Hugo Coelho is the digital asset regulation lead at the Cambridge Centre for Alternative Finance, and Mike Ringer is a partner and co-lead of Crypto & Digital Assets Group at CMS. Opinions are their own.
To warn about the impact of impending EU stablecoin regulation, Dante Disparte, the head of strategy of stablecoin issuer Circle, sought to distinguish it from a turn-of-the-millennium concept that has gone down in technological folklore.
“MiCA is not crypto’s Y2K moment that can be ignored,” Disparte wrote on June 3 on social network X. “Really consequential developments [are] underway for digital assets in the world’s third-largest economy.”
Also known as the “millennium bug,” Y2K refers to the glitch associated with the change of the year to 2000 that threatened to create havoc in computer networks globally.
Y2K was no hoax, and much work went into averting its negative consequences. But “the Bug Didn’t Bite,” as the Washington Post put it the day after, and today it is remembered for the apocalyptic mood and hysteria around it more than anything else.
Disparte’s contrast of this with what is going on in, and what might happen to, crypto markets when the rules for e-money tokens — the legal name of single-fiat currency referencing stablecoins in the EU’s Markets in Crypto-Assets regulation — kick in on June 30, is apt.
EMTs play critical functions in crypto asset markets.
They facilitate crypto trading, by being on one side of most trading pairs, they shield investors from volatility and they provide collateral that fuels decentralised applications.
Any rules that affect their design or restrict their issuance, offering or trading in a market as large as the EU’s will undoubtedly have an impact.
Thus far, crypto markets remain unfazed by MiCA.
According to the Cambridge Digital Money Dashboard, the aggregate stablecoin supply stands above $155 billion, up from $127 billion in January.
The share of the supply per issuer remains broadly unchanged, with the two largest stablecoins, USDT and USDC, accounting for more than 70% and 20% of the market, respectively.
Look beyond the statistics though and you can see some movement.
Major crypto asset service providers have unveiled plans to make changes to their services involving stablecoins in the EU in preparation for the regulation.
OKX moved first, with the announcement that it would remove USDT from its trading pairs.
Kraken then said it was reviewing its position.
Most recently, Binance announced it would restrict the availability of unauthorised stablecoins for EU users for some services, albeit not initially in spot trading.
‘So, what is it about MiCA that could require stablecoins, as we know them, to change?’
The inconsistency in responses suggests there is no shared understanding of the implications of the regulation.
Compared with the weeks and days leading up to the end of the millennium, one could say there are far fewer obvious signs of panic, but nearly as much uncertainty.
So, what is it about MiCA that could require stablecoins, as we know them, to change?
In our view, the major source of disruption is likely to be the localisation requirements for issuers.
For issuers trying to comply with the rules, this will be a much more challenging requirement to adjust to than prudential requirements, including the requirement to hold at least 30% or — in the case of significant EMTs — 60% of the reserves in bank accounts and split them between different local banks.
And it will deliver a more immediate blow than the hard limits on the use of dollar-denominated stablecoins within the EU.
These have been designed to force the market to shift to Euro-denominated stablecoins, but there is not much evidence of that yet.
Under MiCA, no EMT can be offered to the public in the EU, and no-one can seek its admission to trading, unless it is issued by an EU-incorporated entity which is licensed as either a credit or e-money institution — notwithstanding that the authorisation regime for crypto asset service providers will not take effect until December 30.
Some of its reserves will also have to be localised, as described above.
It is unclear how overseas issuers of stablecoins such as the dollar-denominated ones that currently dominate the market can continue to serve EU clients under such a regime.
In theory, issuers could relocate to the EU and distribute EU-issued stablecoins to the rest of the world. But that is highly unlikely in practice.
The strict prudential requirements of MiCA would put these issuers at a competitive disadvantage in many non-EU markets.
It is also hard to see why other jurisdictions would not take tit-for-tat action and require the issuers to localise in the same way as the EU, thus fragmenting the market.
An alternative route would be to issue the stablecoin from two parallel entities, one in the EU, from which it would serve EU clients, the other from overseas, to serve clients from the rest of the world.
This option, oft touted in crypto circles, is marred with legal and operational complexities that have yet to be convincingly resolved.
There are basically two challenges to be addressed.
The first is preserving fungibility between two coins issued from two separate entities, subject to different regulatory requirements and insolvency regimes and backed by different pools of assets.
The second is ensuring EU clients only hold coins issued by the EU entity, including through secondary market trading.
While this issue is more noticeable and imminent in the EU than elsewhere, it would be wrong to dismiss it as an EU oddity.
Jurisdictions such as Japan, Singapore and the UK have also been grappling with the question of how to regulate stablecoins with a global scale.
Regulators need assurance that investors under their watch are afforded sufficient protections and can redeem their stablecoins at par even in times of crisis, even when the issuer and the reserves are kept abroad.
If the history of finance is anything to go by, this will only be possible — if ever — when there is sufficient alignment of rules to enable regulatory deference or equivalence and cooperation between supervisors in different jurisdictions.
Equivalence regimes are more urgent and necessary in crypto than other sectors because of the borderless or digital nature of many activities.
Paradoxically, they are also more distant because of the embryonic and fragmented regulatory landscape.
For some reason, MiCA is one of the pieces of EU financial services regulation that has no equivalence regime in it.
The UK and Singapore also continue to kick the can on equivalence arrangements, and the effectiveness of Japan’s equivalence mechanism remains to be tested.
By virtue of being a first mover in crypto regulation, the EU is exposing the conundrum behind regulating global stablecoins.
Its blunt approach threatens to dislocate a market of $155 billion.
We will soon know if, for stablecoins in the EU, June 30, 2024, is the new January 1, 2000, or something rather worse than that.