Why EU stablecoin rules threaten to upend cryptocurrency markets – DL News

Hugo Coelho is Head of Digital Asset Regulation at the Cambridge Center for Alternative Finance, and Mike Ringer is Partner and Co-Head of the Crypto & Digital Assets Group at CMS. Opinions are their own.

To warn about the impact of impending EU stablecoin regulations, Dante Disparte, head of strategy at stablecoin issuer Circle, sought to distinguish them from the turn-of-the-millennium concept that has become part of technological folklore.

“MiCA is not a Y2K moment for cryptocurrencies that can be ignored,” Disparte wrote on social network X on June 3. “Really significant changes are underway for digital assets in the world’s third-largest economy.”

Also known as the “Millennium bug,” Y2K refers to a year change-to-Y2K glitch that threatened to wreak havoc on computer networks around the world.

Y2K was not a hoax and much work was done to prevent its negative consequences. But “The bug didn’t bite,” as he says Washington Post Office he posted it the next day, and today he is remembered more than for the apocalyptic mood and hysteria around him.

Disparte’s comparison of this with what’s happening in cryptocurrency markets and what could happen to them when rules on e-money tokens come into force – the legal name for the single currency that applies to stablecoins in the EU’s Crypto Markets Regulation on June 30 , is accurate.

EMTs play critical functions in crypto asset markets.

They facilitate cryptocurrency trading by being on one side of most trading pairs, protect investors from volatility, and provide the collateral that powers decentralized applications.

Any rules affecting their design or restricting their issuance, offering or trading in a market as large as the EU will undoubtedly have an impact.

So far, cryptocurrency markets remain unfazed by MiCA.

Total stablecoin supply tops $155 billion, up from $127 billion in January, according to the Cambridge Digital Money Dashboard.

The share of supply per issuer remains broadly unchanged, with the two largest stablecoins, USDT and USDC, accounting for over 70% and 20% of the market, respectively.

But look beyond the statistics and you’ll see some movement.

Major crypto asset service providers have revealed plans to introduce changes to their stablecoin services in the EU in preparation for the regulation.

OKX has made the first move by announcing that it will remove USDT from its trading pairs.

Kraken then said it was reviewing its position.

Binance recently announced that it will restrict the availability of unauthorized stablecoins to EU users for certain services, although not initially for spot trading.

“So what is it about MiCA that might require a change to stablecoins as we know them?”

The inconsistency in responses suggests that there is no common understanding of the implications of the regulation.

Compared to the weeks and days leading up to the end of the millennium, there are far fewer obvious signs of panic, but almost as much uncertainty.

So what is it about MiCA that might require a change to stablecoins as we know them?

We believe that the main source of disruption will most likely be the location requirements for issuers.

For issuers trying to comply with the regulations, this will be a much more difficult requirement to meet than the prudential requirements, including the requirement to hold at least 30% or, in the case of significant EMTs, 60% of reserves in bank accounts and divide them among various local banks.

And it will cause a more immediate blow than hard restrictions on the use of dollar-denominated stablecoins in the EU.

These were designed to force the market to switch to euro-denominated stablecoins, but there is not much evidence for this yet.

Under MiCA, no EMT may be offered to the public in the EU, and no one may apply for its admission to trading, unless it is issued by an entity established in the EU and licensed as a credit or electronic money institution – regardless of whether the authorization system for crypto asset service providers, it will only come into effect on December 30.

Some of its resources will also need to be localized as described above.

It is unclear how foreign issuers of stablecoins, such as the dollar-denominated ones that currently dominate the market, can continue to serve EU customers under such a system.

Theoretically, issuers could relocate to the EU and distribute EU-issued stablecoins to the rest of the world. But in practice this is unlikely.

MiCA’s strict prudential requirements would put these issuers at a competitive disadvantage in many markets outside the EU.

It is also difficult to see why other jurisdictions would not go tit-for-tat and require issuers to localize in the same way as the EU, causing market fragmentation.

An alternative method would be for the stablecoin to be issued by two parallel entities, one in the EU from which to serve EU customers and the other from abroad to serve customers from the rest of the world.

Often touted in cryptocurrency circles, this option is fraught with legal and operational complexities that have yet to be convincingly resolved.

Basically, there are two challenges that need to be addressed.

The first is to maintain fungibility between two coins issued by two separate entities, subject to different regulatory requirements and bankruptcy regimes, and backed by different pools of assets.

The second is to ensure that EU customers only hold coins issued by an EU entity, including through secondary market trading.

Although this problem is more noticeable and inevitable in the EU than elsewhere, it would be wrong to dismiss it as a peculiarity of the EU.

Jurisdictions such as Japan, Singapore and the UK are also grappling with the question of how to regulate stablecoins on a global scale.

Regulators need to be confident that the investors they monitor are afforded sufficient protection and can redeem their stablecoins even in times of crisis, even if the issuer and reserves are held overseas.

If it is possible to build on financial history, this will only be possible – if at all – if there is sufficient regulatory harmonization to enable respect or equivalence of regulators and cooperation between supervisors in different jurisdictions.

Equivalence systems are more urgent and necessary in cryptography than in other sectors due to the cross-border or digital nature of many activities.

Paradoxically, they are also more distant due to the embryonic and fragmented regulatory landscape.

For some reason, MiCA is one of the elements of EU financial services regulation that does not have an equivalence system.

The UK and Singapore also continue to reject equivalence arrangements, and the effectiveness of Japan’s equivalence mechanism remains to be tested.

By being the first to regulate cryptocurrencies, the EU is exposing the puzzle behind regulating global stablecoins.

Its direct approach risks dislocating a $155 billion market.

We will soon find out whether June 30, 2024 is the new January 1, 2000, or something worse, for stablecoins in the EU.