‘Debating the sex of angels’, a French expression for a futile discussion, is how a person involved in drafting the Markets in Crypto-Assets Regulation described the process that rendered the liberal-minded draft essentially inviable for stablecoins in Europe.
Key European Union member state representatives, this official suggested, had hoped these e-money tokens might be a passing fad, or that central bank digital currency may make them unnecessary. The result is a regulatory outcome thwarting what was otherwise intended by him and his team to give Europe a headstart in a key technology.
Events in the meantime are removing Europe’s freedom to choose. These vital ‘on-off ramps’ for distributed ledger technology finance are stealing a march as US policy – via the Genius Act – moves them to systemic components of digital finance. The alternative – a central bank/commercial bank model, which requires wholesale CBDC at its heart – has been confounded by circular policy discussions as well as technical conundrums and is now playing catch-up.
‘Oligopolistic’ dollar stablecoins
Europe’s institutions are now at odds over whether to enable established dollar-denominated coins from the US, which the European Council in a recent ‘non-paper’ described as ‘oligopolistic‘, to be the ‘cash leg’ in Europe’s nascent tokenised finance market, or hinder their use in order to urge the development of European alternatives. This debate has had many faces. Its present one relates to ‘multi-issuance’ provisions which would enable a coin registered both in the EU and in a third country – de facto a euphemism for the US – to operate in Europe. It’s a devil’s choice: make use of existing US private infrastructure to stay in the DLT race or use MiCAR for protectionist purposes in the hope material European players will emerge. The angel gender discussions resulted, for now, in essentially prohibitive conditions for those players.
Euro stablecoins face a fundamental challenge that dollar stablecoins do not: inadequate euro-denominated ‘safe asset’ sovereign bond markets to use as reserves. Joint and several issuance from the EU, which it tip-toed towards in response to the Covid-19 pandemic, might have alleviated this, but the EU is retreating from this idea again in the face of customary North-European resistance.
Multi-issuance
The multi-issuance argument results in contradictions. Regulating the last financial crisis has left many of the bloc’s financial supervisors focused on financial stability. This, some European Commission officials believe, is constraining its ability to compete to the extent that it is inadvertently surrendering relevance in digital finance, and therefore agency over it.
The European Central Bank is also concerned that multi-issuance will enable non‑EU holders to redeem stablecoins via EU entities, perhaps doing so to avoid gating fees or delays imposed in their own jurisdictions. The ECB fears that this could drain EU reserve assets and potentially trigger liquidity crises or runs on stablecoins. Furthermore, MiCAR mandates that 30-60% of EMT reserves be held in deposits with EU credit institutions. If redemptions spike due to third-country holders, the EU issuer may struggle to maintain this composition.
According to a senior official at the Commission however, the ECB appears to be projecting the traditional bank run experience onto the very different context of stablecoins. Bank runs occur due to fractional reserve lending, but stablecoins, especially those governed under MiCAR, are fully collateralised. The reserves exist precisely to ensure that holders can be made whole at any time. Fears of a large-scale redemption may be largely irrational in a system where assets are matched 1:1 and highly liquid. The author of MiCAR has also said that multi-issuance was always intended to be allowed – possibly to ensure that the Europe does not, in the words of two key officials, become a ‘flyover zone’ and get left behind on DLT innovation.
Yet, MiCAR implementation remains fraught. Part of the problem is the rules themselves appear structurally contradictory. The imposition of localised reserve requirements can be understood as an attempt to reduce the risk of stablecoins undermining bank deposits, by redirecting reserves back into the banking systems.
But in the case of dollar-denominated stablecoins, much of the reserve capital placed with banks will be transferred back to the US, held in accounts with US institutions and used to purchase T-Bills. The location requirement creates an impression that the money stays in Europe, under the supervision of the bloc’s regulators and more easily within reach when holders want to redeem their stablecoins, but in reality, it flows right back out.
Fundamental issues
The home-grown European alternative is hampered not just by the fragmented sovereign bond market, but by similar long-running inadequacies in attempts to consolidate a single market for banking. National banking champions have yet to combine efforts on tokenisation in their own countries – either to create a joint stablecoin or fungible versions of tokenised deposits – let alone cross-border within Europe. At the same time, regulator intervention is unlikely as officials hold the ordoliberal view that it is not their job to force the market.
Fundamental issues troubling other non-US regulators are also taxing the Commission. How can a decentralised (‘distributed’) network be supervised? A key official suggested that the uncomfortable semantic concept of ‘permissionless’ (blockchain) is itself needlessly distracting policy-makers to tackle the protocol layer, akin to regulating the internet’s basic transmission processes, where instead it would be better to focus on regulation of the tokens.
Nor is this easy – efforts to constrain ‘asset reference tokens’ in MiCAR are already inadvertently getting in the way of the ability for tokens to move between public blockchains – otherwise a desirable outcome to reduce systemic risk and ‘walled gardens’. An official suggested this perfectly exemplifies the pitfalls of regulating a fast-moving technology, when technologists and lawyers operate in mutually unintelligible domains.
Europe’s bigger problem remains. It is an American colony in terms of technology, defence and to an extent finance. It will take time, and probably American tools, to decouple from it in pursuit of strategic autonomy in these areas.
John Orchard is Chairman, and Katie-Ann Wilson is Managing Director of the Digital Monetary Institute at OMFIF.
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