

German political parties split on how to regulate increasing AI adoption

In April 2021, the European Commission presented its proposal for harmonized rules on artificial intelligence (AI), dubbed the Artificial Intelligence Act (AI Act). After the Council of the European Union and the European Parliament finalized their positions in December 2022 and June 2023, the legislative institutions entered a trilogue on the upcoming AI regulation. 

The negotiations can be challenging due to the significant differences between the Parliament and the Council on specific issues such as biometric surveillance. In Germany, political groups and digital experts are also concerned about proposed changes to the AI Act.

Die Linke calls for stricter regulation and transparency

The German left party Die Linke highlighted significant gaps in European AI regulation, particularly regarding consumer protection, and obligations for AI providers and users. 

It wants to require high-risk systems — including AI systems that pose a high risk to health, safety and the fundamental rights of natural persons — to be checked for compliance with the regulation by a supervisory authority before these AI systems are launched on the market. Die Linke has suggested that the German government appoint at least one national supervisory authority and provide sufficient financial resources to fulfill this task.

“Politics must ensure that a technology that is significant for everyone but controlled by only a few is supervised by a regulatory authority and proven trustworthy before its implementation,” said Petra Sitte, a politician from Die Linke, adding:

“Therefore, do not let yourself be blackmailed by lobbyists of big technology corporations. We can also strengthen an open-source approach in Europe […], meaning that a programming code is accessible to everyone.”

Die Linke also advocates an explicit ban on biometric identification and classification systems in public spaces, AI-driven election interference, and predictive policing systems.

According to the party, the exception for scientific AI systems specified in the AI Act should not apply if the system is used outside research institutions. Die Linke is already calling on the German government to develop training programs on the capabilities and limitations of AI systems, and to evaluate AI systems used in government operations annually “using a standardized risk classification model,” as well as registering them in an AI registry.

The Union prioritizes innovation and openness 

Conversely, the center-right coalition of the Christian Democratic Union of Germany and the Christian Social Union in Bavaria — also known as “the Union” — emphasized that AI should not be overly regulated. It advocates for the federal government to prioritize AI and an innovation-friendly environment in Europe. 

Regarding the trilogue negotiations, the Union noted its position paper, claiming that generative AI will enable German and European companies to excel internationally. The party wants to avoid the establishment of a large supervisory authority in Brussels, as well as differences in the implementation of the AI law in EU member states. While advocating for sharper definitions, it also suggests ensuring legal certainty by aligning with the General Data Protection Regulation, the Data Act and the Digital Markets Act.

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The Union also makes concrete proposals to secure Germany’s technological sovereignty in AI. Recognizing the challenges of building an entirely new infrastructure in a realistic timeframe, the party recommends expanding the existing supercomputing infrastructure of the Gauss Center for Supercomputing. It also proposes that German and European startups, small- and medium-sized enterprises (SMEs), and open-source developers be given dedicated access to this infrastructure.

To encourage the growth of German AI startups, the Union suggested such small businesses be awarded government contracts.

In addition, the Union highlighted an investment gap in university spin-offs and open-source AI, and advocated for targeted support through national initiatives such as the Sovereign Tech Fund. Given the widespread use of AI in various educational institutions, organizations and companies, the Union highlighted the urgent need to establish local systems to prevent accidental information leakage.

The German AI Association requires practical solutions

The German AI Association (KI Bundesverband), Germany’s largest industry association for AI representing more than 400 innovative SMEs, startups and entrepreneurs, also advocates for openness to innovation. 

“Europe must therefore be able to offer its own AI systems that can compete with their American or Chinese counterparts,” said Jörg Bienert, president of the KI Bundesverband. While the KI Bundesverband accepts the idea that a regulatory framework coupled with investment in AI can be a way to boost innovation, the association disagrees with the EU’s approach to this goal. Bienert believes any strategy must include three key components: mitigating potential risks, promoting domestic development, and protecting fundamental rights and European values.

According to Bienert, EU lawmakers have failed to create a regulatory framework focusing on real AI application threats and risks. He further stated that the AI Act risks becoming more of a regulation for advanced software rather than a risk-based approach. Introducing such extensive regulation after the dominance of United States and Chinese tech companies will hinder European AI companies’ chances of strengthening their position and create dependency on foreign technology.

“What is needed now are sensible and practical solutions to mitigate the real risks and threats posed by AI, not ideologically driven political quick fixes.”

Striking a balance 

Germany’s government supports the AI Act but also sees further potential for improvements. Annika Einhorn, a spokesperson for the Federal Ministry for Economic Affairs and Climate Action, told Cointelegraph, “We attach importance to striking a balance between regulation and openness to innovation, particularly in the German and European AI landscape.” The federal government will also advocate for this in the trilogue negotiations on the AI Act.

In addition to the negotiations, the federal government is already implementing numerous measures to promote German AI companies, including establishing high-performance and internationally visible research structures and, in particular, providing state-of-the-art AI and computing infrastructure at an internationally competitive level. Furthermore, during the negotiations on the AI Act, the federal government continues to advocate for “an ambitious approach” to AI testbeds. This enables innovation while also meeting the requirements of the AI Act, according to Einhorn.

Is Europe being left behind?

All these suggestions and ideas may sound promising, but the fact is that most big AI models are being developed in the U.S. and China. In light of this trend, digital experts are concerned that the German and European digital economies may fall behind. While Europe possesses significant AI expertise, the availability of computing power hinders further development.

To examine how Germany could catch up in AI, the Ministry for Economic Affairs and Climate Action commissioned a feasibility study titled “Large AI Models for Germany.”

In the study, experts argue that if Germany cannot independently develop and provide this foundational technology, German industry will have to rely on foreign services, which presents challenges regarding data protection, data security and ethical use of AI models.

The market dominance of U.S. companies in search engines, social media and cloud servers exemplifies the difficulties that can arise regarding data security and regulation. To address these difficulties, the study proposes the establishment of an AI supercomputing infrastructure in Germany, allowing for the development of large AI models and providing computing resources to smaller companies. However, specific details regarding funding and implementation remain to be determined.

“AI made in Europe”

In AI, Europe’s reliance on software and services from non-European countries is steadily increasing. According to Holger Hoos, an Alexander von Humboldt professor for AI, this poses a threat to its sovereignty, as regulation alone cannot adequately address the issue. Hoos emphasized the need for a substantial shift in the German and European AI strategies, accompanied by significant targeted public investments in the European AI landscape. 

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A key aspect of this proposal is the creation of a globally recognized “CERN for AI.” This center would possess the necessary computational power, data resources and skilled personnel to facilitate cutting-edge AI research. Such a center could attract talent, foster activities and drive projects in the field of AI on a global scale, making a noteworthy contribution to the success of “AI made in Europe.” Hoos added:

“We are at a critical juncture. It requires a clear change of course, a bold effort to make AI made in Europe a success — a success that will profoundly impact our economy, society and future.” 

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Europe’s right-wing political groups find cause in crypto

The European crypto scene has gained significant traction over the past few years, with a surge in the interest in and adoption of cryptocurrencies and blockchain technology. While the crypto industry is often associated with decentralization, innovation and financial freedom, it is not immune to various political ideologies and influences, and right-wing movements are no exception.

The attraction of cryptocurrencies for right-wing politicians in Europe can stem from several factors. Right-wing ideologies often prioritize individual freedoms and limited government intervention. Cryptocurrencies, with their decentralized nature, offer the potential for financial sovereignty by allowing individuals to have control over their money without relying on traditional financial systems or government regulations.

Right-wing politicians also may perceive cryptocurrencies as a way to challenge the existing financial establishment and its perceived biases or control. Bitcoin (BTC), in particular, emerged after the 2008 financial crisis, a crisis that led many to lose trust in traditional financial institutions and governmental monetary policies.

In addition, many became concerned about central banks and their influence on monetary policy, and Bitcoin’s decentralized nature appealed to those who advocate alternative monetary systems outside of central bank control.

Bitcoin as an “alternative for Germany”

For example, a German exit from the euro and a return to the Deutschmark (the country’s former currency) is a well-known demand of the right-wing populist political party Alternative for Germany (AfD). Although there is no official or clear strategy within the anti-euro party regarding cryptocurrencies, some members have clearly expressed their positive attitude toward Bitcoin.

For instance, AfD leader Alice Weidel has attended several Bitcoin conferences, called herself a “Bitcoin entrepreneur” and wanted to launch a Bitcoin startup. Even Aaron Koenig, a German entrepreneur and the founder of the brick-and-mortar crypto exchange Bitcoin Exchange Berlin, was on the stage with Weidel, and both presented their view of “money without a state.”

The AfD’s prioritization of crypto is also evident in its behavior in the Bundestag, Germany’s parliament. On several occasions, the AfD has submitted “Kleine Anfragen” (literally, “small requests”) to the government. This instrument of parliamentary procedure requires an official response from the Bundestag and is often a way for opposition parties to demand accountability for specific actions or inquire as to why other measures were not taken.

For instance, the party asked a “small question” about crypto donations for Ukraine, how a cryptocurrency could replace the previous currency, what effects this would have on the banking system, and how much Bitcoin German federal authorities own. AfD also opposed a proposed Bitcoin ban during discussions among European lawmakers last year.

The concept of cryptocurrency is, in some places, being linked to the right-wing — and, in part, radical — positions of the AfD.

For years, some experts, such as David Golumbia — a digital studies professor at Virginia Commonwealth University who researches the politics of cryptocurrency — have warned that blockchain could be hijacked by right-wing and libertarian groups.

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In Golumbia’s view, blockchain technology and cryptocurrencies could be the realization of their vision of a world without government control. As a former member of the Hayek Society, Weidel belongs to the radical economic liberal wing of her party. The Hayek Society is named after Austrian economist Friedrich August von Hayek, who was an advocate of an unfettered market with as little government intervention as possible.

Support for crypto among Europe’s right-wing parties

It’s not only German right-wing politicians who have voiced interest in Bitcoin and blockchain technology as potential disruptors of traditional financial systems, with the leaders of the Dutch right-wing parties Party for Freedom (PVV) and Forum for Democracy (FvD) — Geert Wilders and Thierry Baudet, respectively — also speaking positively on the subject.

Baudet even wants to make the Netherlands a Bitcoin hub and released two NFT series on the theme of his fight against World Economic Forum founder and CEO Klaus Schwab. Baudet is a fierce critic of the WEF, which he believes is leading the world in the wrong direction and causing serious threats to individual freedom.

Polish politician Jaroslaw Gowin and his center-right party, Agreement — formerly known as Poland Together — were part of the ruling United Right coalition from 2015 to 2021. For most of that period, Gowin served as deputy prime minister, as well as being a member of parliament. 

When Gowin was the leader of the Agreement party, he expressed a positive attitude toward cryptocurrencies, acknowledging their potential to promote financial innovation. The politician also consulted with many people from the industry about cryptocurrencies and blockchain. For example, the party held a meeting where Prime Minister Gowin listened to the recommendations of industry experts, including economist Krzysztof Piech and Filip Pawczynski, president of the Polish Bitcoin Association.

Nigel Farage, a prominent figure in British politics and former leader of the right-wing pro-Brexit UK Independence Party, has also shown interest in cryptocurrencies.

In a 2022 interview with Cointelegraph, Farage — also a former member of the European Parliament — said he first became aware of Bitcoin 10 years ago and shared his perspective on the potential future of Bitcoin adoption in Europe: “What happens in America first happens here [in Europe], too. There’s going to be a very, very big change here over the next two or three years, and it [Bitcoin] will become a trusted means of exchange.”

Farage also believes that Bitcoin has gained appeal as an alternative to the existing financial infrastructure, noting the latter’s inefficiency, high costs and slow speeds.

Other right-wing politicians haven’t made specific statements about cryptocurrencies but are still taking steps to embrace digital currencies. Viktor Orbán, the prime minister of Hungary and leader of the right-wing Fidesz party, and his government are currently considering the potential benefits of launching a central bank digital currency. Hungary also appears to be warming up to crypto across the board, with the government revealing plans in 2021 to cut taxes on crypto trading from 30.5% to 15% as part of an economic recovery program.

Right-wing extremists rely on crypto payments

Not only have right-wing politicians discovered cryptocurrencies, but right-wing extremist movements have also been utilizing crypto. In 2022, the Middle East Media Research Institute (MEMRI) published a report on the massive increase in the use of crypto payments by right-wing extremist groups in recent years.

Crypto payments are not a new tool for ultranationalists and European extremist groups proclaiming the superiority of the “white race” and advocating for a “white” Europe and North America. In fact, they are among the early adopters of the technology, accepting BTC donations as early as 2012, according to the MEMRI.

The United States-based Southern Poverty Law Center has further compiled a list of extremist groups accepting crypto donations.

Ultranationalist and extremist groups are actively using cryptocurrencies not only for reasons of convenience and ideology — and because they are being shut out of traditional and mainstream online banking systems — but also because funds held in crypto cannot be accessed or seized by anyone.

So, is crypto a right-wing movement, then?

Does this all mean that crypto in Europe is a right-wing thing? Not really.

While crypto itself is not inherently Right or Left, it is not without ideology, nor is it completely free of political positions — even if its political relations are indirect. Politicians can like it or hate it, regardless of their political persuasion, and support for cryptocurrencies among politicians is not limited to those leaning toward the Right. For example, the German liberal, pro-free market Free Democratic Party also advocates for a friendly policy toward cryptocurrencies.

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While the European crypto scene is not inherently right-wing, there are notable instances of right-wing influence within the community, according to the MEMRI report, which also states that it is crucial to address these concerns by fostering education, implementing regulations and ensuring that the crypto space remains inclusive, transparent and aligned with democratic principles.

MEMRI further stated that social media platforms and online communities need to take proactive steps to curb hate speech, misinformation and extremist content, while also promoting healthy, constructive dialogue.

Liechtenstein adapts blockchain laws to developing crypto landscape

The blockchain and crypto industry is constantly growing and changing around the world, and the Principality of Liechtenstein is no exception. 

The sixth smallest country in the world, located in the middle of Europe between Switzerland and Austria, has attracted the attention of the international and European crypto communities alike since the early days of the industry. 

In 2019, Liechtenstein became one of the first countries in the world to adopt specific legislation on crypto and blockchain, namely the Token and Trusted Technology Service Providers Act (also known as TVTG or the Liechtenstein Blockchain Act), which has been in force since the beginning of 2020 and established one of the world’s first regulated environments for token-related services.

Since 2020, the number of crypto service providers in Liechtenstein has been increasing, as companies find optimal conditions there to establish and develop their crypto business. The TVTG’s high level of regulatory certainty and direct communication with the local financial market regulator, the Financial Market Authority (FMA), have also contributed to this crypto-friendly environment.

What else makes Liechtenstein special and attractive for crypto service providers? Will the upcoming Markets in Crypto-Assets (MiCA) regulation be compatible with Liechtenstein’s Blockchain Act? Or is Liechtenstein’s government planning to tighten the law after the collapse of major crypto businesses like FTX, Celsius or Three Arrows Capital?

To get a betting understanding of crypto’s future in the country, Cointelegraph sat down with Thomas Dünser, director of Liechtenstein’s Office for Financial Market Innovation and Digitization. Dünser is a senior adviser to the prime minister of Liechtenstein, responsible for innovation and digitalization issues within the Ministry of Finance and was the project leader and co-author of the Blockchain Act.

The first comprehensive national token law

From 2016 to 2018, the blockchain and crypto industry faced a tremendous amount of uncertainty as governments around the world had only begun to develop regulatory concepts for digital assets. Amid this uncertainty, the announcement that the Liechtenstein government considered blockchain as a promising technology was already something of a sensation.

With the publication of the draft law, it also became clear how Liechtenstein would treat tokens. In particular, Liechtenstein was the first country in the world to regulate the token as a legal instrument with the Token Container Model (TCM) and to classify tokens differently based on how they function (utility token, security token or payment token).

According to Dünser, this clarification alone that not all tokens are to be considered financial instruments has triggered “enormous positive feedback” from the industry and created “greater legal certainty” in the application of financial market laws.

He explained that the definition of the token, the regulation of ownership and possession of the token, and the delegation and transfer rules have not only clarified basic legal issues but have also “laid the groundwork for the use of tokens by established financial institutions” like custody services, banks or exchanges. Moreover, Dünser emphasized the importance of the “semantics” of the Blockchain Law:

“It created a common language space, which was crucial for technical and regulatory discussions about crypto and blockchain between authorities and market participants.”

The ability to innovate is critical

The Blockchain Act was designed in 2016 and passed back in 2019. At that time, there were no decentralized finance applications or nonfungible tokens (NFTs) on a scale like now, which calls for faster legal development.

How is Liechtenstein dealing with this scale of innovation?

Neither the trend toward decentralization nor toward NFTs was unexpected, said Dünser. “With our national token law, we have created the basis for a broad range of tokenizations, even going beyond NFTs. We have deliberately tried to think far beyond the current use cases of blockchain in our legislation. So, I don’t expect that we will have to re-regulate here anytime soon.”

Liechtenstein regulators have also taken the trend of decentralization into account in the Blockchain Act. The TVTG is “open for innovation” and flexible, “principle- and role-based — as a counter-model to the otherwise usual rule- and business model-based regulation” and “technology-neutral.”

In the Blockchain Act, activities are subject to regulatory requirements if they pose risks to users, regardless of the business model in which they are provided. In doing so, service providers themselves have to consider how to mitigate the risks, whether with technology or human resources. Dünser said:

“Given the rapid pace of technology-driven innovation, the ability of the legal system to innovate is critical. Without it, we not only slow down innovation but also face considerable legal uncertainty. Neither of these can be in the interest of states.”

In Liechtenstein, regulators have, therefore, established an innovation framework with the aforementioned state innovation process and the Regulatory Laboratory at the FMA. In Dünser’s view, it has proven to be “very successful”; however, since the important financial market laws in the European Economic Area are defined at the European level, analogous structures would be necessary for the whole regional regulatory system.

Similarities between the TVTG and MiCA

MiCA is an important step toward a unified European regulatory system, and the TVTG served as a sort of model for MiCA. In particular, the MiCA draft adopts the Token Container Model of the TVTG, the licensing requirement for offering certain blockchain-related services, and also the information requirements for public offerings.

So, there shouldn’t be any major changes to the existing practice in Liechtenstein after MiCA enters into force, and both laws will be well-compatible, noted Dünser.

Crypto service providers newly regulated under MiCA will no longer need to be regulated under the Blockchain Act.

“Like Liechtenstein, the EU Commission sees the token economy — in addition to financial market applications — as a great opportunity for Europe.”

Liechtenstein’s experiences were, therefore, relevant for European lawmakers, and there were “lively discussions” between both sides that are reflected in many regulatory philosophical similarities between the TVTG and MiCA: the token container model, the role-based and, to some extent, principle-based regulation, and openness to innovation.

“However, we need to distinguish between the civil law and supervisory law parts,” Dünser noted, adding, “MiCA includes only the prudential components. Each member state has to clarify the civil law foundations itself. With the Blockchain Act, Liechtenstein already has a comprehensive and robust legal framework for all types of tokenization, from equity tokens, and other crypto assets to NFT and other tokenized rights.”

“We are prepared to act”

As to whether Liechtenstein will tighten rules for the crypto market after the FTX crash and other big collapses in 2022, Dünser said it would better avoid overregulation. Moreover, the Blockchain Act already regulates the custody of tokens and also prescribed legal separation in the event of bankruptcy.

Nevertheless, Dünser agreed that certain adjustments are necessary. “I see greater challenges in staking or borrowing and lending of customer tokens by crypto exchanges, which is not regulated in many jurisdictions.”

In the European Union, for example, regulation for credit institutions, which is set up for similar activities involving money, does not apply to crypto service providers. MiCA also does not cover this issue, at least not yet.

“In my view, this regulatory gap should be closed urgently. We are following and monitoring this development closely and are also prepared to act.”

What’s next for EU’s crypto industry as European Parliament passes MiCA?

On April 20, the European Parliament voted to pass the Markets in Crypto-Assets (MiCA) regulation, the European Union’s main legislative proposal to oversee the crypto industry in its member countries. 

The MiCA regulation is a significant development for the crypto industry in the European Union. Prior to MiCA, crypto companies had to comply with 27 different regulatory frameworks across the EU member states, with Germany or France being costly and burdensome, for example.

Under MiCA, however, EU-wide regulations will apply, allowing companies to operate throughout the entire EU crypto market with a MiCA license granted in one country. This will increase the competitiveness of EU startups and may result in them gaining market share from unregulated competitors.

MiCA will increase the EU’s competitiveness

Moreover, MiCA could encourage more institutional adoption and activity in the EU crypto and blockchain market. Patrick Hansen, director of EU strategy and policy at stablecoin issuer Circle, told Cointelegraph that MiCA will enable European crypto firms to scale and grow faster, allowing licensed companies to offer their services throughout the world’s largest single market, with roughly 450 million people:

“The legal clarity will also foster innovation amongst financial institutions that have been previously hesitant to launch products and services due to regulatory uncertainty. Additionally, as MiCA is the first comprehensive regulatory framework for crypto assets from a major jurisdiction in the world, it is likely to attract considerable foreign capital and talent to the region.”

For Moritz Schildt, a board member of the Hanseatic Blockchain Institute and the German Blockchain Association, the biggest advantage of MiCA is that “it will come into force already this year,” giving the EU a chance to provide a unified regulatory framework for crypto assets and related providers.

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Creating a regulatory framework for a technology that sees new developments and outgrowths practically every month and evolves as dynamically as the tokenization of investment opportunities is “very challenging.”

“It should come as no surprise, therefore, that some regulations are not yet optimal and that questions about concrete applications remain unanswered,” Schildt said, adding that with MiCA, Europe has the opportunity to position itself “as a location for innovation and quality.”

Unregulated companies out of the EU crypto market

Peter Grosskopf, co-founder of decentralized finance (DeFi) project Unstoppable Finance, is also convinced that MiCA will benefit the EU crypto and blockchain market. First, companies from outside Europe will have to register with a company in the EU, so there is a “direct impact on job creation and tax payments.”

Second, many jurisdictions take an overly strict approach to regulating crypto. For example, “the U.S. does regulation by enforcement.” Compared with other regions, the EU will become “a safe space for the industry as a whole, and innovators from around the world will start to build their businesses here,” Grosskopf said.

Stefan Berger also noted that the United States is currently cracking down on the crypto sector. According to the German politician and European Union Parliament rapporteur for MiCA, the European crypto asset industry has regulatory clarity that the United States doesn’t, and it would be wise for U.S. lawmakers to take a cue from MiCA:

“For me, the biggest advantage is that we create trust, which is a crucial booster, especially for young technologies like blockchain. I expect regulation to become a global standard-setter over time. A global MiCA would be desirable at some point.”

NFT regulation unavoidable

Through MiCA, European policymakers are trying to create a reliable framework that builds trust through legal certainty. This includes a uniform classification of assets and the requirement for coin issuers to provide a white paper that discloses all relevant information about the coins, such as their energy consumption and environmental impact.

In addition, MiCA will ensure that every new token is reviewed for approval to check that the business model does not threaten the stability of the cryptocurrency, which creates more transparency for investors.

But the crypto and blockchain sector is constantly evolving. “Tokenization is not hype and will become an integral part of our lives and financial world,” said Berger. More and more business models are emerging based on nonfungible tokens (NFTs), for example, which have been largely exempt from MiCA. (The new regulation will only address crypto-asset service providers that offer services for NFTs).

But according to Berger, NFTs are next on the docket, with European lawmakers looking at what type of regulation would benefit the industry and consumers.

Schildt also expects further regulations on NFTs relatively soon. “We should reconsider the traditional classification of investment products.” According to the expert, in the future, investments “that were previously considered ‘art collections,’ we will also qualify as capital investments.”

DeFi is a hot topic in European policy making

Some aspects of MiCA have yet to be defined through upcoming technical standards and guidelines.

For example, what are the specific liquidity requirements for electronic money token reserves? EU regulators will develop these standards over the next 12 to 18 months, and “the practical success of MiCA will largely depend on this implementation work — also referred to as Level 2 legislation,” Circle’s Hansen said.

Hansen further noted that, beyond MiCA, EU institutions are finalizing a new Anti-Money Laundering (AML) rulebook that will be “critical for crypto firms.”

Another critical review is that of PSD2, the EU’s main payments directive, which will also significantly impact crypto firms.

And finally, in about 18 months, the European Commission will publish a detailed report on DeFi and may take further legislative steps to regulate the space. “Brussels prides itself on being a global regulatory leader, and MiCA is just the first of many steps to come,” said Hansen.

Unstoppable Finance’s Grosskopf also expects DeFi regulation to become a hot topic following the next round of elections in Europe, as MiCA will not apply to “crypto-asset services provided in a fully decentralised manner without any intermediary.”

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“I think it’s important to be proactive and start thinking about how to regulate DeFi as early as possible in order to influence the process,” he said, stating that the new AML regulation is currently under discussion and will most likely become a reality before MiCA.

Although it’s still unclear exactly how European lawmakers will regulate NFT and DeFi or whether there will be new requirements regarding smart contracts, the success of the first step toward regulation — MiCA — could provide a significant boost to both EU crypto businesses and the EU economy as a whole. However, whether this success is realized will depend on the practical implementation standards developed in the future.

Crypto in Europe: Economist breaks down MiCA and future of stablecoins

In October 2022, the European Union finalized the text of its regulatory framework called Markets in Crypto-Assets or MiCA. The final vote on the new regulation is scheduled for April 19, 2023, meaning the days of an unregulated crypto market in the EU may soon be over. The MiCA regulations introduce clear guidelines for handling cryptocurrencies and consumer protection, and divide crypto assets into different sectors, each subject to specific rules.

The European Commission — the executive branch of the EU responsible for proposing new laws — first proposed the far-reaching regulations in 2020. The MiCA would apply to crypto service providers and issuers of digital assets in 27 EU member countries. By proposing to regulate crypto assets, the European Commission has taken a bold step, displaying the capacity and will to address complex issues creatively.

Joachim Schwerin is the principal economist at the Digital Transformation of Industry unit within the European Commission’s Directorate General for the Internal Market, Industry, Entrepreneurship and SMEs (DG GROW).

Schwerin is responsible for policy development regarding various aspects of token creation, its distribution and regulation (token economy), and the economic applications of distributed ledger technologies.

In 2020, Schwerin coordinated DG GROW’s input into the EU’s Digital Finance Strategy, including MiCA. Speaking to Cointelegraph, Schwerin shared his views on the importance of MiCA, the role of stablecoins, and why he hasn’t ever questioned the merits of blockchain and crypto, even in the wake of Terra’s collapse or the FTX crash.

“We want to develop and promote, not slow down”

With MiCA, the European Commission has adopted a regulatory framework that should minimize the negative consequences of incidents like the insolvencies of FTX and BlockFi in the future. The law was not in force at the time of the FTX case, but Schwerin hopes it will come as soon as possible, saying this should “clearly underpin the precautionary principle.”

“We promote the crypto sector and want to support its organic, market-driven development. The many positive opportunities should be recognized and used. It is like in sports here: Defending can make sense in certain phases of the game, but mostly defending means that a team is too bad to take the game into its own hands. We want to develop and promote, not slow down.”

For Schwerin, FTX was a typical case of an emerging and relatively unregulated industry finding its footing and developing its products and services. Indeed, he stated incidents like FTX and Terra’s collapse provided a chance for the cryptocurrency community to rally, condemn illicit behaviors and work to rebuild the industry’s reputation.

The crypto community is now focusing even more on better rule-setting and compliance in regulated or soon-to-be-regulated environments. It’s also looking more at truly decentralized mechanisms to reduce the potential for error by empowered individuals, Schwering added.

“All of this is positive and does not change the narrative of crypto as a success story with much more future potential.”

Blockchain as a philosophy

Schwerin sees the benefit of blockchain technology primarily in applications for the real economy. He said that Bitcoin (BTC) and other cryptocurrencies are “nice and fascinating with lasting significance,” but these are private concepts and “we don’t need to spend public resources on them.”

Schwerin is confident that the benefits for small businesses and the general population must be evident if the government will tackle something with public resources. And this is precisely the potential that blockchain has:

“That’s why, from the beginning, we didn’t see blockchain primarily as a technology but as a philosophy. [We saw it] as something that enables a true form of decentralization that creates trust; trustworthy technology that also opens up market opportunities for small businesses worldwide and allows many people with the same interests — but who don’t know each other — to come together digitally in the real world and develop projects.”

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The European Commission had this understanding of blockchain technology in mind when discussing dubious initial coin offerings from 2017 to 2018, or that money laundering was supposedly easier with crypto.

But European regulators understood that blockchain technology’s nature — thanks to its transparency and traceability — makes it much easier to track crypto transactions, and distinguish between regular and illicit activities on-chain.

According to Schwerin, financial crime related to cryptocurrencies is much lower than in traditional forms of finance.

“That is why we did not depend on any examples of criminality or the Terra case, just as we did not depend on FTX or any next case of that sort, but we were and are 100% convinced of the technology. We got involved with it early on, and because of that, we had already learned so much by then that we were in a position to work on the MiCA regulation in record time.”

But what about stablecoins?

After the collapse of the Terra ecosystem, the European Central Bank (ECB) issued a report claiming that stablecoins posed a threat to financial stability, but Schwerin does not share this view.

According to him, society needs stablecoins in many different forms because they have important functions within the crypto space, like cushioning price fluctuations and facilitating transactions; this is why the European Commission has allowed stablecoins in principle in the MiCA regulation.

“We have not banned anything, but we have developed basic rules for private stablecoin issuers that we think are reasonable. For example, they must have appropriate minimum liquidity as a reserve”.

Regarding Terra, Schwerin sees the whole thing as a learning process, saying, “The next similar project will simply be better because people have already had this experience. It is a natural evolution of innovation.”

Despite this, there are doubts about whether stablecoins will find a home in the EU. The largest stablecoins — Tether (USDT) and USD Coin (USDC) — are pegged to the United States dollar, with Circle’s euro-pegged stablecoin also issued outside the eurozone. When MiCA comes into force, should we expect more euro stablecoins?

Schwerin hasn’t ruled out the emergence of new euro stablecoins in the EU, but he isn’t expectant either. He says that the macroeconomic context, geopolitics, monetary policy and the euro are simply not moving in that direction.

The MiCA alone is unlikely to significantly increase the number of euro-denominated stablecoins in the euro area, Schwerin stated. “However, MiCA could help us to become more open to stablecoins as a whole.”

When asked whether MiCA could become a ground-breaking global regulatory standard, Schwerin said he sees great interest from other countries, especially the United States. In his view, MiCA is a particularly good example of a regulatory approach that is both innovative and liberal for global regulation of the financial sector.

“However, even though MiCA is ready, we have to be aware of the pace of innovation in the crypto sector and the new challenges it will bring. It was, is and continues to be a long process of learning.”

The views expressed in this interview are those of Schwerin personally and do not reflect or represent the official position of the European Commission.

Europe’s digital ID wallet — Easy for users or a data privacy nightmare?

On March 15, the European Parliament voted 418 to 103 (with 24 abstentions) in favor of negotiating a mandate for talks with the European Union member states about revising the new European Digital Identity (eID) framework and creating the “European Digital Identity Wallet,” also known as EUDI Wallet or EU wallet. 

Citizen’s IDs, health cards, certificates and many other documents could soon be digitally stored in a smartphone application for EU citizens.

According to an official statement from the European Parliament, the system would allow citizens to identify and authenticate themselves online without relying on big commercial providers like Apple, Google, Amazon or Facebook.

The new eID framework will purportedly give EU citizens digital access to key public services across the EU. Citizens will remain in “full control of their data” and be able to “decide for themselves what information to share and with whom.”

European lawmakers have set an ambitious goal for this new wallet, aiming to bring it to 80% of the population by 2030. This could be achieved by mandating that the wallet be supported by e-government services and companies that have a legal requirement to identify their customers through Know Your Customer checks. It could require major online platforms like Google or Facebook to offer the EU wallet to log in to their services, with soft law and delegated acts that could require small and medium-sized enterprises to support the wallet.

Negotiations with the European Council on implementation would be the next step, but digital transformation and data protection experts have doubts and differing opinions about implementing the wallet.

Usability is the key to adoption

The EU wallet — like the current electronic ID cards in Germany and other European countries — will hardly be adopted by citizens in their daily lives if it doesn’t offer a good use case.

The challenge is to make it easier and more efficient for citizens to interact with public services and administrations, enabling authentication and verification processes, especially in the private sector.

According to Clemens Schleupner, policy officer of digital identity and trust services at Germany’s digital association Bitkom, the possibility of storing electronic IDs on a smartphone to use online as well as digitizing drivers’ licenses, health cards, passports, tickets, school reports, credit cards, membership certificates, etc., and combining them into one wallet could have mass market potential.

Applying for a bank loan with eID. Source: European Commission

The EUDI Wallet could make that happen; however, this will only succeed “if adoption among citizens in Europe is ensured through security and usability, relevance through a high number of possible uses and interoperability of different applications throughout Europe,” Schleupner told Cointelegraph.

Lack of usability and public awareness are also significant concerns for Christof Stein, spokesperson for Germany’s Federal Commissioner for Data Protection and Freedom of Information (BfDI).

Stein told Cointelegraph that using proven technologies and trusted infrastructures with enforced IT security and data protection standards are crucial for citizens using the EU wallet.

Privacy is king

As the final rules are not yet known, it is too early to evaluate the EU wallet at this early stage of implementation. For citizens, it is important that the legal framework provides a data-saving solution that only lets organizations ask for user data when they need it.

According to Stein, it is critical that users are protected from tracking by wallet providers, and wallet providers must ensure that wallet data processing is in line with legal requirements.

“What is necessary is a central anchor of trust enabling the enforcement of rules for the protection of individuals. For example, the infrastructure must be designed so that all organizations participating in the system must register to ‘identify’ themselves to users.”

The previous proposal from the European Commission lacked essential privacy safeguards that would have enabled third parties to obtain data about user transactions, possibly allowing bad actors to exploit the system for identity theft or fraud.

According to Thomas Lohninger, executive director of data protection Austrian NGO, the European Parliament has drastically improved the law and adopted a good position in the first reading. He told Cointelegraph:

“It is unlikely that the Parliament will win 100% of the trialogue negotiations. But we hope that the Council and the Commission will realize that the success of the whole system depends on the privacy and trust that is built in. Only if it is the trusted and chosen tool of citizens for their most sensitive health, identity and financial data can the European Digital Identity Wallet be a success.”

The problem of “over-identification”

Lohninger also warned of “over-identification,” i.e., if everyone in the EU is obliged to always use the wallet, this could lead to a loss of anonymity and pseudonymity in everyday interactions.

BfDI’s Stein shared this view, arguing that there should be no general obligation to use the EUDI Wallet and that there should be alternatives.

The European Parliament appears to have heard these concerns, as one of the most important safeguards in the recently passed identity framework is a non-discrimination clause that “protects anyone who chooses not to use the EU wallet, whether it’s in access to government services, freedom of business or the labour market.”

In the European Parliament, all four committees adopted this safeguard with a cross-party consensus. Now this safeguard must survive the trialogue — negotiations with representatives from the European Parliament, the Council of the European Union and the European Commission.

What about zero-knowledge proofs?

As Cointelegraph reported, the EU’s Industry, Research and Energy Committee included a standard for zero-knowledge proofs (ZK-proofs) in its eID amendments.

This technology, which allows the selective disclosure of certain information — like revealing only one’s age, for example — could become a core function of the EU wallet, said Stein.’s Lohninger noted that ZK-proofs could provide “unlikability.” For example, someone could prove they are of age to someone else on different occasions without the latter party knowing the former is the same person.

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Although ZK-proofs allow personal data to be anonymized, Schleupner sees two challenges. First, ZK-proofs in their current application are “a new technology and vulnerabilities may arise if they are not implemented properly,” and second, “many use cases [of ZK-proofs] have not yet been conclusively evaluated.”

Before trusting the technology, EU regulators must ensure that ZK-proofs comply with privacy regulations and meet all specific requirements of the General Data Protection Regulation.

The trialogue at the EU has much to consider before passing eID into a usable, safe and reliable tool for Europeans. How regulators balance these considerations could have profound implications for other formers of digital or blockchain-based ID.

UBS’s acquisition of Credit Suisse brings some good and bad for crypto

On Sunday, March 19, the 167-year history of banking giant Credit Suisse ended with a takeover by the largest Swiss bank, UBS. Under pressure from the Swiss government, UBS took over its ailing competitor for 3 billion Swiss francs ($3.25 billion) — less than half the $8 billion market value of Credit Suisse just two days before, on Friday, March 17. 

A day later, on March 20, shares in Credit Suisse plunged more than 60% in European trading, with UBS down 9%.

To cover any losses UBS may incur in the deal, the Swiss government will provide $10 billion. The Swiss central bank will also make a $108 billion bankruptcy loan available to the banks.

Swiss publication, the Neue Zürcher Zeitung, called the takeover the “biggest economic earthquake in Switzerland since the rescue of UBS in 2008 and the grounding of Swissair in 2001.” A rescue should prevent a crisis that spreads to other banks, akin to what happened 15 years ago after the bankruptcy of Lehman Brothers in the United States. The takeover of Credit Suisse was “necessary” not only for Switzerland but for the stability of the entire global financial system, argued Swiss Confederation President Alain Berset.

Billion-dollar merger over a weekend

The deal spurred mixed reactions in the Swiss political arena. The Free Democratic Party of Switzerland (FDP) praised it, stating that the takeover was necessary to avoid severe damage to Switzerland as a financial and economic center.

Criticism came from the co-president of the Social Democratic Party of Switzerland, Cédric Wermuth, who tweeted that nothing had changed since the 2008 financial crisis. “The whole financial system is sick and absurd,” he said, adding that the state must step in again and save it.

The “Occupy” movement at Paradeplatz in Zurich, where UBS and Credit Suisse branches are located next to each other. Source: Ronald Zh

Marcel Fratzscher, president of the German Institute for Economic Research, believes the takeover could lead to one giant bank, which would provoke instability across the board in the event of a notional collapse.

In an interview with Die Tageszeitung, the German economist said the current situation is nowhere near as worrying as before the global financial crisis of 2008. “Today, it is the sharp increases in interest rates by the central banks that have taken many financial institutions by surprise and have led to massive losses.”

In other words, the problem today is “not systemic interdependence between financial institutions or inadequate provisioning in terms of liquidity and capital, but unusually aggressive monetary policy.”

‘Regulatory pressure is likely to increase’

“This takeover of Credit Suisse by UBS has sent many into a deep shock,” said Olga Feldmeier, co-founder of Swiss investment platform Smart Valor, speaking to Cointelegraph. Until 2014, she was an executive director and head of sales in the wealth management business at UBS.

“It had been known for a long time that things were not going so well at the bank. But who would have thought that the bank, which was once worth $80 billion, would be the subject of a $3 billion takeover by its arch-rival UBS?” According to Feldmeier, it’s not just the 50,000 employees who are shocked. The lenders have been hit even harder, especially those with a special high-grade bond type — the so-called Additional Tier 1 Capital.

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But when asked what the alternative would be, Feldmeier agreed that without this takeover, the consequences would be catastrophic. “After all, where is it safe if one of the top 30 systemically important — and Swiss — banks go bankrupt? In a systemic bank run, neither the European Central Bank nor the Fed would be able to help.”

Mauro Casellini, board member at CCA Trustless Technologies Association and, until January 2023, CEO at Bitcoin Suisse Liechtenstein and head of Bitcoin Suisse Europe, shared a similar view.

He told Cointelegraph that it was right that the government and regulators in Switzerland acted quickly to find a solution with the least possible negative impact on the market.

“Although there had been signs for some time that things were not going smoothly at Credit Suisse, it was difficult for outsiders to see just how critical the situation was. It is too early to say whether this was the right solution, but the sheer size of this new ‘super bank’ is impressive and regulatory pressure is likely to increase,” Casellini said.

The good and the bad

The banking crisis has brought some good and some bad for crypto. Despite negative macroeconomic developments, the crypto market performed well when news broke that UBS would take over Credit Suisse. Bitcoin (BTC) won the crypto rally with a gain of 15.5% (reaching $28,671 on March 22). Ether (ETH) gained 3.9%. Driven by the BTC price rally, the share prices of listed Bitcoin mining companies have risen by as much as 120% since the beginning of the year.

According to Feldmeier, it’s a positive phenomenon for crypto exchanges, both big and small. “More trading, higher sales, some of the long missed tailwind would not hurt our industry,” said Feldmeier. “This also increases the certainty that the Bitcoin cycle keeps what it promises — namely, the next bull run around Bitcoin halving in March 2024”.

The loss from clients and investors in traditional financial institutions could positively affect the crypto market as investors turn to alternative assets, such as cryptocurrencies.

However, the Credit Suisse acquisition and the fact that the banking industry faces many different risks and challenges worldwide also has a negative side. Banks are still important partners for crypto companies. If banks are not doing well, they will be even less willing to work with crypto companies or raise fees, which will not make life easier for the crypto industry.

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The recent closures of fiat on- and off-ramp banks such as Silvergate and Signature, followed by the collapse of Credit Suisse, have created “significant risks for the crypto market,” said Casellini. According to the expert, it was necessary “to address issues such as regulation, security, and transparency to build trust with investors and ensure the long-term viability of the market. Regulation will help our industry in the long run to build a successful and more decentralized alternative to the traditional financial system.”

Casellini also expects to see more challenges and risks in the future due to the changing interest rate landscape and additional requirements on banks.

“It will be interesting to see how governments and especially national banks react, and whether they will save struggling banks or let them fail.”