Barely a year after the start of the European Union’s Markets in Crypto Assets (MiCA) regime, formulated to provide a unified regulatory environment across the 30 nations of the European Economic Area, the cracks are beginning to show and there are signs that EU regulators are seeking to ensure they do not widen further.
Concerns have already been raised that some member states are granting licenses too hastily, and reports are now emerging that the European Securities and Markets Authority (ESMA) is preparing to take greater, more centralized control of cryptocurrency regulation in all countries within its purview.
So far, there are few details about ESMA’s plans, but policy watchers at MiCA know where the clues lie. One likely change, which seems technical but could have significant knock-on effects, concerns the sharing of liquidity outside the EU and the use of unified order books.
From a regulatory perspective, a shared order book blurs who is responsible for matching, disclosure, risk management and best execution. From a traders perspective, pooling buy and sell orders across a broader population creates greater liquidity, easier transactions, and more accurate pricing.
ESMA declined to comment specifically on shared order books, but said in an email that the position expressed in a Q&A session earlier this year (which states that MiCA does not allow a cryptocurrency trading company to pool its order book with any non-EU or MiCA-regulated trading platforms) “is part of the effort that ESMA has made, and continues to make, to ensure a level playing field in the application of MiCA in the EU.”
“Shared order books are something that has been possible for a long time and creates a lot of liquidity,” Nikolai de Koning, a financial services lawyer at Norton Rose, said in an interview. “But since the ESMA Q&A, regulators have been asking applicants and companies how they separate order books. So companies have had to demonstrate how they separate those order books, and this includes some of the larger exchanges. Some of the platforms created separate order books, i.e. non-EU and non-EU exchanges, which could actually operate separately.”
Pushing for clarity
Part of the push for more centralized supervision comes from EU countries’ own regulators, the so-called national competent authorities. France’s financial watchdog AMF, Austria’s FMA and Italy’s Consob called on ESMA to take stricter control of MiCA in a co-authored letter in September. The AMF was specific about local order books in an email to CoinDesk:
“The reference to maintaining effective control within the EU is intended to capture, among other things, the need for trading and execution activities – including through local order books – to be effectively located and supervised within the Union,” the AMF said.
“From our perspective, it is important that this interpretation is made explicit in Level 1 of the MiCA framework. Incorporating this clarification directly into the legislative text would ensure greater legal certainty and more effective supervision by avoiding ambiguities about what constitutes genuine EU substance and control over cryptocurrency trading infrastructure,” the regulator said.
What would be the impact of this? Historically, cryptocurrency trading companies have shared liquidity with platforms outside the EU, so any changes will be very relevant for most cryptocurrency trading platforms and ultimately also to prop up companies trading in cryptocurrencies and many other parts of the market, de Koning said.
The devil will be in the details when it comes to what is acceptable to EU regulators, who are still refining their approach. There are platforms that share liquidity, but operationally maintain separate books: There is some routing between the books, but the true matching happens at each location separately, de Koning said. In such cases there is no completely unified ledger, but there are still some benefits of sharing liquidity.
Widening spreads
According to de Koning, changing a shared order book is not only operationally and legally burdensome, but will also have an impact on EU markets.
“This will further concentrate price formation within the EU and will impact order flows and overall liquidity. The larger the pool, ultimately the better the liquidity for platforms and for users. My view is that forcing EU-only pools will likely fragment liquidity and widen spreads at first; markets typically adjust, but the adjustment will not be instantaneous,” he said.
For some crypto companies, the necessary adjustments may not be too difficult. But for a large exchange that draws on liquidity from outside the bloc, there could be significant operational changes.
US-listed Coinbase (COIN) could be one of those companies. Coinbase is authorized in Luxembourg as a broker. As such, ESMA’s “Opinion on the Corridor Model” is more relevant. This says that regulators in EU member states must ensure that any crypto company that submits an application “does not aim to obtain ‘legal cover’ in the Union for third-country companies seeking to solicit clients or potential clients in the Union through a MiCA-authorized entity (which generally belongs to the same group), while continuing to provide services from outside the Union.”
‘In the right place’
Tom Duff Gordon, vice president of international policy at Coinbase, said the opinion provided by ESMA “more or less landed in the right place” and that the situation does not require an immediate review. He also said it was “surprising” to see the joint proposal from the AMF, FMA and Consob calling for areas such as order routing to be reviewed, given that MiCA is barely a year old.
“At one point, it was unclear whether there were two valid parties or whether liquidity had to be internal. We have consistently argued that both models are legally viable. We currently operate a broker on our US exchange where we can provide best-in-class execution to European clients and great liquidity,” Duff Gordon said in an interview with CoinDesk.
“Honestly, we believe that by acting as a broker as we do, we can provide the best results for our clients,” Duff Gordon said. “I think that as long as you can do that, and as long as the European operations have enough substance – which is absolutely true for ours – and as long as the local entity has control over where the execution happens, then, a bit like international finance with MiFID, it is totally valid to have both types of broker models and local platform models.”
Coinbase’s regulator, the Commission de Surveillance du Secteur Financier (CSSF) of Luxembourg, said in an email: “In the context of MiCA, the CSSF acts in full respect of EU regulations and works in close cooperation with the other competent national authorities and the relevant European authorities for the purposes of supervisory convergence.”
Dea Markova, policy director at cryptotech firm Fireblocks, said it’s unclear whether being part of a large, heavily regulated group, such as Coinbase, will mitigate risk in the eyes of European regulators at the ESMA level.
“I think regulators are concerned that a broker in Austria, for example, wants to obtain liquidity from a US or South Korean exchange and typically has to pre-fund that exchange with some of its clients’ assets,” Markova said in an interview. “So if something happens to that exchange, clients’ assets will be lost.”
The debate for regulators now is where to draw the line, Markova added.
“If you think about it logically, everyone eventually gets their liquidity outside the EU. There’s not enough liquidity, so it’s just a question of how many steps they take to get there,” he said.
