Regulation Of Stable Coins In The EU

Stablecoins are similar to other cryptocurrencies.

The values of stablecoins are pegged or equivalent to the value of fiat currency and other financial instruments.

Stablecoins are developed to serve as an alternative to other cryptocurrencies.

Stablecoins reserve assets as collateral to maintain price stability and use algorithmic formulas for its control supply.

The European Union’s Markets In Crypto Assets (MiCA) is the regulation that is expected to regulate the activities of crypto assets.

The European Council published the Markets in Crypto Asset (MiCA) proposal document on the 24th of November, 2021.

The MiCA policy paper used to be 187 pages and was expanded to 405 pages.

Stable coins rely on cash reserves, and if there is not enough cash in reserve for the token, it can lead to a financial crisis.

The cryptocurrency market and its activities are unregulated. All DeFi protocols, such as Stable coins that leverage blockchain technology, are decentralized.

While there are no direct regulations or central governance mechanisms in place, the Decentralized Finance (DeFi) has shown over time that it needs to be regulated by a strong institution.

In a bid to regulate the DeFi and cryptocurrency market, some Government agencies and institutions in the past have had laws and regulations governing the activities of crypto in their territory.

The latest among them that would be the spotlight of this article is the regulation of Stable coins in the European Union. We shall identify the regulation proposed by the EU and the possible effect on cryptocurrency in Europe and the world at large.

Let's begin.

What Are Stable Coins?

Stablecoins are like every other cryptocurrency, and however, the value is pegged or equivalent to that of another currency or financial instrument.

StableCoins were developed to provide an alternative to the popular cryptocurrencies like Bitcoin (BTC) because of their high volatility.

Stablecoins reserve assets as collateral in maintaining price stability or use algorithmic formulas for its control supply. Fiat collateralized, crypto collateralized, and algorithmic are the types of Stablecoin.

The most popular stablecoins leveraging blockchain technology include Diem, Tether (USDT), USD coin, Dai by MakerDAO, and others.

Since stablecoins are mostly pegged to a fiat currency, users can easily convert their money into crypto tokens and vice versa. The Stablecoin market capitalization is about $172 billion at the beginning of 2022.

An example of the price peg of a Stablecoin is that when you buy 50 Tether, you are locking $50 in your blockchain wallet with an assumption that when you need $50 at a later date, you can convert your 50 Tether back to its fiat equivalent.

EU's Markets In Crypto Assets (MiCA) Regulation

On the 24th of November, 2021, the European Council published the Markets in Crypto Asset (MiCA) proposal document. This proposal document is a 405 pages policy paper regulating the cryptocurrency market.

A glance at the proposal shows that it is focused on addressing the challenges posed by stablecoins. Even though a lot of the crypto activities need to be regulated, the proposal is currently focusing on stablecoins.

The main aim of the MiCA regulation is to enable the Government of the EU to insulate the global financial system from cryptocurrency. Ensuring that the on-off ramps follow strict rules is paramount to the European Union.

The new regulation will mandate all Stablecoin issuers to follow the European Union law, obtain a banking license in any EU member state, and be completely transparent in their dealings.

The highlight of the Markets in Crypto Asset (MiCA) proposal document is that “only credit institutions and electronic-money (e-money) institutions” will be eligible to obtain a stable coin issuance license.

In actualizing the full potential of the regulation, the legislation will follow a three-way negotiation. The negotiation will involve the European Council, European Commission and the European Parliament.

A “Markets in Crypto Asset (MiCA)” paper of 187 pages existed before November 2021, when it was expanded to 405 pages and a 55-page supplement. The expanded version of MiCA divides the cryptocurrency into three buckets and addresses them separately.

They are the Asset referenced tokens, e-money tokens mostly called the fiat-backed stablecoins and other forms of digital assets.

In the EU, stablecoins get regulated, and let's take a look at why this occurs.

Why Regulate Stablecoin?

The major concern of the Government is the fact that stablecoins are soaking up money and continue to be injected into an ecosystem that continues to evolve. The height of it is that the Government and its institutions have little control over this ecosystem.

In the stable coin algorithm, they are backed in 1:1 (1 ratio 1) to a real currency. This means that 1 Tether (USDT) or USDC is equivalent to $1.

These stable coins are now the primary on and off-ramps for several investors. They also serve as a critical driver of liquidity and volume in the cryptocurrency ecosystem.

Finally, stable coins rely on cash reserves. Imagine a scenario whereby the Stable coin does not have enough cash in reserve? It will lead to a cryptocurrency crisis, and the stable coin will absorb the available assets to rectify and cover up this crisis.

These DeFi protocols affected will be forced to liquidate their assets at a lower price to control the crisis and get enough money back to their network.

Conclusion

There are mixed feelings about the expanded MiCA regulation that now absolves Stablecoin.

Some Cryptocurrency stakeholders opine that the regulation is necessary to reduce the volatility of the crypto and DeFi tokens; some stakeholders believe it is unnecessary. The ecosystem should be fully decentralized and free from direct regulations.

With a 450 pages expansion, the miCA document still left some cogent parts of the digital assets unregulated. For instance, it is silent on lending and borrowing crypto assets.

It has, however, been announced that after 18 months of MiCA’s deployment, proposals for additional regulation will be submitted and considered.





Author: Valentine. A, Gate.io Researcher
This article represents only the researcher's views and does not constitute any investment suggestions.
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