III. The Inhibiting Impact of EU Regulation on Global Stablecoins
This Section argues that EU Regulation, which introduces more precise regulatory standards based on the FSB’s recommendations, is targeted at global stablecoins, conflating the universe of stablecoins (other than algorithmic stablecoins that are not caught within scope) with global stablecoins. It is uncertain if the desired intention is to properly regulate stablecoins or to simply deter global stablecoins which are seen as potential threats to monetary sovereignty and financial stability. This Section argues that the regulation would disincentivize both banking corporations and non-bank corporations from offering global stablecoins, adding to the inherent business challenges discussed earlier.
The EU has introduced a regulatory regime for stablecoins, which are either ‘asset-referenced’ or ‘electronic money’ (e-money) tokens. The former refer to tokens pegged to ‘another value or right’, including one or more official currencies. This likely refers to multiple currency pegged tokens, or tokens pegged to other assets and one or more currencies. E-money tokens are single currency pegged tokens. The key features of the regulatory regime that are disincentivizing will be discussed as follows:
(a) Concurrent application of mandatory disclosure-based offer regulation as well as an enhanced form of electronic money regulation
(b) The regulation of segregated reserves and particular disincentives for banks which may wish to offer stablecoins
(c) Regulation of liquidity management and holders’ redemption rights which may disincentivize the demand side
(d) The application of service provider regulation, especially conventional payment services regulation, to the deployment of stablecoins.
A. Concurrent Application of Mandatory Disclosure-based Offer Regulation and Enhanced Electronic Money Regulation to Stablecoins
Stablecoin providers have to be authorized to issue stablecoins in the EU, and in addition publish a crypto-asset white paper for the public offer. This regulatory regime imposes on stablecoin providers the need to comply with a form of securities/investment product regulation.
Such concurrent application of regulatory regimes can be regarded as unfavorable for stablecoin providers, as comparison may be made with the baseline of electronic money regulation, where the extension of mandatory disclosure regulation is not made. In other words, if stablecoin providers issue a single currency pegged product i.e., an e-money token, which engages with a distributed ledger or equivalent, stablecoin providers would be subject to significantly more regulatory demands than compared with issuing electronic money as an account-based product. The reference to ‘DLT’ or equivalent likely means a private, shared network, and would capture any means of deployment of the stablecoin other than in conventional account-based systems of centralized ledgers. This significantly disincentives mainstream payment innovations that are based on shared networks or DLT, because even if the network/blockchain system may be permissioned, and in effect centrally controlled or managed by a cluster of signatures and authorized entities, the regulatory compliance requirements would significantly exceed those for a traditional issuance of electronic money.
It may be argued that the white paper requirements are less prescriptive than for securities or other investment products such as open-ended investment or money market funds. Further, one benefit that stablecoin providers may obtain is the ability to admit their stablecoins to trading on a secondary market. Secondary market trading can be beneficial as trading price spreads can provide early signals to stablecoin providers regarding market confidence and these markets could also act as venues for volatility absorption. But the converse may also be true, that secondary trading markets amplify potential volatility for stablecoins. Because the Regulation stipulates rights of redemption for holders, the presence of secondary markets would not ameliorate the risk that holders would herd towards a redemption run against the stablecoin provider.
We are of the view that the case is not clearly established for global stablecoin providers to list their stablecoins for secondary market trading. There may however be good reasons for certain specialized stablecoin issuers, i.e., those who provide on ramp access to cryptocurrency, to list their stablecoins on secondary market venues for trading. For some stablecoins, this is the main access avenue for customers. Further, the price arbitrage opportunities for stablecoins also feed into the Decentralized Finance industry in the crypto economy. On the contrary, it may be counterproductive for stablecoins intended to be developed as mainstream payment instruments to be traded in secondary markets. As payment instruments need to maintain their monetary appeal as a stable store of value, in order to be a unit of account and medium of exchange, there may be no benefit for issuers listing these tokens for secondary trading and allowing the market to introduce price fluctuations.
It is arguable that a white paper may not be needed if the issuer only seeks to issue stablecoins to qualified investors, which may be individuals or corporations above certain financial thresholds. Stablecoin providers can be exempted from the white paper requirement if they only offer their stablecoins to qualified investors or if the offer does not exceed five million euros over twelve months. In practice, some stablecoin issuers only issue stablecoins to wholesale parties such as cryptocurrency exchanges in order to avoid the need for securities registration in the US. But as the white paper requirement applies to issuers who “seek . . . admission to . . . trading,” it can be argued that issuers who issue only to cryptocurrency exchanges intend to have their stablecoins listed for trading. As such, the issues should not be exempt from the white paper requirement. This is a point that needs clarification by perhaps the European Banking Authority. The five million euros threshold for exemption is also extremely low, and it may not be worthwhile for a stablecoin provider if insufficient volume of circulation and network effects is achieved. It is highly likely that stablecoin developers for mainstream adoption would not find the business case below the exemption level to be attractive.
The mandatory disclosure for issuers of stablecoins entails continuing legal risk for them. There are itemized disclosure requirements set out for issuers of stablecoins in relation to their underlying technology, risks, and reserves supporting the stability of coins, alongside other governance and compliance policies. These disclosure items, framed in an open-ended manner, could present continuing legal risk for issuers if a problem subsequently occurs with the deployment of stablecoins that may broadly relate to these open-ended matters. Being a digitally programmed token, stablecoins run the risk of ongoing bug-fixing. Issuers may prefer to disclose sparingly the technological aspects of their stablecoins within the open-ended nature of the white paper requirements. But courts are not prevented from interpreting general or high-level disclosures as being unfair, unclear, or misleading when a problem happens. For example, it is queried if stablecoin issuers would face legal risks from holders’ civil actions if the coin suffers from payment and transfer problems in due course, and blame is pinned on the issuer for inadequate or misleading disclosure of the technology or risks underpinning the stablecoin. The customer may theoretically have an action in terms of unfair, unclear or misleading disclosure in the relevant white paper, such as in relation to the stablecoin’s technology or functionality, as a type of private securities claim against the issuer. Besides the risk of civil liability, issuers may also face regulatory enforcement actions in relation to process, operation, or service standards required elsewhere, if those should apply (as discussed shortly below). In this manner a stablecoin issuer potentially faces enhanced legal risk in providing this as a payment option to customers, as compared to providing an account-based payment service.
In particular, the principal adverse impacts of the stablecoin’s operation on the climate and environment must also be disclosed, presumably targeting permissionless blockchains that utilize an energy-consuming proof-of-work protocol that engages the blockchain’s nodes in competitive actions to validate transactions, therefore wasting the work of many competitors while consuming significant amounts of energy. But as this provision relates to the principal adverse impacts at time of issue of the stablecoins, it is queried if off chain stablecoins are affected as they are not issued over a blockchain as such. An on-chain stablecoin would likely be caught within scope. But ESMA has recently clarified that the sustainability footprint disclosure follows into the network in which the stablecoin is deployed. Such a disclosure may mean that stablecoin issuers need to provide sustainability indicator disclosure of all the blockchains their stablecoins are deployed on and can be an onerous obligation.
Next, it is queried if mandatory disclosure regulation is necessary for stablecoins, because issuers would be subject to merit vetting to be authorized by national regulators. The authorisation requirements are extensive. They relate to the identities and good repute of management or shareholders of the stablecoin provider, or their equivalents. Although the regulatory provision seems to allow legal forms other than the corporate form to seek authorization, alternative legal forms must be able to ensure third party protection in an equivalent manner as a corporate form could offer and be subject to prudential regulation accordingly. This will pose problems for on-chain stablecoins like DAI or its successor USDS whose governing body is an a-legal Decentralised Autonomous Organization (DAO). In this manner, mandatory disclosure regulation may operate particularly unfairly against on-chain stablecoins, as the regulatory design is based on assumptions regarding how stablecoin providers are organized.
Many crypto economy applications are collectively maintained and governed by DAOs that seek to distinguish themselves from existing legal organizational forms, although they are not necessarily immune from legal characterzsation. The uncertainties in organizational law applying to DAOs may be the very flexibility that DAOs seek in experimenting with governance that departs from mainstream norms. The on-chain stablecoin DAI and its successor USDS are governed by communities of governance token holders (MakerDAO, to become Sky) that set policies for the collateralization of the on-chain stablecoin in order for it to be issued. It is uncertain how such a community, which resists hierarchical organization, is able to identify its management body of “good repute” for regulatory vetting. Would this requirement apply, impractically, to the shifting nature of such communities’ membership?
Further, the prudential regulatory requirements for stablecoin providers, though relatively modest, hinge upon concepts such as “own funds,” which refers to shareholders’ capital. Arguably the prudential requirements are not particularly high, as the highest of one of the following options would be applied: either 350,000 euros, a quarter of the fixed overheads in the preceding year or two percent of the average amount of reserve of assets required to be maintained. Other than reference to the fixed overheads, the e-money stablecoin provider is subject to equivalent prudential requirements. It is uncertain if the treasuries of on-chain stablecoins’ DAOs could be treated as the equivalent for prudential satisfaction, as it may fall to be treated as ‘reserves’. ‘Own funds’ would require a separate form of members’ capital contributions, and although the prudential requirements seem modest for conventional financial institutions, they can be financially demanding for a dispersed community of governance members.
The authorization requirements extend to vetting stablecoin issuers’ policies regarding business operations, continuity, organizational governance and even their arrangements with third parties, and other crypto-asset service providers. As these are framed in an open-ended manner, nothing is said about how national regulators would vet the quality and comprehensiveness of such information in applications for authorization. Moreover, compared to the authorization requirements for electronic money issuers, these seem more demanding and extensive.
The authorized status of stablecoin providers would need to be maintained by ongoing compliance in terms of regulatory reporting, such as in relation to their circulation, volume of transactions and reserves. They also need to maintain internal governance policies, conflict of interest management policies that can be qualitatively supervised. The most significant regulatory control over stablecoin providers would be the reserve regulation and liquidity management requirements that ultimately seek to protect stablecoin holders’ redemption rights.
B. Reserve Regulation
Stablecoin issuers must maintain an insolvency-remote reserve of assets in order to address the risks of its business model, with custody held in a regulated third-party institution. One of the concerns the FSB articulated in relation to global stablecoins is the potential run risk on stablecoins, leading to financial stability consequences. A run episode may occur if holders doubt that the stablecoin can be redeemed for its peg, and this can trigger herding behavior on the part of holders rushing to redeem, leading to adverse impact on market confidence and higher risk of the issuer’s insolvency. Further, as stablecoin issuers sell reserve assets to meet redemption needs, this may also cause liquidity volatility in conventional financial markets. Reserve regulation is not an unequivocal good as reserve asset markets, which may be markets for sovereign or corporate bonds, may suffer instability, while it is uncertain if the selling of reserves would necessarily contain a stampede to redeem. That said, it is arguable that the TerraUST collapse happened so spectacularly and quickly because it was essentially uncollateralized and thus, unbacked by reserves. Relying on the working of market forces to stabilize the token was impracticable. The role of reserves, such as conventionally liquid and ‘safe’ financial assets like US Treasury bills, has been perceived to play an important role in stabilizing on-chain stablecoin DAI, which used to be backed only by ether.
Arguably it is less clear that e-money tokens are to be similarly safeguarded in an insolvency remote manner. Litigation in the UK regarding the interpretation of this requirement in the Electronic Money Directive, which remains applicable to e-money tokens as no specific overriding provision as introduced in MiCAR, has led to the clarification that electronic money is not legislatively required to be safeguarded in an insolvency remote manner. Fiat currency payments received for e-money tokens have to be safeguarded within five business days but only supported by a reserve maintained in terms of its liquidity. This discrepancy between the reserve regulation for stablecoins pegged to multiple currencies and those pegged to a single currency needs to be resolved. In the UK, the regulator has proposed bringing electronic money safeguarding within the ambit of insolvency remote requirements, but it is yet uncertain in the EU if the same approach would be taken. This discrepancy can create a disjuncture between the supply and demand sides for stablecoins. Suppliers may see single fiat currency pegged stablecoins as less costly to offer, but holders may view the lower level of protection as unfavorable. This would create disincentives particularly for issuers of multi-currency pegged or global stablecoins.
In relation to the multiple currency pegged stablecoin, i.e. the ‘asset-referenced’ token, the reserve requirement must comprise highly liquid financial instruments that are similarly applied to liquidity regulation for banks, i.e. conventionally highly liquid financial instruments such as low-risk government, local government, public and international organizations’ securities, as well as limited amounts of covered bonds issued by banks and other short-term arrangements with banks such as collateral swaps, repos or reverse repos. Investments in EU-regulated open-ended investment funds which are highly liquid would also count up to ten percent of the reserve. Currency deposits reflecting the pegged currencies/currency for the stablecoin must be at levels exceeding thirty percent of the amount referenced in that currency, or sixty percent where the stablecoin is designated as ‘significant’. For e-money tokens, the liquidity requirements are not dissimilar, in relation to safe, low risk assets and UCITs investments as well.
The reserve of assets must be maintained at all times and regularly reported, subject to remedy under a recovery plan if the reserve falls below what is required. We argue below that both banking institutions and non-financial corporations would be disincentivized by the reserve requirement to issue stablecoins for mainstream use, therefore rendering the concern against global stablecoins rather illusory.
First, turning to banks, the reserve requirement seems excessive in addition to their other regulatory requirements, in particular, the application of micro-prudential regulation to them. To comply with the reserve requirement, banks may have to separate their stablecoin business from their deposit taking business even though there are a lot of synergies between the two. Banks would unlikely be more incentivized to develop stablecoins beyond their business line of account-based electronic money, if they have one.
It is arguable that the banks that issue stablecoins would most naturally do this by converting customers’ deposits, i.e. account-based money into token-based money in the stablecoin. The typical scenario is that a depositor asks for account-based money to be converted to a stablecoin in order to be deployed on either a permissioned network or in a permission-less blockchain. Applying the regulation, the conversion of such a deposit to the stablecoin would result in the following consequences. First, the conversion to the stablecoin would mean that the bank needs to have an equivalent amount of liquid reserves backing the stablecoin. As a deposit, there would have been no equivalent obligation on the bank’s part needed to specifically back the depositor’s claim. This amounts to an extra liquidity surcharge for the bank. Banks are already subject to liquidity regulation in terms of the liquidity coverage ratio, which demands that banks maintain a sufficient amount of highly liquid instruments that would be sufficient to meet 30 days’ worth of stressed outflows. If a stablecoin is regarded as more susceptible to outflow for the bank, then an extra liquidity surcharge can be included in the liquidity coverage ratio for the bank rather than requiring the bank to maintain a reserve equivalent to the value of the stablecoin. Further, if there are concerns about the DLT platform that might exacerbate liquidity outflows or demands, another liquidity surcharge or an extra operational risk charge in relation to the bank’s prudential compliance can be made. We doubt that the redemption or liquidity risk for a stablecoin would vastly exceed the risk of a potential depositor run on the bank. In this manner, reserve regulation as imposed on banks may be excessive, even though it is acknowledged that the EU regulation does not further impose prudential requirements on banks for their stablecoin business because banks are already subject to their own micro-prudential compliance.
Second, the regulatory treatment of a bank-issued stablecoin as backed by reserve and not as equivalent to a deposit, is likely unappealing to the demand side. This means a depositor’s claim loses its status as a deposit upon conversion to a stablecoin and consequently, the deposit guarantee protection attached to the deposit. Further, stablecoin issuers, whether issuing multi-currency or single currency tokens (e-money) are prohibited from paying interest, thus reflecting the clear policy choice that stablecoins will not be regarded as equivalent to deposits. Arguably this position is no different from that for electronic money. But for a bank customer, the position would be highly unattractive as it can be perceived to be an artificial removal of the depositor’s claim from deposit guarantee protection because the same amount has just been converted from account-based money to a digital token. This fundamentally changes the nature of the bank customer’s risk for the period of time she is holding on to the stablecoin or in the process of deploying the stablecoin for payment or remittance.
It may be argued that there are good policy reasons for the above position, which may be seen as extra punitive for banks wishing to develop stablecoins. First, differentiating stablecoins from deposits could prevent deposit migration. Deposits are an important source of funding for banks to fund lending and therefore to contribute to economic development and growth. Deposit migration can adversely affect banks in this role and capacity. But on more careful examination, it is arguable that the fear of deposit migration is exaggerated. For a bank customer, if a stablecoin were to be treated like a deposit and attracts interest payments, it is not necessary for the bank customer to prefer holding their store of value in stablecoins rather than account-based money. Stablecoins are tokens loaded with an instructed value, so customers are likely only to convert to a stablecoin for specific purposes like remittance or transfer. Account-based money offers customers many more options in terms of their operational financial management. Under equal regulatory treatment, there is no reason why customers would necessarily choose to hold their store of value in stablecoins. Where stablecoins converted from deposits are not treated differently in terms of legal risk and obligation, they are tantamount to a form of deposit transformation instead of deposit migration.
But under the EU regulation, it is possible that stablecoins can be traded in secondary markets, so there is a risk of deposit migration in that customers would convert to stablecoins in order to trade, where the secondary market value of stablecoins may be higher than the peg. Nevertheless, empirical research has found that the currently unregulated stablecoin Tether is able to more or less maintain its value at US $1 in secondary market trading, because the trading actions of arbitrageurs neutralize potential market gains and would stabilize Tether at this value. So stablecoin holders’ incentives to trade would be mitigated by collective market forces, and the risk to deposit migration may be ameliorated naturally. Nevertheless, it can be argued that secondary trading creates an operational problem for claims against deposit insurance. Where issuers have failed, ‘bad stablecoins’ can remain in circulation amongst secondary traders and present a persistent risk of claim against deposit insurance. Hence, additional demands would be made on deposit insurance authorities to be able to burn or remove ‘bad stablecoins’, which may make this guarantee more costly than under conventional circumstances. In this manner, the supply and demand sides, as well as regulatory authorities, may all suffer from disincentives in adopting a bank-based stablecoin model for payment services.
It is arguable that non-financial corporations that seek to develop stablecoins may not find the EU’s Regulation that deterring. They could compare with the baseline regulation of electronic money, and find that stablecoin regulation under MiCAR is only slightly enhanced. However, the reserve requirements are more stringent for stablecoins especially in relation to the minimum amount of currency deposits that need to support the stablecoin’s referenced currency/ies. The requirements relating to types and concentration limits for highly liquid instruments are also likely to curtail stablecoin issuers’ investment profits. Such a narrow investment model for stablecoin issuers may only make sense for their business case if they are able to engage in high volume but low margin issues. That however, is curtailed, as there are upper limit caps on stablecoin circulation and transaction levels calculated on a per day basis, in order to prevent fiat currency substitution by stablecoins. The regulation requires stablecoin providers to moderate the circulation of stablecoin tokens to the maximum value of two hundred million euros and to keep transactions below the threshold of one million per day.
Such a cap is designed to protect against the erosion of the importance of the euro. Many European member states’ fiscal capacity are measured in euros, and they borrow in euros. Further, the ECB’s monetary policy and monetary transactions for supporting financial markets, are conducted in euros. Any erosion of the euro could adversely affect many states’ fiscal capacities as well as the potency of monetary policy. Although a privately issued stablecoin is usually anchored in fiat currency/ies, in wide circulation, its unit of account can become self-referential. This can give rise to risks in relation to the private stablecoin issuer exerting monetary power based on its own private profit maximization motives. Its choice of the peg or anchoring fiat currencies can also make it politically powerful against governments. Hence, the cap has to be understood as a preemptive measure to deter potential growing monetary domination by a privately issued stablecoin.
The Regulation further designates stablecoins with certain thresholds of holders, volume of transactions or market capitalization as ‘significant’, and would subject them to additional prudential regulation, applying to both asset-referenced and e-money tokens. The additional prudential requirements include liquidity stress-testing and more proactive liquidity management of the business, including the reserves. The own funds requirement would be increased to three percent of the reserve requirement. The significant stablecoin also attracts the direct supervision of the European Banking Authority rather than a national regulator. The thresholds for the ‘significant’ designation are that holders of the stablecoin exceed ten million, or average volume of transactions exceed 2.5 million a day or five hundred million euros per day. It is arguable that Tether already exceeds these thresholds at a worldwide level, although it is not deployed for mainstream use in the manner a global stablecoin is envisaged to be. The caps and significant designation may all be designed in order to protect monetary sovereignty and ameliorate a stablecoin’s financial stability impact if it should suffer a crisis of confidence. However, the relatively low thresholds would capture stablecoins that are not global stablecoins and do not threaten the mainstream currency orders and payment systems for international transfers and remittances.
C. Redemption and Liquidity Management
The regulation provides redemption rights for holders of stablecoins, as the issuer has an obligation to honor redemption requests at all times. Further, this strong redemption right is flanked by the reserve requirements discussed above and the requirement to regularly stress test reserve positions in relation to meeting the peg promised.
However, if redemptions become a source of pressure for the issuer, the regulation envisages that issuers can provide for redemption mechanisms, processes, timeframes, conditions etc. to preserve orderly redemption. This does not mean that the peg has to be absolutely preserved, unless in the case of e-money tokens which are pegged to a single currency and would have to be redeemed at par value.
The liquidity management requirements seem therefore closer to the management of liquidity risks for open-ended investment funds, in terms of potential redemption gates, staggered redemptions and even fees and charges in order to smooth out liquidity demands. This could make the multiple currency pegged stablecoin less attractive than money market funds, which are now subject to regulation that addresses both the representation of asset value to investors as well as liquidity management needs. Martino discusses the EU’s stablecoin regulation as trading off the investor protection aspect for preserving financial stability. When meeting liquidity needs means selling off instruments in stablecoin providers’ reserves, which could be ‘safe assets’ like government bonds, important financial markets can be potentially destabilized. Hence, managing the demand side’s access to redemption and liquidity can smooth out the pressure on reserve asset markets. This however means that stablecoin holders have less certainty if they can redeem promptly and at what price. In this manner, on the demand side, there could be a lack of incentive to subscribe to the stablecoin as a store of value, which can affect its appeal as a medium of exchange.
On the supply side, although the discretions allowed in MiCAR for liquidity and redemption policies may provide stablecoin issuers with options to manage redemption stampedes, yet, it is arguable that they can be exposed to legal risk in managing such episodes due to the open-ended nature of regulatory expectations. If a stablecoin issuer does not manage optimally a stressed redemption episode, it may be exposed to regulatory liability for failing to adhere to its own policies or maintaining sound liquidity management policies. It could also be exposed to civil liability in relation to customers’ grievances at redemption.
D. The Application of Service Provider Regulations and Payment Services Regulation
Finally, it is also arguable that depending on the nature of services that stablecoin issuers provide customers with, such as payment or other financial services, stablecoin issuers may attract the designation of ‘crypto-asset service provider’ and be subject to other regulatory requirements for conduct of business. For a global stablecoin, it is uncertain if transfer services offered by the issuer for the stablecoin (such as the Diem network) would fall under one of the crypto-asset service providers designation and be accordingly subject to the requirements of MiCAR, or count as a payment service and be regulated as well under the EU’s payment services regulatory regime. MiCAR’s regulation of crypto-asset transfer services contains general requirements for conduct of business, such as acting fairly, honestly and in customers’ best interests, due management and disclosure of conflicts of interest, safe-keeping of customers’ assets in an insolvency-remote manner, and having mandatory complaints-handling procedures to offer customers a prompt and fair means of grievance resolution as a first port of call. These are not vastly different from conduct of business rules established for financial services intermediaries in general. But it may be questioned whether the prudential requirements for crypto-asset service providers would be in addition to those applicable for stablecoin issuers, because these are different business lines.
Specifically for crypto-asset transfer services, providers are required to conclude agreements with clients to ensure that identities of parties in the transfer are established. This likely meets the requirements of ensuring the transfer service provider is able to implement anti-money laundering compliance, that may not be dissimilar to requirements under general payment services regulation for establishing customers’ and payees’ identities. Further, the agreement must specify the modalities of service, security arrangements, applicable law and fees. It is questioned whether service providers have the discretion to agree with customers as they see fit, or would there be implicit service standards imported from general payment services regulation? Arguably, specifying that the applicable law is a Member State law could mean that the EU Payment Services Directive’s provisions would apply in addition to the open-ended stipulation in MiCAR. Stablecoins can be caught within the scope of the Directive as the exclusions specified therein do not apply to them. Further, in relation to security arrangements, the EU’s Digital Operational Resilience Act applies across the financial sector, including stablecoin issuers and crypto-asset service providers. Hence, it is unlikely up to transfer service providers to self-select the levels of cybersecurity control and resilience for the benefit of customers.
If the EU’s payment services regulatory regime applies to the transfer services for stablecoin payments, it would disincentivize stablecoin innovations which utilize new forms of transfer or settlement architecture, such as those which are DLT-based. New architecture would have to comply with existing payment-transfer and settlement standards, essentially applicable to account-based money systems and centralized ledgers, and heavy lifting may be required to ensure that any new architecture would be compliant. Global stablecoin issuers would have to comply with the EU Payment Services Directive regarding customer on-boarding and information collection, authentication, and service standards, including the potential liability for losses. Thus banks are disincentivized from moving away from the account-based transfer, clearing, and settlement network they are already familiar with. Banks are likely already plugged into systems for payment clearing and settlement, such as the Target2, which is maintained by the Eurosystem (European Central Bank) and processes the real-time settlement of transfers in euros. The maintenance of existing arrangements would likely provide safety and comfort for both providers and customers. But developing alternative architecture to meet the same level of service standards and compliance requirements may be financially disincentivizing for a bank. Partnering with other banks or financial institutions to develop such an architecture is also subject to a collective action problem, and Section II’s narrative on actual banking projects so far shows how rare such partnerships are. Non-bank corporations would find the architectural development for payment and settlement a steep hill to climb. If they choose to partner with banking corporations which are already plugged into conventional clearing and settlement systems, there would be a business case to innovate with token-based money. Non-bank corporations would likely fare better working with account-based money as payment Fintechs instead.
Regulators also have an interest in preserving and improving existing payment and settlement architecture, rather encouraging the development of private, fragmented forms of transfer and settlement architecture. Well-established systems of clearing and settlement are subject to oversight and regulatory policy, such as in relation to resilience and continuity, and central banks may be concerned that they may lose their monopolistic hold on their large clearing and settlement systems. There may also be a need for regulators to expend more resources to supervise the functions of private payment architecture in order to ensure that anti-money laundering measures, resilience and continuity policies, customer protection policies, and the technological robustness of the system, such as resilience to cyber risk, are all achieved. For regulators, the fragmentation of payment clearing and settlement systems could exert greater demand on regulatory resources, being both inefficient as well as challenging to established forms of institutional order.
Both banks and non-financial corporations that are uncertain about the legal risk regarding payment regulation of global stablecoins would also be unlikely to design such stablecoins for deployment over permissionless blockchains. In permissionless blockchains, there are legs of the payment process that are not within providers’ control, such as transaction validation and any attacks on customers’ transactions. These processes are subject to the protocols and controls of the permissionless blockchain concerned, while issuers may retain the legal risk of responsibility for customer loss in the case of unauthorized transactions, for example, where a cyber-attack takes place. It is queried whether MiCAR allows such transfer service providers to agree with clients the extent of their responsibilities if certain aspects of the transfer are not within providers’ control. Although the potential conflict between MiCAR’s open-ended provisions and the standards in the Payment Services Directive may not be clearly resolved, banks and non-financial corporations considering the global stablecoin business would have to mind the uncertainty of legal risk.
But it may be argued that innovation and development in payment clearing and settlement systems is not an already done deal, and we should welcome the innovative space in global stablecoins. Even highly regarded central-bank-managed systems can suffer outage and downtime, like CHAPS, the Bank of England’s real time gross settlement system in July 2024, and the U.S. Fedwire’s outage in 2021. Benefits can be obtained from private sector experimentation and innovation of alternative payment clearing and settlement architecture.
The EU’s regulation of stablecoins reflects a mixture of genuine concern for the worst-case scenarios of financial stability and protectionism for established institutions today. This article argues that the regulatory disincentives, coupled with the already high hurdles for banks and non-financial corporations to issue globally innovative stablecoins, would stymie industry going forward. Further, stablecoins that are specialized as on-ramp access to cryptocurrency, caught up in the arguably over-inclusive wash of MiCAR’s regulation, are unlikely to venture on a march toward becoming global stablecoins. A stablecoin issuer that has a specialized business model of issuing stablecoins for users to purchase cryptocurrency will very unlikely wish to operate a cryptocurrency exchange as well. This is because, as discussed above, the stablecoin issuer would attract additional sets of regulatory compliance under MiCAR and potentially the Payment Services Directive. It would be less costly for such an issuer, and less legally exposing, if the issuer left it to users to decide where they want to go to make their cryptocurrency purchases.
We predict that stablecoins authorized in MiCAR, such as the USDC, would not embark on a global stablecoin model involving cross-border transfer and remittance and would confine its business to issuance. At the time of writing, Tether announced the cessation of its euro-pegged USDT, pulling out of the European market, although it is uncertain how its other-pegged products can avoid sales in the EU and extra-territorial regulation. Binance’s stablecoin, the BUSD, will be phased out as holders were given the opportunity to withdraw up to Dec 15, 2024. Further, the on-chain stablecoin DAI will be succeeded by the USDS and its governance body MakerDAO upgraded to Sky. USDS is not available to customers in the EU. These developments show that many stablecoin services withdraw from the European market due to regulatory uncertainty, and in this light, the likelihood of existing stablecoins that serve the crypto economy becoming global stablecoins is remote.
The next Section turns to examine how MiCAR applies to the existing universe of stablecoins that provide on-ramp access to cryptocurrency. The regulatory regime has addressed some concerns with regard to these specialized stablecoins, but arguably regulators have not addressed the particular issues in this market due to their overwhelming obsession with the global stablecoin. This has resulted in regulatory gaps that should be plugged.
IV. Regulating Stablecoins as Investment Instruments Relative to Cryptocurrency
This Section argues that MiCAR’s regulation of stablecoins should be focused on specialized stablecoins that provide on-ramp access to cryptocurrency. Such stablecoins are rather different in nature from the hypothetical global stablecoin that regulators fear. More precisely designed regulation for such specialized stablecoins would avoid introducing superfluous matters that are targeted at global stablecoins, which, as already argued, are still a slow-developing prospect.
First, we argue that mandatory disclosure regulation does work quite well with specialized stablecoins for on-ramp access to cryptocurrency. This is a very different position from our argument in earlier sections regarding the disincentivizing effect of this regulatory design for the global stablecoin. This is because the specialized stablecoin works much more like an investment instrument or asset regarding its hedging or safe-haven functions. There is significant empirical evidence regarding the safe-haven as well as hedging properties of stablecoins like Tether for holdings of cryptocurrency. It is much more debatable in the mainstream whether these stablecoins also provide hedging or safe-haven properties for conventional financial assets like securities, foreign exchange or commodities. Nevertheless, Tether is diversifying into a gold-backed stablecoin (XAUt), giving rise to the potential of new digital tokens backed by other commodities as investment instruments. Gold-backed stablecoins are on the rise, such as Pax Gold (PAXG) and Goldcoin. These can offer a new democratizing way for retail investors to access gold as a safe-haven asset. But there is mixed evidence regarding gold’s safe-haven properties. Moreover, these stablecoins could also find their way into the diversification strategies of mainstream investment institutions. But it is arguable that institutional investors can already diversify into various commodities, metals, or foreign currency exchange-traded funds. Some commentators see the stablecoin as closely resembling a digital money market fund product. But this article sees future business development for such digital tokens as being backed by even more types of exotic assets. This can give rise to new forms of tokenized investment instruments that serve as alternative asset classes that can become generally available for the investing public, a phenomenon which increases risk, but also market choice.
A. ProposedAdjustments to MiCAR’s Regulation of Stablecoins to Be Closer to Investment Product Regulation
The role of pegged stablecoins in investment markets means that the regulation of stablecoin issues by way of mandatory disclosure in a white paper and followed by ongoing disclosure is a suitable regulatory design. This is not dissimilar to mainstream regulation of open-ended investment funds, such as the EU’s UCITs or money market funds. Pegged stablecoins are essentially a form of intermediated collective investment management of assets, as is the case with collective investment management of UCITs and money market funds, but more precisely aimed to preserve the peg. Mandatory disclosure is important to ensure that investors have adequate information about both the intermediary and the product, as well as ongoing accountability. The white paper contents stipulated in MiCAR are relatively comprehensive, but it is arguable that mandatory disclosure can be made sharper and more precise with regard to the financial management of the stablecoin. Further, if the stablecoin business model becomes a digital alternative to the exchange-traded fund backed by exotic assets, then the equivalent of the EU UCITs regulation should be appropriately extended.
The prospectus for UCITs for example refers to the financially material standard for disclosure, while the white paper requirement for the asset-referenced token or e-money token refers to risks and reserves in broader, open-ended terms. While MiCAR’s framing may capture the nature and quality of reserves, greater precision in relation to investment and liquidity management policies would seem to be a desirable clarification. Further, we suggest MiCAR should include a catch all provision in terms of financially material disclosures to investors, as being more relevant to investor protection. It is also noted that UCITs’ financial reporting are accompanied by audited statements, which is not equivalently provided in MiCAR. A third-party auditor’s gatekeeping can be important to secure the credibility of financial reporting, especially in relation to reserves discussed below. The ongoing reporting envisaged for asset-referenced tokens is much more concerned about the significance or systemic footprint of the stablecoin than with investors’ financially material concerns. Further, there seems no on-going reporting required for e-money tokens, possibly because the anchoring of such tokens in the euro would unlikely trigger concerns of monetary substitution. But, these lacunae in the Regulation should be plugged, in view of recognizing the real market nature of these products as investment instruments. Investors should be provided with ongoing reporting of matters that they more likely regard as financially material, such as investment and liquidity policies, and for asset-referenced tokens, redemption frequencies and valuation ranges.
We also question whether MiCAR’s broad reference to ‘risks’ in the white paper, and the disclosure of technology, would encompass investors’ concerns regarding specific uses for stablecoins, such as in relation to Decentralised Finance (DeFi). DeFi is a type of peer-to-peer service in the crypto economy, exclusively focusing on the financial activities that can be carried out with crypto-assets. DeFi applications encompass many types of automated or algorithmically matched/executed transactions, usually between crypto-assets, with a view to generating ‘yield’ for crypto-asset holders. What this means is that crypto-asset holders are able to ‘financialize’ and earn a profit on their assets by deploying them in a manner similar to conventional financial functions, such as market-making, lending, fund management, insurance and so on. A fundamental tenet of DeFi’s business model is to attract pooled participation by individual crypto-asset holders contributing their crypto-assets according to a protocol. Pooled participation brings about network effects, allowing DeFi protocols to enable transactions quickly and easily amongst crypto-asset holders, such as swapping, trading, lending, borrowing, hedging and so on. In this manner, there is no centralized intermediary bringing assets onto its own balance sheet or investing proprietarily-managed pools of funds.
DeFi applications all inevitably involve stablecoins as they provide the necessary collateral for other crypto-assets to be swapped, borrowed, staked, etc. In this manner, it could be questioned if the white papers for asset-referenced and e-money stablecoins should mention their compatibility with protocol blockchains and DeFi applications. Investors would also be more interested in the financially material aspects of the stablecoin’s programming and its technological capabilities than the matters subject to ongoing reporting.
It may be argued that we should be careful to legitimate stablecoins as an alternative asset class, especially for retail investment. If the regulation for stablecoins were to proceed in such a way as to map more equivalently upon collective investment management, such a risky asset class could be legitimated for retail access by regulatory provision. Nevertheless, there can be benefits in allowing diverse asset classes to come to market, especially in terms of market choice for retail investors. Retail investors in the EU, unlike in the US, do not readily access money market funds as an alternative store of value for cash-like liquidity. Being able to access pegged stablecoins, with the appropriate warnings already provided for in white papers, is not necessarily sub-optimal in terms of market choice. Why should regulated stablecoins be regarded as necessarily more risky compared to floating value money market funds in the EU, or the dizzying range of exchange-traded funds which can be based on exotic and highly illiquid assets including private credit? But, in that regard, it can be argued that pegged stablecoins should be watched in terms of how it evolves as an asset class. Equivalent regulation with exchange-traded funds may be warranted if they become referenced to a wider range of assets other than fiat currencies. Hence, it is all the more imperative that stablecoin products are regulated to inform investors and protect their financial interests in accordance with the manner that they will be put to use—i.e., as investment products.
Circle, which issues USDC, has now achieved an e-money license for its EURC token that is MiCAR-compliant. Its supply has jumped significantly in the EU, possibly as users decide to use this as on ramp access to cryptocurrency instead of other stablecoins that are not hitherto regulated. The footprint of USDC as an alternative asset class for diversification, hedging or safe haven purposes will be keenly watched.
Next, we argue that MiCAR is correct about introducing reserve regulation for stablecoins. Reserve regulation provides the basis for market confidence in stablecoins, consistent with the approach in investment and liquidity regulation for money market funds and collective investment funds in general. If the nature of stablecoins evolves in terms of being referenced to other types of exotic assets or commodities, then it is conceivable that the current set of reserve regulation may need to be reviewed, especially because there is currently a strong focus upon deposit-type or currency reserves. More sophisticated forms of reserve regulation and liquidity management may also need to be introduced.
In light of the lessons learned affecting the USDC, when Silicon Valley Bank in the US was teetering on the verge of collapse, a regulatory refinement should arguably be introduced for the nature of currency reserves backing the asset-referenced or e-money stablecoin. USDC placed US$3.3bn of deposits in Silicon Valley Bank as cash reserves backing its stablecoin. But when it was revealed that Silicon Valley Bank had significant losses in the value of its U.S. Treasury bills holding due to the rise in the interest rate environment, this sparked off a depositor run. The USDC reserves were in jeopardy as they would not be protected by the federal deposit guarantee scheme. Policy-makers should carefully consider if the requirement for currency reserve holdings is counter-productive as it displaces stablecoins’ liquidity risk to the banking sector. The levels of such holdings, if moderated downwards, could mitigate the level of liquidity risk migration to the banking sector. Further, we suggest that the European Banking Authority should consider if currency reserve deposits backing stablecoins should be held at a number of different depository institutions in different member states in the EU. Where a banking crisis occurs in a local jurisdiction, it may not be contagious for other EU member states depending on the nature of interconnections and systemic impact. The diversification of currency deposits in different member states’ banks could be a way of mitigating the risk to reserves.
We now turn to the gaps in MiCAR’s regulation of stablecoins. As these products more clearly function as investment instruments, more regulatory attention should be paid to investors’ needs and protection. If stablecoin issuers do not take on additional crypto-asset service provider roles and be subject to more regulation, the conduct of business regulation of service providers would not apply to these issuers. It is arguable that the general provisions of fair and honest dealing, management of conflicts of interest and having a complaints handling procedure would be largely consistent with other regulatory regimes. But, the Regulation has missed an opportunity to address specific issues we draw attention to below.
B. MiCAR’s Anomalies in Protecting Investors
MiCAR’s regulation of stablecoins, targeted at their payment functions and potential monetary substitutability, is arguably excessive in light of the more limited function that many pegged stablecoins play, i.e. an investment instrument as discussed above. In this light, it is questioned whether the circulation and transaction volumes caps, which are designed to prevent the potential for monetary substitution, may be necessary. As USDC has become one of the first pegged stablecoins to be authorized by the French regulator for use in the EU, now named as EURC, its supply in the EU has risen dramatically, hitting 91million euros by October 2024. In view of the cap at 200million euros, EURC supply would have to be carefully controlled, arguably artificially, in order to avoid non-compliance. But , the EURC is primarily used for on ramp access to cryptocurrency, being operational on multiple protocol blockchains. Its headline appeal is made to crypto developers and businesses, as well as users in DeFi. This does not resemble a global stablecoin model competing for mainstream payment and remittance business. It is arguable that policy-makers should review the cap and its intended purpose. Although the purpose underlying the caps is not explicitly explained in the MiCAR preambles, one can take its cue from Preamble 45 that directs national regulators to refuse to authorize an issue of asset-referenced tokens if risk is posed to the smooth operation of payment systems, monetary policy transmission or monetary sovereignty. It is arguably excessive to apply a pre-emptive cap to an investment instrument serving specific needs for on ramp access to cryptocurrency, as well as portfolio diversification, hedging and safe haven functions.
Further, the focus on the payment function of stablecoins has also led the French regulator to issue certain remarks about on-chain stablecoins in order to bring them within the scope of the regulatory regime. These regulatory expectations for on-chain stablecoins are arguably conflicting with the nature and purpose of their business and governance models, and if a clearer perspective of their ‘investment’ nature is taken, a more appropriate regulatory position can be designed.
Taking the on-chain stablecoin DAI (which would be succeeded by USDS) for example, it is pegged to the US dollar but it is a decentralized project that is collectively maintained off-chain by a community for governance. The governance community, collectively known as MakerDAO, maintains a protocol for issuing DAI against users’ collateral, which used to be exclusively in the form of ether. MakerDAO has since accepted a range of other crypto and even conventional financial collateral. An over-collateralisation policy is embedded in the protocol, updated with current market prices of ether, in order to determine an appropriate amount of over-collateralisation. In this manner, users lock their ether by smart contract in vaults in exchange for DAI which they can hold as a store of value or for deployment in DeFi. They can easily exchange their DAI for ether if they need to execute transactions on the Ethereum blockchain.
If the issue of on-chain stablecoins like DAI, or its successor USDS, were to be possible in the EU, there would be regulatory hurdles in terms of authorizing its governance body and securing compliance with the prudential, organizational and governance requirements imposed. These are discussed shortly below. A more important hurdle for the authorization of such stablecoins and their governance bodies relates to the stablecoin’s on-chain nature and incompatibility with the regulatory expectations for payment functions.
The transfer of an on-chain stablecoin can be treated as a payment transfer that should be governed by the regulatory regime in the EU Payment Services Directive 2015. But the transfer protocols and settlement mechanism on protocol blockchains (where the transfer takes place) would need to be equivalent to the robustness and resilience of conventional payment systems. These relate to: the need to authenticate customers properly and ensure they initiate payment instructions correctly, payment information completeness and travel through the entire process, settlement timelines and finality standards, confirmation and accountability to payment customers and allocation of liability for loss, such as arising from the lack of authorization. It is highly doubtful that the validation protocols on the Ethereum blockchain for example, will meet these requirements due to the pseudonymous nature of transactions and the voluntary nature of transaction validation, subject to fluctuating levels of gas fees. The French regulator is of the view that communities such as MakerDAO may need to be incorporated, blockchain protocols may have to be vetted for compliance, validators themselves may need to be subject to authorization or concentration limits, and perhaps permissionless blockchains should be turned into permissioned ones in order to show appropriate management and control as required for the purposes of the conventional regulatory regime.
The suggestions above would be highly incompatible with the nature of an on-chain stablecoin project which purports to be decentralized, operating on a permissionless open-source protocol. The decentralized nature of the project allows the community to gradually build-out its governance, usually defying a hierarchical structure such as a corporate structure vesting management power in a management body. The organic build-out of governance is also arguably incompatible with regulators’ expectations that many organizational policies such as conflict of interest management, reserve and liquidity management may be in place ahead of authorization. The most significant regulatory hurdle is however the potential requirement for on-chain stablecoins to operate in a permissioned system in order to comply with equivalent regulatory expectations for conventional payment systems. This would defeat the purpose of an on-chain stablecoin’s business model of providing easy on ramp access to cryptocurrency and a specialist store of value relative to cryptocurrency.
The regulatory status for on-chain stablecoins is currently indeterminable, as MiCAR explicitly does not apply to ‘fully decentralized’ crypto-asset services. This threshold is high as ‘partly decentralized’ crypto-asset services are caught within scope. It is uncertain what this means, and whether forms of crypto-financial services that are not organized by a centralised intermediary, and managed by way of decentralized forms of governance, would be sufficient. If there are concentrations of influence within a DeFi application’s governance body, would this count for being ‘fully decentralized’ or not? MiCAR envisages that regulators would take stock of DeFi and further report on their development and appropriate regulatory treatment by 30 December 2024. This may mean that DeFi can be interpreted as not yet falling within the scope of MiCAR. In anticipation of MiCAR’s application, IP addresses from the European continent are now blocked from accessing Sky.money which is the new governance community for USDS, the successor of DAI.
Instead of regulatory obsession with stablecoins’ role in payment and contriving to fit them within that space for compliance, it is argued that MiCAR’s stablecoin regulation regime should instead be geared more towards real investor protection needs. In that respect, there are several shortfalls in MiCAR’s provisions.
First, reserve regulation is a cornerstone of investor protection, as the maintenance of sufficiently robust and liquid reserves provides confidence for users that their redemptions would be met. But in stressed redemption conditions, the provisions governing asset-referenced token-holders’ redemption rights are rather open-ended, in terms of conditions, processes and valuation. This is different from e-money tokens which are stated explicitly to be redeemed at par. Indeed, issuers have to mind the stability of market conditions in administering redemption, managing orderly sales of reserves in order to avoid causing excessive volatility in the markets for reserve assets. Such open-ended framing may not help token-holders as it is uncertain if issuers could delay or freeze redemption requests indefinitely or charge liquidity fees for redemptions. Comparing to the FSB’s proposals for open-ended investment funds’ liquidity management, the open-ended framework in MiCAR provides less guidance and can be jeopardizing for investors’ interests. There should be a need to consider greater ex ante transparency on the part of issuers, the monitoring for adherence to published policies and the ex post accountability for fair treatment of redeeming investors.
Next, although MiCAR provides for issuers of stablecoins to identify, prevent, manage and disclose conflicts of interests broadly, there could be areas of conflicts of interest where more specific forms of transparency or protection may be needed to ensure investor protection. One example would be issuers’ relationships with cryptocurrency exchanges which often list or distribute the stablecoins for sale. It has been opined that Tether’s relationship with Bitfinex requires much more transparency as its common ownership by iFinex could lead to sub-optimal practices such as arbitrary transfer of assets between the entities: It has been documented that Tether’s reserves have been transferred to Bitfinex to cover for losses, while the converse has also occurred in order for Tether to report a healthy level of reserves. It is arguable that the general provision for conflict of interest management in MiCAR would encompass stablecoin issuers’ due disclosure of arrangements such as the above. This article suggests that more can be done to account to investors how stablecoin issuers are managing conflicts of interests with distribution channels such as cryptocurrency exchanges. It can also be considered if third party audit of conflict of interest disclosures could be relevant for investor protection.
Conflicts of interest also exist where the stablecoin issuer is a cryptocurrency exchange itself. Where the business of stablecoin issuance is integrated within a multiple-line cryptocurrency exchange business, such as Binance’s issuance of the BUSD, policies for stablecoin issuance, redemption or rewards can be based on the benefit of the cryptocurrency exchange as a whole, instead of user protection. For example, in September 2022, Binance purported to convert other stablecoin holdings of its customers to its own issued stablecoin, the BUSD. BUSD is being phased out as Binance weighs the challenges of complying with MiCAR. But, the question of how stablecoin businesses should be governed where they are part of other crypto-financial businesses remains relevant.
Finally, stablecoin issuers’ policies should be examined in terms of market manipulation in relation to cryptocurrency prices. There is a lacuna in MiCAR providing for stablecoin issuers’ transparency and policies in relation to issuance and supply, and the need to avoid manipulating cryptocurrency prices. Empirical research suggests that Tether issuance is often correlated with a prompt afterward rise in the price of bitcoin, suggesting that the stablecoin’s issuance policies may be geared towards the maintenance of bitcoin’s prices. Other studies seem to have found similar effects although the case for market manipulation is yet unclear. Further, it would also be important to prevent stablecoin issuers from manipulating the prices of their underlying reserve assets. In this regard empirical research for market price correlations would be needed, but it is arguable that issuers should maintain anti-market manipulation policies and transparency as fundamental tenets of a regulatory regime for investor protection in fair and transparent markets. Taking the lens of stablecoins as investment products would turn us towards regulatory policies that address issues of importance to investor protection, such as the suggestions above.
It is arguable that although MiCAR has not addressed the investor protection issues discussed above, its introduction has forced a number of large stablecoin players like Tether which was pegged to the euro, the BUSD and DAI to be phased out for European customers. It may be said that the European market is now protected from practices that may not be MiCAR-compliant. However, the investor protection lacunae for these stablecoins have merely migrated elsewhere. We are still in need of regulatory policy leadership that is suitable for these stablecoins as on ramp access to cryptocurrency, not mainstream payment instruments. The clear effect of MiCAR is that: the potential for such stablecoins to move into a global stablecoin business model would be even more remote, and the current provisions of MiCAR likely more anachronistic than ever.
V. The Way Forward for Regulating the Stablecoin Industry and Concluding Remarks
MiCAR’s regulatory framework arguably neither regulates effectively stablecoins intended for payment and remittance, by excessively disincentivizing global stablecoins, nor does it cater appropriately for specialized stablecoins used mainly as a bridge to cryptocurrency and held for investment and hedging purposes.
It is therefore proposed that a functional approach to the purposes of stablecoins should guide regulatory policy for them. A functional approach should inquire into a financial product’s characteristics that relate to their use or function, so that regulatory design is appropriate to enable the function/s. In other words, stablecoins should not be regulated merely because they have the characteristic of referring to fiat currency or other conventional financial instruments (therefore potentially entangling with conventional financial markets). They are a broad description of different functionally designed digital tokens with asset-referenced aspects, hence, stablecoins should be regulated differently in relation to the uses they are being put to.
Where stablecoins’ interface is with cryptocurrency and Decentralised Finance, regulators should consider the regulatory adjustments argued in Section IV and also have in mind the broader picture of Decentralised Finance markets. Regulatory policy could usefully provide market standardizations and consumer protection in this market, which is growing and has attracted regulators’ attention. Stablecoin regulation can then be treated as a part of this wider mosaic in relation to their uses in terms of being collateral for staking, lending and swapping activities, and their broader ‘investment’ and ‘hedging’ purposes in DeFi.
In relation to global stablecoins that are geared towards cross-border remittance and payment, Section II has already shown that these are inherently challenging business models although their innovations can be useful and disruptive. It is yet uncertain if these business models would innovate upon account-based money in an incremental manner, or become really disruptive in becoming token-based, bearer money that are denominated in private units of account. Regulators, instead of fearing the disruptive implications of global stablecoins, should instead encourage businesses to engage regulators with their innovations in dedicated regulatory sandboxes for global stablecoins. Many jurisdictions have been attracted to instituting regulatory sandboxes for financial technological innovations. These sandboxes allow innovations to be tested in limited markets without the full application of rules in order for regulators to appreciate the nature of innovations as well as the impact of regulatory compliance. It is arguable that global stablecoins should be subject to extended gestation and development in regulatory sandboxes coordinated by financial regulators and central banks, in order to fully apprise of the disruptive implications and institutional confrontations this innovation may entail. International cooperation between central banks and financial regulators for such sandboxes would be a better way forward for engaging with such innovations that are only nascent and emerging. The FSB should, instead of adhering to conservative conceptions of financial digital innovations (which sets the template for Europe’s MiCAR), consider hosting an international sandbox for global stablecoin engagement.
Although the EU’s MiCAR is a pioneering regulatory framework for many aspects of crypto-finance, it should perhaps be regarded as a starting point that needs refinement, particularly in its regulatory treatment of the stablecoin industry. This article argues that the stablecoin regulatory regime is based on the conception of stablecoins as possibly becoming global stablecoins. This article argues that such a design for stablecoin regulation is misplaced as it conflates the global stablecoin model with the existing stablecoin business model, which provides on ramp access to cryptocurrency, and serves largely as an investment instrument for diversification, hedging and safe haven purposes.
In its anxiety to deal pre-emptively with the institutionally disruptive potential of global stablecoins, MiCAR’s regulatory regime is disincentivizing for global stablecoin innovations, on top of the inherently challenging nature of this business model for both banks and non-banks such as BigTech. The article urges that the excesses of this regulatory inhibition be reconsidered and in its place, greater internationally-coordinated engagement with this industry in regulatory sandboxes is needed before the firming up of any regulation in this area. Stablecoins purposed for conversion into cryptocurrency or for deployment in DeFi should be regulated differently from global stablecoins for international remittance.
