Regulating Stablecoins as Private Money. A Critical Take on the EU Proposal between Liquidity and Safety

Edoardo Martino (University of Amsterdam)

Abstract

Stablecoins are crypto-assets that purport to maintain a stable value by referencing other physical or financial assets. Stablecoins are attracting considerable attention as a new way of creating private money.

From a regulatory standpoint, most of the debate has so far revolved around two main issues. On the one hand, the potentially disruptive impact on the payment infrastructure and monetary policy. On the other hand, the need to protect investors and society from potentially abusive behaviours of stablecoin providers. Financial stability represents a serious concern as well, even though it has remained at the periphery of the debate so far. More importantly, this article demonstrates that financial stability is a direct function of the applicable legal framework.

To achieve such conclusion, I develop two main arguments. First, I argue that trade-offs exist between a regulatory framework that promotes innovation, protects investors, and safeguards financial stability. This posits that the legislator cannot achieve these three goals simultaneously but can only prioritize two. This framework is applied to analyse the current EU ‘Market in Crypto Asset’ (MiCA) regulation proposal, as it is the most advanced regulatory proposal currently available. The analysis highlight that the current proposal mainly focuses on investor protection and promoting innovation, whereas financial stability remains in the background.

Second, I discuss the liquidity risk inherent in stablecoins and how such risk is linked with the regulatory framework applicable to stablecoins. This underlines a functional equivalence between stablecoins and money market funds (MMF) insofar as both aim at guaranteeing the stable value of a claim without it being backed by entities with fiscal capacity. A key element to understanding the relevance of the regulatory framework to shaping the resilience of the financial system is to investigate the legal roots of the MMF business model, how it is vulnerable to liquidity shocks, and how the post-global financial crisis regulation coped with those vulnerabilities.

Based on these two arguments, the current EU ‘Market in Crypto Asset’ (MiCA) regulation proposal generates incentives that may increase the risk of a run on stablecoin should liquidity dry up. This leads to a conclusion whereby the MiCA proposal, in its current formulation, falls short in addressing the potential financial stability risk even providing incentives to run should liquidity dry up. In contrast, MiCA should, to a large extent, align with the current MMF Regulation insofar as the functional resemblance hold. Such alignment is even more pivotal in terms of market and funding liquidity and ‘early crisis management'.

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