Deciphering the Enigma: The Definitive Guide to Classifying Crypto-Assets According to ESMA. MiCA or MiFID 2?

On December 17, 2024, ESMA published a final report on criteria for classifying crypto-assets, ahead of the imminent entry into force of the MiCA regulation. Below is a brief guide to the most relevant issues addressed.

What type of criteria does ESMA consider to classify a crypto-asset as a financial instrument?

ESMA considers several criteria, including whether the crypto-asset confers ownership or voting rights, whether it resembles stocks, bonds, or other traditional financial instruments, or whether the asset can be considered an investment unit. The nature of the rights conferred by the token, the way it is traded, and the purpose stated by its issuer are key elements in the evaluation.

How does this report relate to the Crypto-Assets Markets Regulation (MiCA)?

The ESMA report helps clarify which crypto-assets should be regulated under the MiCA framework and which could qualify to be considered financial instruments, generating the need to comply additionally with other existing financial regulations, rather than just MiCA.

What is ESMA’s role in supervising crypto-asset markets?

In the context of crypto-assets, ESMA plays a key role in interpreting and applying the regulations, as well as promoting supervisory convergence among member states.

What do the ESMA Guidelines say?

Guideline 2 (ESMA) on the classification of crypto-assets as transferable securities (as transferable securities – art 4(1)(44) MiFID2)

1) Fundamental Criteria for Classification:

For a crypto-asset to qualify as a transferable security under MiFID II, it must cumulatively meet three criteria:

1. i. Although MiFID2 does not provide a definition of “payment instrument,” this is the first criterion: it must not be a payment instrument.
2. ii. It must belong to “classes of securities.” Tokens belonging to a “class of securities” are those that are interchangeable and grant holders similar dividends and voting rights. Being interchangeable requires them to have identical rights and obligations.
3. iii. It must be tradable in the capital markets.

2) Exclusion of Payment Instruments

1. A crypto-asset that meets the definition of a payment instrument cannot qualify as a transferable security. ii. An instrument that is used as a medium of exchange is considered a payment instrument.
2. iii. For crypto-assets with multiple components, including the payment instrument component, a case-by-case analysis is required.
3. “Classes of Securities” Criterion

3) To determine if it belongs to a “class”:

a) Main indicators:

1. i. Issuance by the same issuer.
2. ii. Interchangeability between assets (same rights and obligations).

b) Specific considerations:

1. i. Crypto-assets from the same issuance must confer the same rights and obligations.
2. ii. The existence of multiple classes in an issuance does not affect the classification if each class maintains clearly defined rights and characteristics.
3. iii. It must be evaluated whether the rights granted are equivalent to those typically conferred by a specific type of transferable security.

4) Examples of Classification by Rights

a) Similar to shares:

1. i. Represent ownership in the capital.
2. ii. Grant voting rights in corporate decisions.
3. iii. Include rights to dividends and liquidation.

b) Distinction in governance rights:

1. i. Corporate voting rights (typical of shares).
2. ii. Technical/operational governance rights (do not qualify as securities).

c) Utility tokens: Do not qualify as transferable securities if…:

1. They only provide access to services.
2. They do not offer financial returns comparable to financial instruments.
3. They lack the element of a class of securities.

5) Criterion of Tradability in the Capital Markets

a) Main requirements:

1. Ability to transfer or trade freely.
2. The abstract possibility of transfer is sufficient. iii. Inherent restrictions that prevent trading disqualify the asset.

b) Additional considerations:

1. DLT technology facilitates the transfer of ownership.
2. Restrictions must be evaluated on a case-by-case basis.
3. iThe interpretation of “capital markets” is broad.
4. Trading on online platforms can be an indicator but is not determinative.

6) Conclusion

To classify a crypto-asset as a transferable security, two dependent criteria must be met: i. Transferability and interchangeability (tradability and belonging to a class). ii. Possession of rights similar to those of other securities.

Guideline 3 (ESMA) on the Classification of Crypto-Assets as Money Market Instruments (as money-market instruments (art. 4 (1) point (17) MiFID2)

1) Basic Criteria for Classifying Crypto-Assets as Money Market Instruments:

1. They must be instruments normally traded in the money market.
2. Payment instruments are excluded.
3. They must possess characteristics similar to:

• • Treasury bills
  • Certificates of deposit
  • Commercial paper

2) Specific Characteristics of Crypto-Assets as Money Market Instruments

1. They represent short-term negotiable debt obligations.
2. Issued by governments, credit institutions, or corporations.
3. They must incorporate credit balance repayment obligations.
4. Important distinction with standard bank deposits under Directive 2014/49/EU.

3) Maturity Requirement for Crypto-Assets as Money Market Instruments

1. They must have short maturity periods.
2. They need a predefined or residual maturity.
3. They must align with the Money Market Funds Regulation (MMFR).

4) Practical Example

Case of a company issuing crypto-assets for short-term loans. Key characteristics:

1. Tradable on a platform by CASP.
2. Not a payment instrument.
3. Represents a certificate of credit balance.
4. Refundable with interest.
5. Value linked to the Euro for stability.

Guideline 4 (ESMA) on the Classification of Crypto-Assets as Shares in UCITS (Undertakings for Collective Investment in Transferable Securities). Criteria for a crypto-asset to be qualified as a “unit in a collective investment undertaking (CIU)”

1) Fundamental Requirements for a Crypto-Asset to be Considered as Shares in a UCITS

For a project to qualify as a share in a UCITS, it must involve collectively: i. Pooling capital from multiple investors. ii. Investment according to a defined investment policy. iii. Generating collective returns for investors. iv. Acceptance of contributions in fiat currency, equivalents, or crypto-assets.

2) Control and Management Criteria

1. Analysis of daily control over operational matters.
2. Not relevant if decisions are made by:

• • Humans.
  • Codes/algorithms.
  • Smart contracts.

3. Must follow an established investment policy.

3) Specific Case: Liquid Staking Services

Liquid staking services are an innovation in the world of cryptocurrencies that solves one of the main problems of traditional staking: the lack of liquidity during the lock-up period. To better understand the concept, we must first understand what traditional staking is: when a user stakes their cryptocurrencies, they essentially “lock” or “deposit” them to help secure and validate transactions on a blockchain network that uses the Proof of Stake (PoS) consensus mechanism. In return for this service, the user receives rewards. However, during this staking period, the cryptocurrencies are locked and cannot be used for other activities such as trading or as collateral. This is where liquid staking comes in: this service allows users to receive a representative token for their staked cryptocurrencies. This token can be used in the DeFi ecosystem while the original cryptocurrencies continue to generate staking rewards.

Let’s look at a practical example:

Imagine you have 32 ETH and want to participate as a validator in Ethereum 2.0. In traditional staking, you would have to lock your ETH without being able to do anything else with them. However, with a liquid staking service like Lido, by staking your 32 ETH, you would receive 32 stETH (staked ETH) in return. These stETH represent your staked ETH and you can: (1) Trade them on exchanges; (2) Use them as collateral for loans; (3) Participate in liquidity pools; and (4) Use them in other DeFi applications.

Meanwhile, your original ETH continues to generate staking rewards, and the value of your stETH is automatically updated to reflect these accumulated rewards. It’s like having a fixed-term savings account in a traditional bank, but instead of having your money completely locked up, the bank gives you a negotiable certificate that you can use for other financial operations while your savings continue to earn interest. This mechanism has gained much popularity because it allows users to maximize the efficiency of their capital: they can obtain staking rewards and simultaneously participate in other financial activities with the representative tokens, effectively “having their cake and eating it too,” as the English saying goes.

The received tokens could represent participation in staking rewards.

It does not always qualify if:

1. There is no collective management by third parties.
2. Users maintain daily control.
3. Tokens can be freely traded.

4) Additional Important Aspects

1. Diversification is not a classification criterion.
2. Liquidity is not a determining criterion.
3. It must provide a collective return generated by shared risk.
4. Investors must have the right to profits or losses.

5) Classification of Crypto-Assets as Alternative Investment Funds

Specific requirements for a crypto-asset to be considered an Alternative Investment Fund include:

1. Raising capital from several investors.
2. Investment according to a defined policy.
3. Benefit for investors.
4. Careful evaluation of the investment policy.

6) Commercial or Industrial Purpose

A key factor for classification: The project must not have a general commercial or industrial purpose.

Defined as traditional commercial or industrial activities:

1. Buying/selling goods.
2. Supplying non-financial services.
3. Producing goods.
4. Building properties.

Guideline 5 (ESMA) on the classification of crypto-assets as Derivative Contracts

The guide establishes two fundamental situations in the relationship between derivatives and crypto-assets that must be differentiated:

Two Scenarios

Two scenarios not contemplated by MiCA: The first scenario, not contemplated by MiCA, is when crypto-assets serve as the underlying asset for derivatives. The second situation occurs when the crypto-assets themselves can be classified as derivatives.

First Scenario:

Regarding the first situation, competent authorities and market participants must consider the possibility that crypto-assets are eligible underlying assets in derivative contracts. This evaluation must align with the categories specified in Annex I, Section C, points 4-10 of MiFID II. An illustrative example would be a crypto-asset designed as a pre-established sale agreement where one party agrees to buy a specific amount of crypto-assets at a future date at a predetermined price.

The guide pays special attention to perpetual futures, which are derivative instruments without an expiration or settlement date. Despite their unique structure, these must be treated as derivative contracts as they involve an agreement between parties to exchange the performance of an underlying asset over time.

Second Scenario:

Regarding the second situation, for a crypto-asset to qualify as a derivative contract, it must meet three main conditions: (1) the rights of the holders must be conditional on a contract based on a future commitment, (2) the value of the crypto-asset must be derived from an underlying asset, and (3) it must follow the settlement modalities referred to in MiFID II.

It is crucial that the crypto-asset has an underlying reference point such as rates, indices, or relevant instruments according to MiFID II. The value of the crypto-asset must depend on changes in the value of the underlying reference asset. The guide makes an important distinction: when the value of a token is established through reserved assets, it must be considered an asset-referenced token under MiCA and not a derivative.

The guide provides several practical examples, such as the case of a company issuing a crypto-asset to reflect the value of a stock or bond, or a crypto-asset designed to track the performance of an index composed of crypto-assets from emerging markets. It also mentions crypto-assets that represent synthetic exposure to a basket of tokens.

Regarding the specific classification of derivatives, the guide establishes that a crypto-asset model where one party agrees to buy a determined amount in the future will likely be a forward/future. If it provides a right (but not the obligation) to buy or sell, it will likely qualify as an option.

Finally, the guide emphasizes that the method of settlement, whether in cash or through crypto-assets, does not necessarily affect the fundamental classification of the product if all other inherent characteristics and functions of derivative contracts according to MiFID II are met. However, this requires a case-by-case evaluation.

Guideline 6 (ESMA) on the classification of the issuance of carbon emission rights

ESMA’s response addresses these concerns through three fundamental aspects:

• First, ESMA emphasizes that its guidelines are carefully designed to align with the broader EU regulatory framework governing emission rights, specifically under the EU ETS and MiFID II. This alignment aims to ensure that crypto-assets classified as emission rights comply with the strict criteria set by these regulations, thus maintaining consistency and avoiding regulatory overlap.
• Second, the guidelines have been updated to include more concrete examples in the context of crypto-assets. This practical approach ensures that only those crypto-assets that genuinely represent a right to emit greenhouse gases, in compliance with Directive 2003/87/EC, are classified as emission rights.
• Third, ESMA has taken specific measures to prevent the misclassification of other types of tokens, such as voluntary carbon credits, as emission rights. The guidelines clearly state that for a crypto-asset to be classified as an emission right, it must be recognized for compliance with the EU ETS and must confer a clear right regarding emissions.

An important aspect that ESMA underscores is its adherence to the principle of technological neutrality. The guidelines focus on the substance of the asset rather than its digital format, thus ensuring that the classification is based on the fundamental characteristics of the asset and not its technological format.

This comprehensive response from ESMA demonstrates a balanced approach that seeks to provide regulatory clarity while maintaining the integrity of the emission rights market and preventing potential abuses or misunderstandings in the classification of crypto-assets related to emissions.

Guideline 7 (ESMA) on Classification as Crypto-Assets

The guide establishes that authorities and market participants must evaluate whether the crypto-asset constitutes a digital representation of value or rights that can be transferred and stored using DLT. It is fundamental to consider whether these values or rights represent a right against the issuer or someone designated by them.

An important aspect of the guide is the treatment of utility tokens with governance rights. Although these tokens may include governance rights, they should not replicate the rights linked to financial instruments, especially those associated with transferable securities under MiFID II. The mere expectation of future benefits is not sufficient to qualify a crypto-asset as a financial instrument.

The guide excludes from the scope of MiCA crypto-assets that are not transferable to other holders and are only accepted by the issuer or offeror. Also excluded are those crypto-assets that are unique and not fungible with other crypto-assets.

Guideline 8 (ESMA) on Unique and Non-Fungible Crypto-Assets (NFTs)

This guide provides a detailed framework for the evaluation of NFTs. The main aspects are:

1. Scope of Application: NFTs fall outside the scope of MiCA, including digital art, collectibles, and tokens that represent unique services or physical assets. However, if they meet the criteria of financial instruments, they will be subject to MiFID II.
2. Uniqueness Criteria: To be considered unique, NFTs must be non-substitutable and have clear distinctive characteristics or rights. The classification should not be based solely on technical specifications such as unique identifiers.

• Evaluation Indicators:

1. 1. Intrinsic value and rarity.
   2. Utility and functionality.
   3. Exclusive ownership and rights.

• Interdependent Value Test: Authorities must consider:

1. 1. If the value comes mainly from unique characteristics.
   2. The interconnection of values between different crypto-assets.
   3. The unique characteristics that distinguish them from others.

• Treatment of Fractional NFTs (F-NFTs): They are not automatically considered unique and non-fungible. The evaluation must consider:

1. 1. If they represent partial ownership of a unique token.
   2. If the fractional parts are unique in themselves.
   3. If they share identical attributes.
   4. The possibility of reconstructing full ownership.

The guide emphasizes that the ability to trade a crypto-asset on secondary markets does not inherently affect its classification as unique or non-unique under MiCA. This provides a clear framework for distinguishing between genuine NFTs and other types of tokens that might attempt to exploit this classification.

Guideline 9 (ESMA) on Hybrid Crypto-Assets

The guide establishes a hierarchical and methodological framework for evaluating crypto-assets that present hybrid characteristics, i.e., those that combine multiple functionalities or attributes. The fundamental aspects are:

Prioritization in Evaluation:

The guide establishes a clear order of evaluation where the first step must be to determine whether the crypto-asset meets the criteria of a financial instrument. If the hybrid token exhibits characteristics of a financial instrument, this nature must prevail in its classification.

Only after ruling out this possibility should alternative classifications, such as utility token, be considered.

“Substance over Form” Principle:

Competent authorities and market participants must prioritize the evaluation of the inherent attributes of the crypto-asset over the labels provided by the issuers. This aspect is particularly relevant in the case of hybrid tokens whose functions or attributes may evolve during their lifecycle.

The guide places special emphasis on identifying how these tokens can combine:

• Investment-oriented functions (such as returns or capital appreciation).
• Utility-centered purposes (such as exclusive access to services or digital platforms).

Complexity Evaluation:

Authorities and participants must consider whether the crypto-asset possesses a range of characteristics that complicate its classification, specifically evaluating:

• If the crypto-asset fulfills multiple roles.
• If it combines various attributes (aspects of financial instrument, payment, and utility).
• The extent to which the presence of these diverse characteristics and functions contributes to the overall definition of the crypto-asset.

This approach seeks to provide a clear framework for the classification of complex crypto-assets that do not clearly fit into a single category, ensuring that the presence of financial instrument characteristics is the determining factor in the classification, regardless of the additional characteristics the asset may present.

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