Digital assets: how to decipher a cryptic phenomenon?

Benjamin Leisinger
Homburger, Zurich
Benjamin.Leisinger@homburger.ch

Report on the joint session of the Banking Law Committee and the Securities Law Committee at the 37th International Financial Law Conference in Venice

Thursday 12 May 2022

Session Co-Chairs

Dirk Bliesener Hengeler Mueller, Frankfurt

Benjamin Leisinger Homburger, Zurich

Speakers

Jan Ceyssens European Commission, Brussels

Professor Arthur Gervais Imperial College, London

Barbara Napolitano Gatti Pavesi Bianchi Ludovici, Rome

The panel on digital assets at the 37th International Financial Law Conference in Venice was co-chaired by Dirk Bliesener, Vice-Chair of the IBA Banking Law Committee and partner at Hengeler Mueller in Frankfurt, and Benjamin Leisinger, member of the IBA Securities Law Committee and partner at Homburger in Zurich.

Dirk Bliesener started the panel discussion by introducing the panellists and topic. Professor Arthur Gervais, who, in addition to his academic career and research, also founded several companies in the crypto space, then explained some of the fundamentals of crypto markets. He explained the different asset standards (native coins, fungible token and non-fungible token), the inherent nature of composability (ie, the feature of crypto networks to take existing programs and adapt or build on top of them, unlocking completely new use cases – comparable to a Lego set) and the concept of ‘atomic’, that is, instantaneous, settlement of transactions.

Professor Gervais then gave specific examples of behaviour that would – if done in connection with traditional financial instruments – constitute market abuse and come within the scope of financial regulation. For example, in what is called a ‘sandwich attack’, an ‘attacker’ identifies the large purchase of a certain crypto asset by a ‘victim’, for example, by using a specific bot. The attacker then quickly ‘front-runs’ the large transaction of the victim before it is validated/approved and purchases said crypto asset, thereby increasing the price for the victim. The attacker then also sells the respective crypto asset at the increased price, possibly to the victim. Professor Gervais’s research shows that significant value is extracted from decentralised finance and other crypto markets by way of such market abusive behaviour and the resulting imperfect markets.

Barbara Napolitano continued by giving an overview of the European Union’s answer to crypto asset regulation: the proposed Markets in Crypto-Assets regulation (MiCA). In her speech, Napolitano focused on the proposed obligations and regulation of ‘crypto-asset service providers’. The proposed rules provide for well-known concepts, such as the duty to ‘act honestly, fairly and professionally’ and in the best interest of existing and prospective clients, prudential safeguards (eg, capital or insurance requirements), organisational requirements and so on.

Jan Ceyssens then guided the audience through the key design elements and reasoning of the pilot regime for distributed ledger technology (DLT) market infrastructures and MiCA. The DLT pilot aims to introduce a pilot regime for DLT market infrastructures pursuant to which such infrastructures can request exemptions from specific requirements embedded in EU legislation. The underlying idea of the DLT pilot is to ensure a level playing field across the EU and to define the exemptions and the conditions for granting them to market players. MiCA also aims to make EU regulation in this field more uniform. MiCA intends to be a comprehensive regulation for all actors across EU countries and to be complementary to existing financial market regulation.

The pointed questions and engaged discussion that followed the panellist’s speeches clearly showed that, while traditional lawyers and central bankers still question the intrinsic value of decentralised finance, they need to recognise that market abusive behaviour in the crypto sector is – or at least seems to be – unregulated. On the other hand, the discussion revealed that the apparent absence of intermediaries in the crypto world, such as in decentralised finance applications where software and code make traditional intermediaries and reliance on them superfluous, brings certain challenges that have not existed before – and where traditional concepts of regulation may not be the right answer, but rather concepts such as certifications from private auditors or similar gatekeepers may be the more promising approach to protect users.