What kind of butterfly effect will the EU's latest crypto asset "unboxing order" produce?

Author: Xiaoza Team, Xiaoza Lawyer

The Xiaoza team has noted that around mid-January 2024, the European Union, as the world's first major jurisdiction to establish a comprehensive regulatory framework for cryptocurrencies with the "Markets in Crypto Assets regulation bill (MiCA)" (referred to as the MiCA bill), has once again proposed to enhance its anti-money laundering regulatory package by introducing stricter rules for cryptocurrency transfers and private wallet regulations, including restrictions on anonymous transactions and increased KYC obligations for platforms.

On March 23, the European Parliament and the Council of the European Union officially turned this concept into reality by issuing the latest anti-money laundering "open box order." Today, the Xiaoza team will interpret the new law and analyze its potential demonstrative effects in the future.

I. Overview of the EU's Latest Crypto Asset "Open Box Order"

"Open box" was originally industry jargon referring to the act of using hacking software to steal all information from others, including but not limited to ID numbers, social security card numbers, bank account numbers, personal document photos, etc., and exposing it. Now, it generally refers to any act of "revealing" the real identity information of internet users, similar to "doxxing."

As mentioned earlier, the European Parliament and the Council of the European Union have introduced new anti-money laundering regulations targeting cryptocurrencies, which we refer to as the "open box order." This is mainly because the regulatory purpose of the new regulations is to "erase" the anonymity of cryptocurrency transactions, thereby regulating money laundering and the use of crypto assets for tax evasion and asset transfer. The main rules are: (1) Within the jurisdiction of the EU, no unidentified self-custody crypto wallets (i.e., private wallets) may be used for any scale of cryptocurrency payments; (2) Crypto companies must conduct due diligence on transactions over 1,000 euros. The main subjects regulated by this provision are cryptocurrency users and Virtual Asset Service Providers (VASPs).

The Xiaoza team believes that the latest crypto asset "open box order" is a new regulation that is extremely "eye-catching" on both the positive and negative sides. On one hand, this regulation, in conjunction with the previously issued MiCA bill and the rules for collecting cryptocurrency transfer information (TFR), can maximize the use of legal tools to regulate current market activities involving money laundering, tax evasion, asset transfer, and fundraising for terrorism using cryptocurrencies. At the same time, this "open box" behavior can also lay a good foundation for the subsequent potential designation and implementation of related crypto asset tax policies, further clarifying the objects and bases for taxation. However, on the other hand, the "open box order" is extremely blunt, as it directly erases "anonymity," one of the core and essential characteristics of cryptocurrencies, and shakes the financial ecosystem that has long been established based on the "decentralized" technological characteristics of blockchain (public chain).

Overall, not only is the regulation of crypto assets becoming stricter, but the new anti-money laundering law introduced by the EU also imposes a new round of strict controls on all tools and channels that can be used for money laundering. The new anti-money laundering law prohibits the use of cash payments exceeding 3,000 euros in commercial transactions, while cash payments of 10,000 euros are completely prohibited in commercial transactions. Additionally, sales entities related to the luxury goods industry must conduct identity verification similar to KYC for customer transactions and retain records for inspection. Furthermore, the previously notorious money laundering hotspot—professional football—will be closely monitored by the EU, with several well-known teams already beginning compliance rectifications, and it is expected that they will meet compliance standards within three years after the new anti-money laundering law is officially implemented.

II. Impacts of the EU's Latest Crypto Asset "Open Box Order"

As mentioned earlier, the EU's latest crypto asset "open box order" indeed has very obvious positive and negative impacts, and as a major global jurisdiction, its related legislation and judiciary will have an important regulatory demonstrative effect on the entire crypto asset industry. It is expected that subsequent regulatory rules in various countries will reference this legislative example. So, how should we correctly view this butterfly effect of EU regulation?

On the positive side, the EU's "open box order" does not prohibit the existence of cryptocurrencies, nor does it restrict users from using cryptocurrencies. Instead, it places a heavy "shackle" on users and VASPs—requiring them to use and invest in cryptocurrencies in a public, regulated environment, and it does not rule out the possibility of taxing users' holdings and transactions of cryptocurrencies in the future. Compared to a blanket ban on cryptocurrencies, this is undoubtedly a more "flexible" regulatory measure, and it aligns with the Xiaoza team's consistent attitude towards crypto assets: it is better to guide than to block.

However, this relatively "flexible" regulation also has a hard edge. The Xiaoza team believes that the reason why the crypto community and many Web3 participants and builders recognize and trust blockchain technology and the narratives surrounding crypto assets is that these crypto assets, based on blockchain technology, possess unique "technological trust" characteristics, allowing them to operate without centralized regulation while also granting users the right to freely manage their own assets. Once the users of crypto assets are "opened," it not only strips them of anonymity but also creates obstacles to their rights to freely manage their property. The most serious issue is that this move will allow traditional centralized regulatory powers to encroach upon the crypto asset community.

In fact, every time the EU tightens regulations in the name of "public safety," "financial security," and "combating money laundering crimes," it has not gained the support of the majority of the public. For example, when the European Commission publicly solicited opinions on the cash payment restriction bill in 2017, over 90% of citizens opposed the bill, with the main objection being that such measures do not effectively curb large-scale, systematic money laundering crimes but instead improperly restrict citizens' rights to freely use their own property.

From this perspective, the Xiaoza team believes that the EU's "open box order" may be an overcorrection. Once formally implemented, it will be difficult to find an appropriate balance among various legal interests, including financial and technological innovation, financial order, and social order security. More likely, it will push local EU crypto asset users, who are gradually beginning to use crypto assets in compliance, into other unregulated crypto asset camps. Meanwhile, VASPs will face heavy KYC obligations and the dilemma of gradually losing crypto asset users.

III. Does the EU's Latest Crypto Asset "Open Box Order" Cover Other Crypto Assets Besides Cryptocurrencies?

A simple answer: The "open box order" currently only affects cryptocurrency transactions, but it does not rule out the possibility of covering other crypto assets in the future.

At present, the purpose of the "open box order" is to curb the largest cryptocurrency by volume among crypto assets. Although there has been intense debate within EU regulatory bodies about whether NFTs, DeFi, GameFi, and other crypto assets and Web3 applications should be subject to a comprehensive anti-money laundering law, we do not currently see any direct signs in the legislation that the EU will include other crypto assets beyond cryptocurrencies in its regulatory framework.

The Xiaoza team believes that this is mainly due to two reasons: (1) Other crypto assets besides cryptocurrencies are too small in volume. Although they have the potential to become alternatives to cryptocurrencies, they currently do not have a sufficiently large market to be used as tools for money laundering, tax evasion, and other criminal activities; (2) The EU still maintains sufficient caution in the relevant legislation on crypto asset regulation and is unwilling to place other crypto assets, which have not yet matured and whose related technologies have not reached large-scale application, into a regulatory cage.

Thus, we can simply conclude that the future smooth development of other crypto assets and various applications largely depends on the joint efforts of Web3 builders to form a relatively effective self-supervision and self-driven mechanism to reach a consensus with regulators and form a synergy.

IV. Final Thoughts

From the perspective of EU judicial practice, although the "open box order" will not officially take effect until after a three-year window period, the purpose of this window period is solely for compliance rectification. In other words, it is already impossible to use self-custody wallets for anonymous cryptocurrency payments within the jurisdiction of the EU. In discussions with some crypto asset practitioners, the Xiaoza team found that opinions on this matter vary. Some experts who lean towards a free commercial environment believe that the "open box order" is a blow to the EU's free competitive business system, and there are even concerns that this regulation may infringe on basic civil rights.

The Xiaoza team believes that just as we should not easily pass value judgments on a new phenomenon, the pros and cons of the "open box order" should be evaluated based on the results of its subsequent implementation. While the EU currently lacks sufficient statements on the effectiveness and necessity of implementing the "open box order" to combat crime, the EU itself, as a pioneer willing to take the first bite of the regulatory "crab" regarding crypto assets, deserves at least some encouragement for its courage.