Swarm联创 How does EU regulation on stablecoins promote financial innovation?

Swarm联创 How Does EU Stablecoin Regulation Support Financial Innovation?

Author: Swarm Co-founders Philipp Pieper and Timo Lehes, Source: medium; Translation: Songxue, LianGuai

Stablecoins are essentially tokenized forms of fiat currency. They serve as an entry point for people to move on-chain and sometimes act as safe-haven assets for those looking to escape the volatility of native cryptocurrencies like Bitcoin and Ethereum.

Stablecoins are becoming increasingly important as blockchain-based products become part of consumers’ daily lives, as they are digital cash and offer additional benefits compared to traditional financial products.

There are various types of stablecoins to choose from. Algorithmic stablecoins use a combination of complex algorithms, crypto asset reserves, and token economics to maintain a stable value pegged to their underlying fiat currencies.

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However, algorithmic stablecoins face challenges in harsh market conditions. The most severe collapse of an algorithmic stablecoin was the Terra/Luna crash in the spring of 2022, when the digital asset market estimated losses of $60 billion.

1. Asset-backed Stablecoins

Now, asset-backed tokens have become the preferred choice for stablecoin issuers in recent years. The stablecoin market is now valued over $125 billion, with the most popular tokens being Tether’s USDT and Circle’s USDC, which together account for 90% of the market share.

Even within asset-backed tokens, high-profile decoupling has led to a greater demand for transparency in the reserve assets supporting stablecoin prices. Since the last bull market, people have also started to shift towards high liquidity tokenized traditional financial products, moving away from unstable crypto assets and commercial notes.

2. On-chain Fixed Income

This year, the growth of tokenized short-term US Treasury bills has exceeded $600 million, bringing a yield of 4.5% to many stablecoin issuers. In fact, Tether, with a circulating value of $84 billion USDT, reported operating profits of over $1 billion in the second quarter.

The development of supervised investment in Germany means that retail investors have a way to directly invest in the same income-generating assets that stablecoin issuers use to support their tokens and subsequently profit from them. We expect the business models of stablecoin issuers to change, with part of the profits being transferred to stablecoin token holders who are helping these companies generate such high profits.

3. Regulatory Understanding

As tokens that integrate directly with web3 infrastructure and traditional financial asset categories, it makes sense for these tokens to be first dealt with by regulatory authorities, as they are most easily understood in the realm of traditional financial market regulation. MiCA is the first attempt by European legislators to regulate euro-denominated stablecoins, with Singapore following closely behind.

MiCa will take effect in June 2024 and requires stablecoin issuers to obtain licenses in one of the 27 European Union countries. Those who issue stablecoins backed by the Euro must also have an electronic money license, which will inevitably hinder the stablecoin market in the EU, as the regulatory barriers for issuance are higher than in the United States and Asia.

Legal experts are also concerned that the daily limits imposed by MiCa regulations may bring problems to the market. The trading restrictions indicate that provisions need to be flexible and adaptable according to the markets they serve, both in wording and application.

There will always be issues that need adjustments in the initial framework – legislators and regulators have a responsibility to pay attention to the industry and its needs in this sense. But more broadly, we may see the emergence of MiCa II at some point, similar to MiFID and MiFID II.

4. Innovation Beyond Regulation

The difference here is that the pace of regulatory change seems to be accelerating. The second MiFID took several years to complete, but we expect the theoretical updates of MiCa II to be faster in this case.

The market is growing rapidly, and regulatory authorities need to stay ahead and continue providing the most encouraging environment. It is inevitable when participating in the global regulatory race. Due to its shortcomings, the EU often takes a leading position in regulatory issues, and many other jurisdictions are following suit.

A regulated stablecoin market will incubate a healthy DeFi system. While some see a regulated stablecoin market as a way for DeFi to integrate with traditional banking, we may actually end up seeing more financial applications completely bypassing the banking system.

We have already seen innovation-driven companies adopting tokenized forms of cash and financial products, enabling consumers to directly access revenue-generating assets, eliminating intermediaries. They not only profit from these assets, but also trade them, use them as collateral for loans, and consume them.

In this new world, traditional financial institutions will need to rethink consumer-centric financial product designs.

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