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Regulation and compliance for Web3 companies

Published
December 14, 2023
Updated
October 27, 2023
< 3 min read

Linda Derkaca, the CCO and co-founder at Swaps visited the bootcamp for Web3 Startups Founders where she talked about the balance between decentralization and regulation, explores the MiCA framework and its implications for the web3 companies landscape.

We have been persuaded to believe that there’s no room for regulation in the decentralized web, but with a lot of turbulence that has hit the investors from the past months restates the need for a way to protect users and investors. Regulation and decentralization can coexist while remaining legally decentralized. Web3 is still a lawless landscape to date. Still, regulations are required to make decentralization safer and more acceptable for investors and also bring malicious actors to Justice. A new standard for products and services being offered in this space is inevitable. To restore the integrity lost due to widely spread hacks and scams in the space, a clear regulatory framework that protects user data and maintains privacy while being fair and transparent is required.

MiCA

MiCA is an acronym for the market in crypto assets which is a crypto regulatory framework poised to be a game-changer for crypto in the E.U. The law was created to safeguard the user’s fund better and eliminate the risk of anonymity in the entire crypto assets sector in every state under the European Union. The innovation-friendly framework is a consensus of each state, meaning that all regulation is the same across all the European Union States to avoid regulatory arbitrage. The situation where businesses can go legal shopping for the state with the most attractive regulatory framework might result in the race to the bottom among the E.U. states to attract more Business to their respective country.

The law defines a crypto asset as a digital replica of transferable values or rights electronically stored on the distributed ledger technology. All assets must be registered as obligated commodities to curb money laundering practices. Additionally, each E.U. State has to supervise every Business running any regulated services in their country. However, the legal requirements in the new framework seem problematic for new businesses looking to provide any of these services compared to the current market status. It may reinvent the monopoly culture of the web2, as critics say. What are the requirements? Let’s explore them one after the other.

MiCA Requirements

  1. Custody and administration of assets: The law states that businesses looking to help users store and manage assets must sign a formal agreement with their clients. The agreement should clearly state the responsibility of the Business. Additionally, a register of open or closed positions should be kept for each client. A clear policy to deal with custody is required. The business must regularly report to the clients. Clients’ assets must be distinguished from the businesses and stored separately. There should be compensation for users in the case of losses due to system errors or security breaches.
  2. Operation of trading platforms: Most prominent exchanges are known for being notorious for malicious activities like wrongly accusing innocent users of money laundering and blocking access to their assets. MiCA demands that special operating rules conform to the framework and be published publicly. A solid system should back the operations. Additionally, no more room for unforeseen charges as all fee structures must be made public and fair for all.
  3. Exchange of assets: The framework demands exchanges to come up with commercial policy without any discrimination highlighting the type of client they’re willing to work with, transaction size that can be processed or subjected to delay, plus any condition clients need to fulfil to use their service smoothly. Many exchanges are characterized by fees beyond customers’ knowledge that only materialized while using their service. To end that, the law demands Service cost and pricing methods to be made accessible for the public before commencing operation. All transactions receipt must be published to the customers.
  4. Order execution: Exchange must provide an order execution policy. Must also craft and implement the best strategy for order execution.
  5. Advice: The advisor must clearly evaluate the compatibility of the assets recommended with the client’s needs and be sure to warn about the volatility of the recommended asset.
  6. Coin Emission: Before launching any coin developer must create a whitepaper featuring all the info about the coin. The info needed includes: About the issuer, what they would do with the fund realized from the coin sale, The tech behind the token and the risks attached to it.

SEC Cracking Down on Crypto in the United States

The U.S. Securities and Exchange Commission (SEC) is responsible for enforcing and overseeing security laws in the united states. SEC has suddenly made the move to announce over 50 crypto coins as securities hence must be registered with them and comply with all the rules guiding securities in the state. Crypto exchanges offering the trade of such assets are not exempted. The body urges them to comply with security laws and allow them to oversee their operation to protect investors’ funds.

The pressure on exchanges intensified after the third largest crypto exchange in the world(Ftx) filed for bankruptcy in September 2022, to the extent of suing the two largest exchanges with different allegations.

Binance: Market Manipulation, Customers fund mishandling and wash trading.

CoinBase: Operating as an unregistered international security exchange.

None of them was found guilty yet, which has provoked the crypto community to criticize SEC for attempting to incriminate exchanges and commodities in the industry instead of creating a clear regulatory framework the sector demands.

Conclusion: Ultimately, The MICA regulation has been poised to protect users and create a plane ground between businesses and investors. However, the regulation didn’t cover the defi and nft sectors. Regardless, it’s a strong signal for a bright future in crypto. The difference in architecture between web3 and web2 demands a separate regulatory framework, not just trying to make it one-size-fits-all, which has increased the exchange account restriction rate. A regulatory framework designed for the sector should surface soon if the SEC is determined to protect investors.

Watch the complete interview on YouTube https://www.youtube.com/watch?v=3mDOl6a2NU0

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