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Ep 64: When Tokens Don’t Fit the Rules: LSTs & MiCA
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Liquid staking tokens may sound like a niche corner of crypto, but they raise a much bigger question: can regulation actually keep up with decentralized systems? Juan Ignacio Ibañez of the MiCA Crypto Alliance dicusses why LSTs are so hard to classify under MiCA, and why that ambiguity creates real compliance risk for platforms and service providers. The conversation moves beyond labels to a deeper issue: what happens when existing rules are built for assets with issuers, managers, and clearer boundaries than Web3 often provides.
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Transcript
Introduction to the Policy Layer Podcast
00:00:06
Speaker
Welcome to the Policy Layer, where we talk about the real decisions shaping crypto, tech, and the future of trust. I am Silvia Sanchez, your host from the Avalanche Policy Coalition. We aim to bridge the gap between the builders of Web3 and the people that are shaping the rules. On our podcast, you'll hear from policymakers, developers, academics, and others working at the edge of tech and regulation.
00:00:32
Speaker
We ask the questions that everyone's actually wondering and we keep it easy to follow. This is the Policy Layer.
00:00:43
Speaker
Hi everybody, it's so great to be back with another episode.
Focus on Liquid Staking Tokens (LSTs) and European Regulation
00:00:46
Speaker
Today we're talking about a very specific corner of crypto that sounds kind of niche. We're going to be talking about LSTs, which stands for liquid staking tokens. But this is actually a stress test for how regulation handles decentralization, focusing more on the European side.
00:01:04
Speaker
So LSTs sit right at the intersection of staking, liquidity and asset classification. and under Mika, markets and crypto assets, that intersection can get kind of messy. and what's interesting here isn't just whether LSTs are e-money tokens or asset reference tokens or something else, it's okay, what happens when regulators try to force genuinely new structures into old legal boxes? So do we get clarity before the market moves on or do we clean this up after damage is already done and go with this back and forth of doing and undoing?
00:01:44
Speaker
So this is very complex complex and we're going to unpack it with a very special guest.
Interview with Juan Ignacio Ibanez on Blockchain Regulation
00:01:49
Speaker
Today we're joined by Juan Ignacio Ibanez. He is the General Secretary of the Mika Crypto Alliance and ESG and Policy Director at Exponential Science. His work focuses on blockchain and regulation, particularly on disclosures and reporting.
00:02:05
Speaker
He has authored numerous MECA white papers and peer-reviewed articles on blockchain. And he is also a researcher at the University College London Center for Blockchain Technologies and a lecturer at the Catholic University of Argentina. So that was quite a handful of an introduction, but this is going to be really fun, bit technical, but we're going to try to keep it very digestible as much as we can. So Juan, thank you so much for joining us today.
00:02:32
Speaker
i Thank you so much for the invitation. It's a big pleasure to be here. Amazing.
Evolution and Efficiency of LSTs in DeFi
00:02:37
Speaker
So before we even and touch Mika, what problem were liquid staking tokens built to solve in the first place?
00:02:45
Speaker
So liquid staking is probably the largest niche in DeFi today, right? Like when we think of decentralized finance, typically we think of lending and borrowing protocols.
00:02:57
Speaker
um and liquidity mining and all. But there's this new market within DeFi that's emerged just a few years ago, um which is liquid staking.
00:03:08
Speaker
um Liquid staking, has led to this this instrument, this asset, the liquid staking token, as the most visible phase of the industry. um And they were created initially to solve the high minimum problem for staking. So liquid staking had been in and attempted prior to Ethereum moving ah from proof of work to proof of stake. and It was not really invented within Ethereum.
00:03:44
Speaker
However, it gained a lot of visibility when Ethereum they moved and they did the merge. um But they came up with this... and very high minimum to stake, right? So in Ethereum to stake, you need to stake a minimum of 32 ETH, which is very expensive for the majority of the people.
00:04:02
Speaker
So pooling schema and emerged where multiple um token holders that had some assets, but not as much as to reach the minimum would come together to stake altogether.
00:04:18
Speaker
ah Now that was in one particular chain how it got started, how it started getting big, but this started, and did this proof of concept if you wish, validated and expanded to other blockchains.
00:04:32
Speaker
And liquid staking protocols and the tokens started solving other problems as well and proving that their usefulness in proof of stake chains that don't have minimums or that have minimums that are not really that high. Because there's inefficiencies in the staking process that um make the market go slower and price signals transmit a bit less efficiently. So there's exit queues, you know, unbonding periods. There's also some risk when you need to select which validator to stake to.
00:05:05
Speaker
You may be um selecting a very good validator, but even a good validator may have some downtime. So it's good to pull that risk. um There's also just...
00:05:16
Speaker
a price discovery um functionality that liquid staking tokens have. Yes, information about which validators um one can stake their their assets to and point towards can flow, but having a liquid staking token summarize that information um really makes the information aggregation much more efficient. And you can compare multiple staking opportunities by just looking at how the liquid staking tokens are trading. So...
00:05:53
Speaker
It started as a tool to overcome high staking minima, but it's gone much beyond that. And they are a tool for information sharing, abstraction of complexity, and just efficiency of the of the market.
Regulatory Challenges of LSTs
00:06:08
Speaker
Okay, and I think that's a really helpful way to ground it into the reality and the purpose before we actually get into the legal technicalities a bit more. So, up next, I'd like us to explore at what point did LSTs go from useful infrastructure to regulatory question mark? Because this didn't necessarily start as a policy problem, but it sort of became one. So, can you unpack that a bit more?
00:06:35
Speaker
Yeah, well, it it in a way, it was there from the beginning due to an inadequacy of the regulation, but it did not really, as you as you correctly say, it did not really become a problem until the proliferation of liquid staking tokens became a thing. and It did not really become a problem um up until liquid staking protocols became so big in DeFi, leading to and crypto asset service providers, crypto asset trading platforms wanting to list these tokens. And as regulations started kicking in, requiring um certain steps to be followed by the trading platforms listing the assets, suddenly liquid staking tokens began
00:07:25
Speaker
began to have, like you say, a question mark, right? How do we classify these assets? Because, well, there's different regulatory regimes. We started looking at this from a European perspective, but this problem is there in the US, it's there in the UK, it's there all over the world.
00:07:42
Speaker
um this This problem that these liquid staking tokens, they can look like a security. They if you If you quickly look at them, you see that there is something like an investment, there's an expectation of profit, and you can make the case that there's a common enterprise, and even that sometimes there's a promoter, and that puts you in security territory.
00:08:07
Speaker
In the EU, we have different categories. We have what we call collective investment undertakings, um where you know there's a manager executing an investment strategy, and then investors will share the risks and they share their returns.
00:08:25
Speaker
And you know the liquid staking a token looks like a collective investment undertaking instrument sometimes, especially because one of the of the characteristics is of these kind of undertakings is that, well, investors are sharing the risk and the returns, right? Which has a clear correlation in the Web3 world with, you know, having reserves and having your risks exercised against the reserves rather than against an issuer.
00:08:55
Speaker
But you also have sometimes the possibility of classifying them as other kinds of financial instruments. In the EU, we have the MIFID regulation. But then the EU also has a crypto regulation. It's called MECA, Markets and Crypto Assets.
00:09:08
Speaker
which also classifies ah crypto ah into asset reference tokens, e-money tokens, and other crypto assets. And you can also make the case that these liquid staking tokens fall in these categories, not in the financial instruments categories, but which one?
00:09:26
Speaker
And it's not fully clear which one. And this is quite a compliance headache because if you put yourself in... the feet in the shoes of the compliance or the listing team of a trading platform, when they're going to be listing an asset and admitting it to trading, they want to follow the right steps to do so and to be on the good side of the regulation.
00:09:53
Speaker
But if you don't know how to classify these assets, you don't know which is the correct series of steps to begin with. And if you don't know that, i mean there's there's no clarity. You expose yourself to legal liability. So that, um unfortunately, is, as you say, a regulatory question mark, and it's what we're trying to solve.
00:10:15
Speaker
Exactly. yeah and just building on that, like... You were explaining the different types of classification frameworks that exist, and you also mentioned the compliance headaches of this ambiguity, of this gray zone of actually leaving LSTs undefined. But who actually takes the hit? Also building on that, why do LSTs break the existing MECA categories? And would actually be the most affected one as a result? Yeah, so let me start with the second question first. So who takes the hit for this lack of definition? I would say there's two parties, two sides to the story.
00:11:00
Speaker
On the one hand, as I mentioned before, is the trading platforms. The trading platforms, they need to follow a series of steps to list a crypto asset.
00:11:11
Speaker
The series of steps is different if you classify this asset as an, for instance, and the Mika as Title 2 cryptoasset, the other cryptoassets, or as an asset reference token or as an e-money token.
00:11:23
Speaker
In each one of these scenarios, the series of steps you need to follow is different. If it's a security, team it's another series of steps. If it's ah an an alternative investment fund or collective investment undertaking, it's another series of of steps.
00:11:39
Speaker
And you know, maybe the trading platform does not quite care what is the classification of the asset. They just, want to be sure that whatever the classification is, that's the correct one.
00:11:53
Speaker
Because the risk that they are getting themselves exposed to is that months or years after admitting an asset to trading, the supervisory authority comes to them and say, you know what, that asset that you listed few months ago or a few years ago, You thought you had classified it correctly and followed the right series of steps, but you didn't.
00:12:18
Speaker
Because we have now, after the fact, come to the conclusion that this asset needs to be reclassified and we are making you liable for having made a mistake months or years ago, even though months or years ago, we didn't know it was a mistake ourselves.
00:12:35
Speaker
So that is a problem of clarity. um So, trading platforms and and service providers, more generally, they need clarity. That's one side of the story.
00:12:47
Speaker
The other side of the story is that clarity for clarity's sake is not um is not enough. um It could be a very clear...
00:13:00
Speaker
outcome to come to the conclusion that all crypto assets or all the liquid staking tokens, they're all securities, right? They're all method regulated financial instruments or whatever.
00:13:11
Speaker
And if you if you come to that conclusion, then you achieve clarity, yes. But at the cost of harming the industry way too much, right? Because you are probably placing the assets in the
Decentralization and Legal Complexities of LSTs
00:13:24
Speaker
incorrect category. So you don't want that. And that affects Well, the proof of stake blockchains and the DeFi infrastructure as well.
00:13:36
Speaker
ah You had also asked me another question, which was, um which can what are these categories in which we can place the the crypto assets? Is is that right? Yes. So pretty much it was more about like,
00:13:48
Speaker
the fact that LSTs sort of break the existing Mika categories. And it would be more like something structurally strained, not necessarily wrong, but incomplete, in the sense that the current framework doesn't really cover that very well. So I just wanted like to build on that a bit more, explore like the fact that LSTs have this special nature, and the fact that they sort of break the mold when you talk about the existing Mika categories. Right. So let's start with Mika. um
00:14:21
Speaker
Mika establishes three main categories of crypto assets. One of them are e-money tokens, right? And that's what we typically think of as stable coins. um So, you know, you are tracking usually an unofficial currency and you need to have some reserves and so on.
00:14:38
Speaker
Then Mika created a second category called asset reference tokens. And the rationale for this category was, well, sometimes we have stable coins. um But these stablecoins, they don't have, say, a reserves in ah in in US dollars or Euro. They have their reserves in a combination um of other assets.
00:15:04
Speaker
Or what if you have a stablecoin, something like Facebook's Libra project, of course, years ago, doesn't exist anymore, where you're not really tracking one currency, you're tracking a basket of currencies.
00:15:20
Speaker
right You're trying to create some sort of new asset that can be a medium of exchange, but technically it's not tracking any currency. So the European regulators said we need another category for any other asset that seeks to have stability of value.
00:15:36
Speaker
And um so that nothing escapes the regulation, right? And we're gonna call that asset reference token. But now you have the question, is a liquid staking token one of those assets?
00:15:46
Speaker
Because you could say, well, these assets, they are designed for stability of value too, and they're not tracking a single currency. um Is STATES not designed for stability with ease? Like to to give that example. And you can make that case outside of legal staking tokens as well, right? Is wrapped Bitcoin designed for stability with Bitcoin?
00:16:07
Speaker
Is that what stability means? So that's one problem. But there's a second problem, which is both these categories, e-money tokens and asset reference tokens, are categories that very clearly require the issuer of the asset to get authorization.
00:16:26
Speaker
So if you fall in, there's another category, ah a third category, a residual category called other crypto assets, and that one is is easier to navigate. But if your asset is classified as a new money token or as an asset reference token, you need to get a license basically. You need to get an authorization. You need to get approval from the regulation and for the regulator for the issuer.
00:16:47
Speaker
But that's where, as you as you were saying yourself, these assets sort of break the regulation because they don't have a clear issuer. Well, at least not all of them. Many of these liquid staking tokens are decentralized. that They're part of the DeFi ecosystem. There's no clear issuer.
00:17:05
Speaker
So how can you meet a requirement to have the issuer get an authorization if there is no issuer to begin with? Does that make all of liquid staking tokens illegal?
00:17:17
Speaker
Because that would be a terrible, terrible regulatory outcome. So that's why we need clarity, but we also, we don't just need clarity for clarity's
Risks of Misclassification in Current Regulations
00:17:26
Speaker
sake. We also need to strive for an outcome that does not break our industry for the sake of clarity either. So that's also part of what we're trying to explore.
00:17:35
Speaker
And there's a third and last problem, which is MECA, the regulation. It has one of the articles, it it says very clearly, that it does not apply to financial instruments.
00:17:48
Speaker
So this regulation regulates crypto, except when the crypto is a financial instrument, because that's MIFID territory or the territory of other directives, like the Alternative Investment Funds Directive.
00:18:01
Speaker
so many many of them and many many Many practitioners will simplify this as saying, well, MICA is a subsidiary or or residual or regulation to MIFID. It's not exactly residual, it's is in par, but in practice, first, you also need to study, well, is the liquid-staking token a financial instrument, yes or no?
00:18:23
Speaker
And only if the answer is no, you can go and and ask yourself this question. Is a liquid staking token an asset reference token? So you need to solve the problems at two different levels.
00:18:34
Speaker
And with financial instrument regulation, there's a further complication. um MICA establishes some way out for at least some assets when they don't have an identifiable issuer. There are some exceptions, at least partial exceptions within MICA, they're subjected to interpretation, when an asset is fully decentralized. And there's a whole legal debate about what fully decentralized means, but there is some way out of some of the regulatory requirements.
00:19:05
Speaker
method and really the financial instrument regulation more generally it does not offer this sort of way out so from the perspective of of financial instrument regulation if a crypto is a security and it does not have an issuer it does not stop uh to be a security it does not cease to be a security um there is no like decentralization exemption in method Now that's a problem because of course the entire regime, and this applies both in mica and in mefid, they are issuer centric regimes. They were designed for another time where an acid had an issuer and this is this is no longer true.
00:19:47
Speaker
But even if there is no exemptions for decentralized assets, you have to that liquid-staking tokens, and it's is it's just very hard to classify them as financial instruments when there is no issuer.
00:20:07
Speaker
Because, you know, for for them put for there for an instrument, for an asset to be a security, there needs to be counterparty against which you can exercise your rights.
00:20:22
Speaker
And if there's no counterparty to with corresponding obligations, how can you have rights? If there is no manager with discretion to execute an investment policy, then how can it be a collective investment undertaking? So even if there is no exemption for decentralization, decentralization really disrupts the regulatory categories. And at one point, if a protocol is sufficiently decentralized,
00:20:51
Speaker
it's It's my opinion that you need to conclude that it's out of scope of this regulation. I think that's a very complex complex thing and it's so much more nuanced than actually just playing a game of mixing and
Call for Evolution in Regulatory Frameworks
00:21:04
Speaker
matching. Like, okay, you have one asset type and then you have these main categories and where does it fit best because...
00:21:10
Speaker
Even if it can't be super, super specific and we can't go to the other extreme of having so many narrow categories and over-complicating the regulation, as you said, treating them and classifying in a certain way for the sake of classifying them also poses its own risk because when you are treating all tokens as financial instruments or the trading of tokens as financial activity, I think that outtoken is just that it will unnecessarily limit their use in commerce, communications, entertainment, and pretty much anywhere else establishing ownership. so
00:21:45
Speaker
Again, as you mentioned, it's very complex when you look at it. And zooming out, because we are talking about LSTs on this particular episode, but is this really about LSTs or is it about whether Mika can handle decentralization at all? Because I think that this feels bigger than one asset type. Yeah, it's definitely a bigger issue than just LSDs. The issue is LSDs are a very visible um side of the problem that is generating actual interest from trading platforms to list these assets and to get clarity. But the problem, as you say correctly, is about decentralization. There's probably ah a double ah double problem. One with decentralization, another with the
00:22:32
Speaker
a crypto asset wrapping or referencing another crypto asset. The regulation is not designed to cover these cases, but it's mostly ah a problem with decentralization. So what other assets could be in a similar circumstance? Well,
00:22:48
Speaker
I mentioned wrapped coins or wrapped tokens. Some of these wrapped tokens are decentralized and some are not. So in some cases, you know, there is an a custodian freezing an asset in one chain and minting a representation of the same asset in another chain. And sometimes this is done in a completely decentralized manner.
00:23:08
Speaker
And you have a very similar issue as with liquid-saking tokens. In this case, you don't have the yield, which further complicates things, but the problem is still there. A similar thing happens with bridged stablecoins.
00:23:19
Speaker
um So, you know, not all the stablecoins that you see out there are issued by issuer, like Circle or Tether. People can also create their own bridged versions of these stablecoins, and this creates all sorts of of situations because um it was hard to classify the asset, first of all, because is USDCX tracking USD or USDC? That changes the legal classification. But also, is there an issuer behind these assets? um Again, decentralization is is a problem disrupting the regulation.
00:23:56
Speaker
And it it goes beyond um the token nature itself. ah One of of the situations that we see with with Mika, for instance, is that whenever you are trying to um admit an asset to trading, you need to publish a white paper, which is basically disclosure with information about the asset, and you need to disclose whether the asset has an issuer and provide information about the issuer, and the obligations change if the asset has an issuer or if it doesn't.
00:24:28
Speaker
One of the issuer is a DAO, right? Take as it's like a SKY, which you could make the case that is issued by SKYDAO. Does SkyDAO count as an issuer? Because it's not a legal person. It's not a natural person either.
00:24:44
Speaker
could say it's an entity or an undertaking, but the members are not identifiable. So does that count as an issuer or not? The truth is, we can speculate, we can make our proposals, but the problem is with the regulation. The regulation is just not built to handle ah decentralization.
00:25:03
Speaker
It was ah probably a a political compromise that we could reach. Obviously, um our policymakers are not Web3 experts. But ah as a result, the regulation has these deficiencies.
00:25:17
Speaker
So, yeah, there's still quite a bit of work to do to update and upgrade the regulation and actually allow us to... properly represent this new generation of asset classes that do not neatly fit into existing categories. that's That's a really good way to conclude. And I think it also shows the fact that even though there's still, um even though like we've advanced in the sense of, okay, there's more openness, as you said, there's some compromises, there's still a lot of work to be done.
Conclusion and Resources for Further Learning
00:25:51
Speaker
And just as we wrap up this episode, since we're almost out of time, just to like,
00:25:56
Speaker
do the the takeaway. I always like to conclude with one practical item because I know that especially when you talk about like blockchain and policy and the legal technicalities, it can get a bit, a how can I say, like very, very granular and also a bit too much. So I like to end on a practical note. Like even if the listeners are like, i don't know, listening listening to this episode when they're like driving or whatever, there's like a short attention stand. I always like to live with like,
00:26:26
Speaker
something to to hit home. So what should they take away from this moving forward from LSTs and this taxonomy work? um What would be like your your closing statement to leave our listeners with? I really hope I didn't lose too many of the listeners along the way. Sorry if I i made it a bit technical. My quick takeaway like my quick takeaway would be...
00:26:51
Speaker
abs For LSDs in particular, they're not all securities, right? Liquidity taking is part of our infrastructure and it needs to be understood in this way. and Second takeaway, more general, not everything needs to be regulated and forced into an existing regulated category. Those categories are there for those assets that do fit in the categories. And if they don't fit in the categories, then that's also okay.
00:27:17
Speaker
And a final point is it's important to have regulation and to get basic points across. But when you implement and roll out the details of the regulation, getting the details right matters, which is why...
00:27:33
Speaker
The implementation and specification of regulation needs to be informed by research. That's what we're trying to do. And we strongly encourage for an effective regulatory regime um to share knowledge, detailed granular knowledge with the regulators, with the supervisors, so that the regulation can actually work and lead to results that that we all want to strive for.
00:27:56
Speaker
Amazing. Well, I think that's a really good way to just end this amazing discussion. And we will link to your working paper on the crypto asset taxonomy for investors and regulators and on the podcast description and on the promotional materials in case people want to check it out as well. And where can they find your work and follow what what you're doing?
00:28:16
Speaker
Yes, so you can find us in the website of the Mika Crypto Alliance, www.mikacryptoalliance.com. My name is Juan Ingers Ibáñez. I'm the general secretary. You can also find me on LinkedIn. I'm not very active on X, so LinkedIn is the right place to to find me. Amazing. Well, thank you so much, Juan Ignacio. I think this was a really fascinating discussion. and I hope that we all continue to remember that classification is about understanding what an asset actually does, how it's used, and where real risk is living. And i think it's also interesting as we... exposed and LSTs in this way because they didn't really break the rules, but I think that they actually shed the light on where the rules were written for a simpler world and that the reality is way more complex than that. And I think that this is exactly the kind of work that we'd like to unpack here on the Avalanche Policy Coalition and also with the great guests that we feature. So once again, thank you so much, Juan Ignacio. Thanks to our listeners for tuning in and I'll see you all next time.
00:29:22
Speaker
We hope you enjoyed this episode of the Policy Layer. If you want to learn more, check out avalanchepolicy.com for free educational resources. And also follow us on social media at avalanchepolicy to stay updated.