Crypto payments – a danger to consumer protection?

ABSTRACT

The original intended function of bitcoin was as a means of payment, but this has turned out to be just one utility of the underlying technology – cryptography. This article goes back to the initial purpose, the means of payment in cryptocurrencies, and examines the problems arising for consumers when paying in crypto. Problems covering execution of payments, liability and the missing issuer of cryptocurrencies, and the volatility of cryptocurrencies and inherent systemic risks will be examined in relation to the MiCA Regulation. This enables a discussion on possible regulatory solutions to protect consumers paying with cryptocurrencies. The paper concludes that the MiCA Regulation does not sufficiently protect consumers in this aspect but proposes an alternative solution to secure appropriate levels of consumer protection.

KEYWORDS:

• Cryptocurrencies
• consumer protection
• unbacked crypto-assets
• MiCA Regulation
• payments

Acknowledgements

I would like to express my gratitude to the conference organisers, the participants, and fellow presenters at the Institute for Advanced Legal Studies’ 2022 conference on Cryptocurrencies, Smart Contracts, and Alternative Payments for your interesting thoughts and inputs on an early draft of this article. I am also grateful to the anonymous reviewers who provided me with useful comments. Any errors or omissions are solely my responsibility.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market.

2 While the literature generally refers to this class of crypto-assets as cryptocurrencies the MiCA Regulation 2023/1114 reduces this class to unbacked crypto-assets by establishing a clear line between these and e-money tokens and asset-backed crypto-assets. In this article the terms unbacked crypto-assets and cryptocurrencies will be used interchangeably.

3 UC Cabuk and M Silenzi, ‘Cryptocurrencies in Retail: Consumer Adoption Report 2022’ (2022) shows an increase in crypto-consumers from 2021 to 2022; C Baker and K Werbach, ‘Blockchain in Financial Services’ in J Madir (ed), FinTech – Law and Regulation (Edward Elgar 2019) 136 report industry participants to be keen on investing in the payment solution; Deloitte, ‘Merchants Getting Ready for Crypto – Merchant Adoption of Digital Currency Payments Survey’ (2022) reports on merchants expecting to accept crypto payments within two years; and M Rimol, ‘Gartner 2019 Hype Cycle for Blockchain Business Shows Blockchain Will Have a Transformational Impact Across Industries in Five to 10 Years’ (2019) reports continuous uptake and progress in the crypto industry.

4 MA Schillig, ‘Cryptocurrencies: Development and Perspectives’ in I Chiu and G Deipenbrock (eds), Routledge Handbook of Financial Technology and Law (Routledge 2021) 333, also see J Son, M Huseyin Bilgin and D Ryu, ‘Consumer Choices Under New Payment Methods’ (2022) 82 Financial Innovation 4.

5 Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets, recitals 5 and 6.

6 That is, crypto-for-crypto and crypto-for-fiat currency exchanges are not covered by the scope of this paper which only covers crypto-for-goods transactions.

7 Also see J Armour and others, Principles of Financial Regulation (Oxford University Press 2016) 60.

8 European Banking Authority, ‘EBA Financial Education Report 2019/2020’ (2020) documents a lower than expected literacy as well as insufficient financial education provided by NCAs, Financial Conduct Authority, ‘Research Note: Cryptoasset Consumer Research 2021’ shows a group of crypto consumers mistakenly believing they have the same protection paying in crypto as when paying in fiat currencies, and Cabuk and Silenzi (n 3) section 6 document a not insignificant number of crypto consumers holding cryptocurrencies as a last resort to enable payments. As such, there is not always a difference in the level of sophistication between crypto consumers and consumers in general.

9 According to Baker and Werbach (n 3) 136, industry participants are also highly interested in investing in blockchain-based solutions in the payments area.

10 In particular, of course, the bitcoin as described by S Nakamoto, ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ (2008).

11 As recital 22 MiCAR also establishes, these de facto intermediaries are not covered by the scope of the MiCAR.

12 It is for the individual merchant to decide whether they receive cryptocurrencies or if the payer’s cryptocurrency will be transferred into a fiat currency or a different cryptocurrency. The merchant pays the fees to the service provider, but of course, this does not prevent the merchant from charging the payer a transaction fee, which further highlights the consumer protection-related issues of crypto payments.

13 Nakamoto (n 10).

14 H de Vauplane, ‘Cryptocurrencies and Central Banks’ in Madir (n 3) 112.

15 ibid 113 and C Harwick, ‘Cryptocurrency and the Problem of Intermediation’ (2016) 20 The Independent Review 569, 573.

16 Vauplane (n 14) 114 and Harwick (n 15) 573 who also refer to Ludwig von Mises' regression theorem stating that somthing is money when people use it as money.

17 European Securities and Markets Authority, ‘Crypto-Assets and Their Risks for Financial Stability’ (2022) 3.

18 A Herman, ‘Will the FTX Crash Kill Crypto?’ (Forbes, 14 December 2022) <https://www.forbes.com/sites/arthurherman/2022/12/14/will-the-ftx-crash-kill-crypto/?sh=6088e52421f3> (accessed 31 January 2023).

19 Vauplane (n 14) 114 also compares cryptocurrencies to FX trading when dealing with volatility and inflationary risk.

20 Also see European Securities and Markets Authority (n 17) 9, L Hermans and others, ‘Decrypting Financial Stability Risks in Crypto-Asset Markets’ (2022) Financial Stability Review and I Chiu, Regulating the Crypto Economy: Business Transformations and Financialisation (Hart 2021) 209.

21 Vauplane (n 14) and Son, Bilgin and Ryu (n 4) 4.

22 Also see the conclusion in European Securities and Markets Authority (n 17) 14.

23 Although the current situation is found to be manageable by ESMA, see ibid.

24 PSD2, art 4(1)(25).

25 European Commission, ‘Commission Staff Working Document Impact Assessment Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on Markets in Crypto-assets and amending Directive (EU) 2019/1937’ SWD(2020) 380 final 2020, 11.

26 Also see Baker and Werbach (n 3) 129.

27 European Banking Authority, ‘EBA Financial Education Report 2019/2020’ scores EU citizens to have a low financial literacy score on average.

28 Financial Conduct Authority (n 8) found that a not insignificant number of consumers holding crypto-assets thought there were legal protection connected to their holdings.

29 This problem is also raised by Chiu (n 20) 213.

30 ibid 209 also argues the need for a regulatory framework to address needs such as cost and quality in the execution of payments.

31 Specifically, payments are covered by the PSD2.

32 MiCAR, recital 6.

33 MiCAR, recitals 5 and 6.

34 Case 283/81 Srl CILFIT and Lanificio di Gavardo SpA v Ministry of Health ECLI:EU:C:1982:335 para 20.

35 Chiu (n 20) 209 and Vauplane (n 14) 113.

36 Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions.

37 PSD2, art 4(1)(7).

38 PSD2, art 4(1)(5).

39 PSD2, art 4(1)(3) and Annex 1.

40 PSD2, art. 2(1)(2).

41 See Chiu (n 20) 210 for a similar argumentation.

42 Chiu (n 20) 209 also highlights the need to intervene to solve the volatility problem connected to unbacked crypto-assets.

43 ibid 208 likewise finds that the functional approach is the most optimal to regulate crypto tokens.

44 On the lack of stability in value also see European Securities and Markets Authority (n 17) 5.

45 As also pointed out by DA Zetzsche and others, ‘Liabilities Associated with Distributed Ledgers: A Comparataive Analysis’ in Madir (n 3) 193. The idea to denationalise money was most prominently disseminated by FA von Hayek, Denationalisation of Money (The Institute of Economic Affairs 1976).

46 The number of merchants accepting crypto payments is expected to be rising, see Deloitte (n 3) and the demand among consumers is increasing as well according to Cabuk and Silenzi (n 3).

47 Financial Conduct Authority (n 8) found that 5% of consumers using crypto believed they had some form of protection and 12% believed their cryptocurrency investments had financial protection.

48 For more on the categorisation and applicable law to security tokens see L Damkjær Christensen, ‘Initial Coin Offerings – Are Tokens Transferable Securities?’ (2022) Nordisk Tidsskrift for Selskabsret (Nordic Journal for Company Law) 44.

49 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments.

50 MiCAR, art 103(2),(3), (4), and (5).

51 Also see Baker and Werbach (n 3) 127 and Zetzsche and others (n 45) 187.

52 This problem is also raised by Chiu (n 20) 213.

53 European Securities and Markets Authority (n 17).

54 ibid 12.

55 ibid.

56 Chiu (n 20) 215 also advocates for a strong regulatory framework to create optimal circumstances for the payment function of unbacked crypto-assets.

57 See J Durham, ‘Regulatory Sandboxes Enable Pragmatic Blockchain Regulation’ (2023) 18 Washington Journal of Law, Technology & Arts 29, 46 coming to the conclusion that regulatory intervention is necessary in most aspects of the crypto-economy.

58 This conclusion is also supported by Chiu (n 20) 210 and J Lee, ‘Law and Regulation for a Crypto-market – Perpetuation or Innovation?’ in Chiu and Deipenbrock (n 4) 370.

59 See also Hermans and others (n 20) section 3.

60 See Cabuk and Silenzi (n 3) and Deloitte (n 3).

61 European Commission, ‘Consultation Document: Targeted Consultation on the Review of the Revised Payment Services Directive (PSD2)’ (2022).

62 Regulation (EU) 2023/1113 of the European Parliament and of the Council of 31 May 2023 on information accompanying transfers of funds and certain crypto-assets.

63 Chiu (n 20) 210 also promotes the use of regulation to mitigate the hazards for users of unbacked crypto-assets for payment purposes.

64 ibid 209 offers two rather restrictive solutions to the volatility problem but neither entails cryptocurrencies continuing in the currently known form.

65 In the online realm, it could also be discussed who holds jurisdiction, but such discussions are extensive and beyond the subject of this article.

66 Proposal for MiCA Regulation, recitals 4 and 5.