Estonia once promoted itself as a leading crypto destination. Now, keen to protect its status as a trusted global hub for tech, its authorities have been cracking down on virtual asset service providers.
In 2021, Estonia was home to just 1.3 million people but 55 per cent of the world’s registered virtual asset service providers (VASPs). But on May 8, Estonia’s Financial Intelligence Unit (FIU) announced the number of registered VASPs had dropped 80 per cent since the regulator began enforcing new anti-money laundering (AML) rules in 2022.
Those new rules were just the latest part of a crackdown by a country that just years prior worked to promote itself as a leading crypto destination.
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Estonia is the EU and global leader in digital public services. The latest Emerging Europe IT Competitiveness Index ranked Estonia first in the region for its abundance of talent and its business environment. Estonia has the most start-ups and unicorns per capita in Europe, and Estonians played key roles founding Wise, Bolt, and Skype.
Estonians receive a state-issued e-ID that allows them to vote, pay taxes, and sign contracts online. e-Residency allows non-Estonians to access the country’s e-services – including online tax filing – without gaining physical residency or citizenship.
Of Estonia’s more than 100,000 e-residents, many are from Finland, Russia, or Ukraine. In 2017, there was a proposal for the launch of ‘estcoin’ as a national cryptocurrency pegged to the euro targeting these e-residents, but Estonia’s government backed away from the plan after it drew criticism from the European Central Bank.
Esontia’s e-residency programme, simple taxes, and status as a tech hub made it an appealing site to register cryptocurrencies. However, the country soon faced a pressing need to crack down on money laundering, which would necessitate comprehensive regulation of crypto.
That need came when news broke in 2017 that Danske Bank had allowed 200 billion euros of illicit funds — largely from Russia — to flow through its Tallinn branch between 2007 and 2016. The scandal is believed to be the largest ever money laundering case in Europe, and possibly the world.
New rules
In 2018, the European Union (EU) adopted the Fifth Anti-Money Laundering Directive (AMLD5), which introduced AML and know-your-client (KYC) requirements for cryptocurrency exchanges and wallet providers. To comply with the EU directive and restore confidence in its commitment to financial transparency after the Danske Bank scandal, Estonia began a regulatory clampdown on cryptocurrency and money laundering.
Estonia enacted amendments to the Money Laundering and Terrorist Financing Prevention Act, implemented in March 2020, which brought crypto-related activities under the purview of the FIU. The FIU became responsible ensuring crypto entities registered in Estonia complied with anti-money laundering, due diligence, and know-your-customer regulations and had share capital of at least 12,000 euros and management boards located in Estonia.
The FIU began revoking licenses of crypto service providers that failed to comply with the new regulations, withdrawing licenses for over 1,000 crypto companies by the end of 2020.
Regulators found that many of the thousands of crypto companies registered in Estonia were dormant and that the country had been largely functioning as an offshore jurisdiction.
“The Estonian state did not benefit from the situation [with so many dormant crypto companies] – it meant no jobs, no tax money; often only fictitious connections with Estonia and a potential for reputational damage, and systemic risk,” said Marko Kairjak, a partner of the Ellex Raidla law firm.
Both Estonia and the EU continued to introduce new regulations on the sector.
In the immediate aftermath of Russia’s invasion of Ukraine, Estonia suspended e-Residency applications from Russian and Belarusian citizens so the programme could not be used for sanctions evasion.
In late December 2021, Estonia’s parliament approved further amendments to the Money Laundering and Terrorist Financing Prevention Act that significantly increased capital reserve requirements for VASPs from 12,000 euros to 125,000 euros or 350,000 euros depending on services provided.
Quality, not quantity
The new rules took effect in March 2022 and service providers had through mid-June to renew their authorisations. Since the beginning of these rules’ enforcement, service providers abandoned nearly 200 authorisations and the FIU revoked almost the same number of authorisations due to non-compliance. As of May 1, 2023, there were 100 active authorisations for VASPs in Estonia.
“I don’t think we have become too tough, but what we are focussing on is on the quality, not quantity [of crypto companies] and the quality means, first and foremost, those companies who actually want to innovate the field, or want to, to do a legitimate business,” said Andres Sutt, Estonia’s Minister of Entrepreneurship and Information Technology.
The need for legitimacy was further highlighted in November 2022, when a joint operation involving over 100 Estonian police officers and 15 agents of the United States Federal Bureau of Investigation (FBI) busted a 575 million US dollars crypto fraud scam. Washington requested the extradition of the two men arrested from Estonia.
The decentralised nature of cryptocurrency has presented challenges for countries working to prevent its use in cybercrime, but the European Commission is set to move forward with a harmonised set of rules for crypto assets.
Originally proposed in September 2020, the Markets in Crypto Assets (MiCA) regulation was passed by the European Parliament on April 20, 2023 and will come into effect sometime between mid-2024 and early 2025. MiCA is the first regulatory framework for crypto assets in the world and covers digital assets that use decentralised ledger technology but not the Decentralised Finance (DeFi) industry and non-fungible tokens (NFTs).
As MiCA comes into force, Estonia’s FIU is signalling its purges are done—for now.
“We will continue reviewing the applications for amendment of authorisations, but soon, we can return to normality in terms of supervision, where we will be moving largely from assessment on paper to daily on-site supervision,” said FIU director Matis Mäeker.
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