Stablecoins Unstable in Europe

Authors: Andrew J. Zammit & Nicholas Scerri

Has the EU inadvertently caused destabilised stablecoins in its attempt to provide stability and clarity? Stablecoins play a pivotal role in the financial system as it bridges the gap between traditional financial systems and the cryptocurrency market, offering a more stable alternative to volatile assets such as Bitcoin. Stablecoins are designed to maintain a consistent value, by being pegged to a fiat currency such as USDT being pegged with a 1:1 ratio to the US Dollar. In the EU’s attempt to uniform market rules in the crypto space, they are introducing the Markets in Crypto-Assets Regulation (MiCA) which became fully applicable from the 30^th of December 2024. At first glance, the implementation of regulation in an uncharted landscape would appear to provide stability in a volatile market. On the other hand, MiCA’s restrictions on non-euro dominated stablecoins could limit their use and drive liquidity away from European markets. With this being the case, will MiCA really bring stability or will it cause more disruption than security?

What Does MiCA Bring to the Table?

MiCA introduces unprecedented legislation aimed at regulating crypto-assets across the European Union. Stablecoins are being classified by MiCA into 2 different categories: Asset-referenced tokens (ARTs) and e-money tokens (EMTs). Asset-referenced tokens derive their value from a basket of assets, such as multiple fiat currencies, commodities, or cryptocurrencies. On the other hand, e-money tokens are directly pegged to a single fiat currency, such as the euro or US dollar, and are intended to function like digital cash. These categories determine the degree of regulation based on their backing mechanism. Issuers must ensure that they obtain licenses, maintain sufficient reserves and adhere to the strict transparency requirements set out in MiCA to safeguard consumers and ensure financial stability.

However, the benefits of MiCA can be considered to be bittersweet due to the consequences it brings about. One such consequence that effects stablecoins of all sizes is the transaction caps being introduced on non-euro-denominated stablecoins, explicitly demonstrated through the introduction of capping transactions at 1 million per day or €200,000,000 in volume. Giant stablecoins such are at risk of not being able to operate in the EU as they become less viable for cross border transactions, creating gigantic holes in an already volatile market.

Whilst some argue that these restrictions are a measure necessary to protect the euro and enhance its sovereignty on the international stage, critics warn that these restrictions could result liquidity being driven away from European markets. The EU’s bet on Euro-pegged stablecoins has yet to be proven successful, resulting in an era of doubt regarding competition and accessibility.

Why Is MiCA’s Stablecoin Restriction Problematic?

While MiCA has been adopted to introduce a controlled and stable crypto market, restrictions imposed on non-euro stablecoins will run counter to the reduction of risk and creation of systemic inefficiencies. This threshold of 1 million transactions or €200 million per day represents an artificial constraint on liquidity that would make USDT and USDC less viable for cross-border payments and remittances, and for institutional trades. Otherwise, as those assets become less viable within the EU, major exchanges will be compelled to delist them or limit their availability, which will have the lkely unintended effect of decreasing competition and driving European users to unregulated alternatives outside of the EU.

Other legislators also justify such restrictions as a way to keep the euro currency dominant in digital transactions, and preserve financial sovereignty. However, the regulation seems to assume that euro-pegged stablecoins would easily supplant USDT and USDC, which is not currently a trend that appears to be shaping up within the market.

This regulatory framework also means a hugely excessive compliance burden for the stablecoin issuers, further discouraging large providers like Tether and Circle from focusing on the European market. If these large issuers conclude that the benefit of compliance is limited, they might decide to withdraw or scale back their European operations, with implications for the region’s competitiveness in digital finance.

Challenges for Stablecoins in the EU

While MiCA’s stated focus is on improving financial stability, the stringent requirements are likely to have the reverse effect of draining liquidity, disincentivizing innovation, and ultimately harming consumer choice. Some of the potential implications include:

Liquidity Shortages: Should stablecoin giants such as USDT and USDC become impractical for European markets, liquidity will dwindle on EU exchanges, thereby increasing transaction costs and decreasing market efficiency.

Regulatory Arbitrage: Users and businesses could move to offshore or decentralized platforms that will not fall under EU jurisdiction, hence weakening MiCA’s enforcement power.

Reduced Competition & Consumer Choice: Fewer options of stablecoins available mean that EU-based traders, businesses, and financial institutions might suffer from higher fees and more restrictive options when settling digital transactions.

Innovation Stagnation: MiCA’s incredibly burdensome regulatory regime will make crypto startups and institutional investors reluctant to operate in the EU; thus, the union will be less dynamic financially.

Significance for Stakeholders

MiCA’s influence will span the whole stablecoin ecosystem, affecting everyone from issuers and exchanges to consumers at large. For instance, stablecoin providers like Circle and Tether need to decide whether it is worth staying within the EU market given the significant cost of compliance, or alternatively, whether they should consider focussing their efforts and resources elsewhere.

Crypto Exchanges: Restrictions or removal of access to non-compliant stablecoins by platforms such as Binance and Kraken would decrease liquidity and make European trading markets less competitive.

Consumers & Businesses: In the event of major stablecoins being delisted or restricted, everyday users would have fewer reliable options for cross-border transactions and remittances; businesses would face higher transaction costs and less flexibility in financial tools.

Navigating MiCA:

MiCA’s arrival is a significant test for the market of stablecoins, which requires a strategic and informed approach to this new regulatory reality. License requirements are strict, and the backing of reserves, as well as transparency, will also be very high. For more liquid stablecoins, such as USDT and USDC, this could mean dramatic overhauls in operations, especially considering MiCA’s caps on non-euro-denominated token transactions. This could make them less appealing in the payment and settlement systems of the EU, which may lead the issuers to reconsider their products.

Overlapping of MiCA with existing e-money regulations may result in legal uncertainty and further complicate compliance. This will also have to be a period of change for trading platforms, such as Binance, as any restriction on the use of non-compliant stablecoins could result in reduced functionality for EU users. These exchanges need to review their listings, develop user communication plans, and perhaps shift their marketing to support MiCA-compliant tokens, such as RLUSD. Consumers may find that their favorite stablecoins are not as available and may require education on alternative options.

Overcoming this, there are various main ways in which issuers and platforms may get by these challenges: full re-viewing of operations to find places needing alignments with MiCA, perhaps a move into euro-pegged stablecoins, direct or through partnerships with compliant issuers; secondly, proactive engagement with regulators and legal advisors will help work out ambiguities and tailor a road to compliance relevant for their particular business model.

The way ahead might be somewhat treacherous, but this also presents an opportunity to reinforce market resilience and engender trust among users. In charting this course, working with advisors who can specialize in EU financial regulation means getting critical insights with workable solutions. Understanding MiCA is not just about complying; it’s actually using the framework to further create and secure a competitive edge within Europe’s evolving landscape for stablecoins.

Conclusion

MiCA’s institution marks a critical, yet potentially precarious, shift in the European stablecoin market: one that harmonizes the need for stability with the risk of unintended, unbalancing consequences. By setting out to harmonize and secure the crypto-assets market, MiCA has, in effect, imposed requirements and caps that could undermine the established position that major players have so laboriously carved out for themselves. Yet, this era of change represents a chance toward adaptation and heightening of standards within the crypto market.

The success of stablecoins in Europe will depend on proactive engagement with these regulations, fostering collaboration between issuers and trading platforms along with regulators for striking an appropriate balance that does justice to both necessary compliance and desirable market growth. With the new era of European crypto regulation comes the question of how stablecoins may finally find traction and grow to succeed within these evolving rules-and-orders, or if such stability remains simply unattainable under this approach.