In a detailed response to ESMA’s third consultation package, the firm outlined potential negative impacts on both EU citizens and the broader crypto ecosystem stemming inadvertently from some of the proposed rules.

MEV concerns

ESMA recently said MEV will be considered a “clear form of market abuse” under the upcoming MiCA framework. However, Paradigm expressed concerns that the regulatory body’s current approach misinterprets the mechanics and implications of MEV, a key feature in the operation of DeFi ecosystems.

MEV refers to the potential value miners and validators can extract from reordering transactions within a block, which Paradigm argues is vital for the efficiency and security of decentralized networks.

Paradigm said that MEV plays an “important role” in supporting the DeFi ecosystem by enabling the efficient allocation of blockspace and aiding in essential market activities. According to the firm:

“ESMA’s characterization of MEV as a form of market abuse akin to front-running in traditional financial markets shows a fundamental misunderstanding of blockchain technology.”

The firm added that traditionally, front-running involves someone using inside information to execute trades before others, gaining an unfair advantage. Paradigm pointed out that this definition does not apply to blockchain transactions, which are typically public and transparent by design.

Paradigm said that since all participants can see pending transactions on blockchains, no insider information is involved, making the traditional concept of front-running inapplicable in this context.

Regulatory overreach

Paradigm’s feedback also addressed broader concerns regarding ESMA’s intention to apply Market Abuse Regulations (MAR) to the “base layer” of crypto assets. This layer involves decentralized infrastructure operators who record and validate blockchain transactions.

Paradigm contends that MAR, designed for traditional financial markets, is unsuitable for this decentralized infrastructure. According to the firm:

“Applying MAR to crypto’s base layer would be a significant divergence from traditional financial market regulations. This could inadvertently include Internet Service Providers, cloud data centers, and networking software developers under its scope, which is impracticable and inconsistent with ESMA’s mandate.”

The firm urged ESMA to conduct further research and engage with the private sector to better understand the nuanced role of MEV in blockchain ecosystems. It cautioned that misapplying MAR to blockchain operations could stifle innovation and force key technology firms to relocate outside the EU.

Paradigm proposed that MAR’s applicability should be limited to situations involving centralized services and platforms operated by Crypto Asset Service Providers (CASPs) with direct customer relationships.

The firm said:

“CASPs operating centralized exchanges should ensure fair market practices and transparency.”

Paradigm’s response highlights the complexities of regulating emerging technologies with frameworks designed for traditional markets. As ESMA continues its consultation process, the crypto industry remains watchful of potential regulatory developments that could shape the future of blockchain and digital assets in Europe.