July 2024 Recap
Rest assured, LexDAO is bringing home the gold
Well folks, it’s official. Summer is in full swing, and we all know what that means. Plenty of time spent outdoors, tasty grilled meals with family and friends, and pool parties. But no summer is complete without a newsletter from your favorite name in web3, LexDAO! Join us to learn about MiCA, what has happened this past month, and what you should be keeping an eye out for.
What’s New at LexDAO
We laugh. We cry. At times we just can’t help but be mired in the sheer, incomprehensible weight of our immense talent. But one thing is for sure. Nobody does it like LexDAO, and this month we are back with another banger. Read on for recent headlines in the web3 world, how MiCA affects crypto operations in the European Union, and our most recent Study Group session taking its own dive into the MiCA waters.
LexNews+ Weekly Highlights
written in part by Kyler (@kyler56)
The Battle for Ethereum ETFs: A Timeline and Analysis
The journey toward the approval and launch of Ethereum ETFs has been a tumultuous one, mirroring the broader regulatory and political challenges faced by the cryptocurrency industry. Here's a brief historical timeline and analysis of the major events and players involved in this saga.
Historical Context and Initial Developments
The SEC's approval of Bitcoin ETFs in early 2024 set the stage for a potential wave of similar products, including those based on Ethereum, the second-largest cryptocurrency by market capitalization. On July 23, 2024, the SEC approved eight spot Ethereum ETFs, marking a significant milestone. These funds allow investors to gain exposure to Ether without directly holding the asset, catering to a growing demand from retirement accounts and other traditional investment vehicles.
Prior to the approval of spot Ethereum ETFs, the market offered Ethereum strategy ETFs, which utilized futures contracts to track the price of Ether. However, these were seen as less accurate and more expensive compared to the newly approved spot ETFs.
Key Players and Market Reactions
Several major financial institutions and asset managers have entered the Ethereum ETF space. Notable among them are BlackRock, Fidelity, and Grayscale, each offering distinct products with varying fee structures. For instance, the iShares Ethereum Trust (ETHA) by BlackRock offers a promotional fee waiver, reducing fees to 0.12% for a specified asset amount.
Despite the initial enthusiasm, the market's reaction has been somewhat subdued. For example, on the first day of trading for these ETFs, Ether's price actually dipped slightly. This tepid response can be attributed to the large outflows from Grayscale’s Ethereum Trust (ETHE), as investors who bought at a discount to net asset value converted their shares into Ether, further depressing prices.
The SEC's Evolving Stance and Political Dynamics
The SEC's approval of Ethereum ETFs is seen as a softening of its stance towards crypto, following a series of legal defeats, including a notable case against Grayscale. The SEC's regulatory push has faced criticism and scrutiny, particularly from political figures. The upcoming U.S. presidential election adds another layer of complexity. With President Biden announcing he will not seek re-election, Vice President Kamala Harris, the likely Democratic nominee, has shown interest in courting the crypto community, which comprises a significant portion of the electorate. Approximately 46 million Americans hold cryptocurrency, making them a crucial demographic.
Analysis of Inflows and Outflows
Since their inception, the new spot Ethereum ETFs have experienced mixed results. BlackRock's Ethereum ETF, for instance, saw inflows of $118 million, surpassing its Bitcoin counterpart's $75 million on a notable trading day. However, this positive trend is overshadowed by substantial outflows from Grayscale's product, resulting in a net negative inflow of $400 million across all Ethereum ETFs.
Analysts suggest that once Grayscale’s high-fee Ethereum product is fully unwound, other ETFs might see more stable inflows. This could potentially lead to a price rebound for Ether, especially if market conditions improve, such as through anticipated Fed rate cuts or favorable political developments.
Future Prospects
The future of Ethereum ETFs looks cautiously optimistic. While they currently do not offer staking, which is a significant attraction for direct Ether holders, the products provide a regulated and more accessible way for institutional investors to enter the crypto space. The industry's response, coupled with political shifts and ongoing regulatory changes, will likely shape the landscape for these financial instruments.
Sources:
Private Law aspects of MiCA
written by DG
The Markets in Crypto-Assets Regulation (MiCA) is one of the first regulatory frameworks aimed at creating a harmonised law for European crypto markets. The EU is once again trying to be at the forefront of regulation and may be recreating the well-known "Brussels Effect.”1 The main objectives of the regulation are to promote the new technology, increase market stability and protect investors.2
To achieve this, the EU places an emphasis on public law regulation as it requires crypto companies to adhere to strict and extensive standards. A smaller part of the regulation deals with private law and how individuals can protect themselves in inter-party dealings. This article takes a look at the private law provisions of MiCA and how they are structured.
Right of Withdrawal
The Right of Withdrawal is set forth in Art. 13 (1) MiCA and provides retail holders of crypto-assets with a right of withdrawal against the offeror or, under certain circumstances, from the crypto-asset service provider.
The object of withdrawal is a crypto-asset other than an asset-referenced token (ART) and e-money token (EMT). These tokens are excluded because they are already redeemable against their underlying asset and thus holders do not require special protection.
The person exercising the right of withdrawal must be a retail holder. According to Art. 3 (1) (37) MiCA, a retail holder is any natural person who is acting for purposes which are outside that person’s trade, business, craft, or profession. Some might remember this wording as it is heavily influenced by the definition of “consumer in the Consumer Rights Directive.3 The implementation of this definition expresses and underlines the telos of this provision. It aims to protect persons that are affected by a power imbalance with the counterparty to a transaction.
The counterparty must be an offeror or a crypto-asset service provider placing crypto-assets on behalf of that offeror. Offeror is legally defined in Art. 3 (1) (13) MiCA as a natural or legal person or other undertaking or the issuer who offers crypto-assets to the public.
A crypto-asset service provider may be a counterparty if it is placing crypto-assets on behalf of that offeror. Crypto-asset service provider is defined in Art. 3 (1) (15) MiCA as a legal entity or other undertaking whose occupation or business is the provision of one or more crypto-asset services to clients on a professional basis and which is authorised to provide crypto-asset services in accordance with Art. 59 MiCA.
The retailer has a right of withdrawal once he has purchased a crypto-asset. The provision does not provide any further explanation of the purchase process. Therefore, a broad scope of application can be assumed, which is also underlined by the telos of the provision. This interpretation is also supported by Maume, who states that the overall nature of the contract is irrelevant for the right of withdrawal, which also includes so-called "over-the-counter" transactions.4
One of the few cases where the right of withdrawal does not apply is in the case of stakes or loans, as these are planned transfers and not one-way purchases.5 A further exclusion from the right of withdrawal is where the tokens have been admitted to trading before purchase by the retail holder.6 The purpose of this exclusion is to protect the offeror from a retail holder who exercises his right of withdrawal in mala fide solely because of the change in market price. This idea, once again, comes from the Consumer Rights Directive, which excludes the right of withdrawal for goods subject to price fluctuations.
Prior admission to trading includes the admission of crypto-assets to trading on a trading platform for crypto-assets within the meaning of Art. 1 (2) lit. a MiCA. The tokens do not necessarily have to be purchased on such a regulated platform. It is only important that there is a general market price on such a platform for the purchased tokens, as this could motivate holders to exercise their right of withdrawal.7
The right must be declared by the retail holder to the counterparty within 14 days after the agreement was concluded. The time period may be shorter if the offeror set a time limit on their offer to the public in accordance with Art. 10 MiCA (Art. 13 (5) MiCA).
The legal effect of the right of withdrawal is that the offeror or crypto-asset service provider has to reimburse the retail holder for all payments that they made within 14 days after they declared the withdrawal (Art. 13 (2) MiCA). The reimbursement must make the holder whole and include any transaction or exchange fees. To ensure a known reimbursement process, the retail holder must receive the reimbursement in the same way that they purchased the assets.
Whitepaper Liability
The whitepaper liability mirrors the common concept of prospectus liability which is known within traditional financial markets. The EU adopted the term Whitepaper, which is widely used in the industry. MiCA provides clear guidelines for publishing whitepapers and related questions of connected liability. The whitepaper liability is regulated for ART (Art. 26 MiCA), E-Money (Art. 52 MiCA) and crypto-assets other than asset referenced token and E-Money (Art. 15 MiCA).
The claimant must be a holder of crypto-assets, EMT, or ART. Depending on the category of token, the counterparty differs. For crypto-assets, the counterparty is governed by Art. 15 (1) MiCA, the offeror, the person seeking admission to trading or the operator of a trading platform and the members of its administrative, management or supervisory body.
For EMT and ART the liability addressee is the issuer so a natural or legal person, or other undertaking, who issues crypto-assets (Art. 3 (1) (10) MiCA).
The party is liable if the whitepaper is not complete, fair, or clear or if it is misleading.8 The exact requirements that the parties have to fulfill are different for crypto-assets, EMT, and ART and governed by Art. 6, 19 and 51 of MiCA.
In the case of a breach of duty, the holder has to provide proof that he bought the crypto asset based on the wrongful information.9 This means that the burden of proof on the issue of causality of damage lies with the crypto-asset holder, which weakens the possibility of a liability claim by the holder. This creates a serious hurdle for claimants, as it is often difficult to provide such proof. The question is whether this is a fair approach given the tremendous information-driven volatility in crypto markets. It may be better to follow the fraud on the market theory and assume that causality.
Liability does not require any intentional wrongdoing by the parties with respect to the breach of duty. This means that the publisher of a whitepaper may be liable in any case. The only requirement is an objective breach of duty. This approach has been criticized by Zickgraf as the current regulation of whitepaper liability leads to excessive diligence in the preparation of disclosure documents resulting in wasted economic resources.10 On the other hand, this approach has a holder-friendly effect, which might balance out the requirement of providing proof of causality.
If the previous requirements are met, the crypto-asset provider is liable for any loss incurred.11 The regulation does not provide any further explanation on the matter. Considering the choice of the word “loss” instead of “damage” one could argue for a narrow interpretation that focuses on the loss that occurred due to price changes of the crypto-asset.12 This interpretation also makes sense when looking at other European prospectus regulation. The cost of any additional transaction or fee are typically not included.13
Another point that is not clearly ruled is the handling of contributory negligence and the impact on the loss calculation. These gaps will have to be addressed by the European or national lawmakers.
Losses in Reserve Assets
Art. 37 (10) MiCA governs the liability for losses in reserve assets of issuers for ART.
Under Art. 37 MiCA, issuers of ART have specific obligations regarding the custody of reserve assets. They must ensure that reserve assets are held securely, avoid concentration of the reserve assets by custodians, and provide accessibility for the issuer to guarantee a fast redemption process for the holder. The aim is to maintain stability and confidence in the value of these tokens, reduce risk to investors, and ensure compliance with regulatory standards.
The parties that are addressed in Art. 37 (10) MiCA are the custodian, which could be a credit institution, investment firm, or crypto-asset service providers (CASPs), and the Issuer of an ART. The term custodian is not legally defined in MiCA but can be understood as a service provider that holds financial-, crypto-, or other assets on behalf of a third party. An Issuer is according to Art. 3 (10) MiCA a natural or legal person, or other undertaking, who issues crypto-assets.
The subject of liability must be a financial instrument or a crypto-asset. Financial instruments are not specifically defined but include a basket of investment products such as bonds, stocks, derivatives, and commodities. Crypto-assets are legally defined in Art. 3 (1) (5) MiCA and include digital representations of value or of a right that is able to be transferred and stored electronically using distributed ledger or similar technology. These assets must be held in accordance with Art. 37 (6) MiCA, which describes the way different types of reserve assets must be custodied.
The breach of duty is the loss of the reserve assets. “Loss” is not precisely defined, but looking at the telos of the reserve assets, liability can be assumed when the reserve assets are inaccessible to the custodian or issuer and thus cannot fulfill their purpose as reserve assets for the ART.
The liability is exempted if the custodian can prove that the loss occurred as a result of an external event beyond his reasonable control, the consequences of which were unavoidable despite all reasonable efforts to the contrary.14 This exemption is fair since, in the case of force majeure, the loss results out of the general risk of reserve assets and is not connected to failure of the custodian. Reasonable efforts tend to be defined by industry standards and may include proper security measures against all expectable attack vectors. These safety measures could be different depending on the nature of the stored reserve asset.
If the custodian did lose reserve assets and could not prove force majeure or reasonable efforts, he is obliged to compensate or make restitution to the issuer of the ART with a financial instrument or a crypto-asset of an identical type or the corresponding value without undue delay.15
The right of redemption is governed by Art. 39 (1) MiCA. It regulates the redemption right of a holder of an ART and thus provides an essential framework for the safe use of ART. The holder of ART have the right to redeem their ART against the reserve asset from the issuer if the issuer fails to comply with the regulatory requirements.
The obligations of the issuer are governed by Chapter 6 of MiCA and include a recovery plan with appropriate conditions and procedures to ensure that remediation measures can be implemented quickly. It must include a wide range of remediation options and further address the liquidity on redemption, limits of one the amount of the ART that can be redeemed in one working day and suspension of redemptions. Furthermore the issuer must notify the authority of the recovery plan within six months of the authorisation or approval of the crypto-asset white paper.16 The recovery plan must be regularly reviewed and updated, though it is unclear what time interval meets this standard.17
The issuer also must draw up and maintain a plan for the redemption of ART against the reserve asset.18 The plan has to show that the redemption process works without any economic harm to the holders of the ART and provide information on contractual agreements, procedures, and systems and the designation of a temporary administrator with applicable law to ensure the that ART holder are paid in timely manner by the sales of the reserve assets.19 It should also ensure the continuity of critical activities performed by the issuer or third parties.20
The issuer must also notify the competent authority of the redemption plan within six months of the authorisation or approval of the crypto-asset whitepaper and review and update it on a regular basis.21
To exercise the right of redemption, the holder has to request a redemption. The provision does not require any further formal criteria for the request, which is in favour of the holder as he can choose any kind of request method. The redemption can be done by paying an equivalent amount in funds based on the market value of the asset referenced by the token or by redeeming the actual reserve asset that is referenced by the token.22 The issuer has the choice of which kind of fund he provides the holder with. This choice is limited if the issuer accepts an official currency in exchange for the sale of the reserve asset, in which case it must then redeem the asset in the official currency to the holder.23
Besides that, the issuer must define the terms of redemption, the redemption mechanisms, the valuation principles, and the settlement conditions for the ART holder to ensure transparency. The holder should not have to pay a fee for the redemption of the ART.24
Liability for the loss of crypto-assets
Art. 75 MiCA addresses the general obligations that CASPs have towards their clients, when they provide custody or administration of crypto-assets. Liability for CASPs in relation to their clients for the loss of crypto-assets is governed by Art. 75 (8) MiCA.
CASPs are legally defined in Art. 3 (1) (15) MiCA as a legal person or other undertaking whose occupation or business is the provision of one or more crypto-asset services to clients on a professional basis, and that is allowed to provide crypto-asset services in accordance with Art 59 MiCA. A client is a natural or legal person that uses the service provided by the CASPs.
The client of a CASP may have a claim if the CASP loses the crypto-assets by itself or if it loses the means for the client to access them. The loss must be attributable to the CASP and may be excluded if it is attributable to the client or another third party.
Attribution is assumed as the CASP must prove that the loss occurred independently of the provision of the relevant service, or independently of the operations of the crypto-asset service provider, such as a problem inherent in the operation of the distributed ledger that the crypto-asset service provider does not control.25 The liability is capped and is based on the market price at the time of the loss of the crypto-asset.26 The CASP’s culpability for the loss of crypto-asset is not necessary, qualifying the Art. 75 (8) as imposing strict liability.
Conclusion
MiCA provides some private law regulation which is clearly influenced by other European Directives, such as the Consumer Rights Directive. The framework tries to strike a good balance between adequate protection of users and freedom of action for businesses. Some provisions leave questions unanswered and may leave room for Member States and national legislation to develop further. But it remains to be seen how the practical impact of private law regulation will affect the general crypto market once MiCA comes into force in July 2024.
Bibliography
Buck-Heeb P, ‘Whitepaper-Haftung Nach MICA' (2023) 689 Zeitschrift für Bank- und Kapitalmarktrecht.
Bradford A, ‘The Brussels Effect’ (2012) 107 Northwestern University Law Review 1, Columbia Law and Economics Working Paper No. 533.
Maume P, ‘Das Widerrufsrecht nach MICA' (2023) 493 Recht Digital.
Meier J, Schneider A and Schinerl F, ‘Staking via Intermediär‘ (2023) 365 Zeitschrift für Bank- und Kapitalmarktrecht.
Zickgraf P, ‘Primärmarktpubliziät in der Verordnung über die Märkte für Kryptowerte’ (2021) 362 Zeitschrift für Bank- und Kapitalmarktrecht.
Legislation
Directive 2011/83/EU of the European Parliament and of the Council of 25 October 2011 on consumer rights.
Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets.
LexDAO Internal Updates
As LexDAO continues to grow and evolve, we have realized the need to refine our governance processes to better serve as an example of what is possible to others within the web3 community. As part of this, LexDAO will be introducing more structure into its ongoing relationships with members and contributors to strengthen the DAO’s legal standing and mitigate risks. This means better defining its relationship with active members in the DAO through structured agreements that more clearly define the DAO’s ongoing rights and obligations.
We are also tightening our budget and looking for support from members and others in the community to aid us in our ongoing sponsorship and grants efforts, as well as looking for additional contributions to our publications. Anyone interested in helping out can qualify for membership by assisting the DAO in its ongoing projects. So if the price tag on membership seems prohibitive for any reason, you can get involved and earn a seat at the table.
If you are interested in contributing, stop by our Discord server and let us know what you would like to work on!
LexDAO Study Group Session on MiCA
LexDAO’s Paolo Maria Gangi (@pmgangi on Discord and @PaoloMGangi on X) put together another excellent Study Group Session together with EUCI on July 23 on Titles II, II, and IV of the Markets in Crypto-Assets Regulation (MiCA). This study group session focused on the rules established by MiCAR for tokens (utility tokens, assets referenced tokens [ART], e-money tokens [EMT], and NFTs) and featured a number of panelists: Vyara Savova from EUCI; BLD founder, Francesco Paolo Patti "Eagle"; EUCI founder, Marina Markezic; Bird&Bird financial law specialist, Peter Paulikovics; and Elvin Sababi, junior partner at Nordic Legal.
A video of the event will be posted on LexDAO’s YouTube channel. If you would like to stay up-to-date on future Study Group Sessions, make sure to visit our Discord to stay on top of new events as they are planned!
Upcoming Events
MCON
Metacartel is hosting MCON III on September 26 - 28, 2024 in Detroit, MI. This will be “…a [three day] gathering of dynamic DAO Operators, Governerds, and Builder-Philosophers to reconnect to the vision and values of decentralization, and dive deep into innovative onchain experiments and the spiciest topics of Web3.” LexDAO will be joining the event as co-organizers and sponsors. Any and all LexDAO members interested in attending should reach out today to get involved!
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Bradford, 107 Northwestern University Law Review 2015, 1
Recital 4-6, Regulation (EU) 2023/1114.
Art. 2 (1) Directive 2011/83/EU
Maume, 'Das Widerrufsrecht nach MiCA' (2023) Recht Digital 493.
Meier, Schneider, and Schinerl, 'Staking via Intermediär' (2023) 365 Zeitschrift für Bank- und Kapitalmarktrecht.
Art. 13 (4) Regulation (EU) 2023/1114.
Recital 37, Regulation (EU) 2023/1114
Articles 15, 26, and 52, Regulation (EU) 2023/1114.
Articles 15 (5), 26(3), and 52 (3), Regulation (EU) 2023/1114.
Zickgraf, 'Primärmarktpublizität in der Verordnung über die Märkte für Kryptowerte' (2021) Zeitschrift für Bank- und Kapitalmarktrecht 362.
Art. 15 (1), Regulation (EU) 2023/1114.
Buck-Heeb, 'Whitepaper-Haftung nach MiCAR' (2023) Zeitschrift für Bank und Kapitalmarktrecht 689.
Ibid.
Art. 37 (10) Regulation (EU) 2023/1114.
Art. 37 (10) Regulation (EU) 2023/1114.
Art.46 (2) Regulation (EU) 2023/1114.
Ibid.
Art. 47 (1) Regulation (EU) 2023/1114.
Ibid.
Ibid.
Art. 47 (3) Regulation (EU) 2023/1114.
Art. 39 (2) Regulation (EU) 2023/1114.
Ibid.
Art. 39 (3) Regulation (EU) 2023/1114.
Art. 75 (8) Regulation (EU) 2023/1114.
Ibid.