Stablecoins Redefined: EMTs vs ARTs
A ‘stablecoin’ is a cryptographic asset that attempts to maintain a stable value in reference to some other asset. This asset is usually a Fiat currency, like the US Dollar or Euro, but the reserves used to maintain that value may not necessarily be the same asset that the stablecoin refers to. Stablecoins are an area of increasing interest to both the Traditional Finance (TradFi) and the Decentralized Finance (DeFi) markets alike, due to them functioning beyond the fiat/crypto border but also generally being able to avoid the volatility that follows free-floating cryptocurrencies. In this third part of our blog series on the EU’s coming Markets in Crypto Assets Regulation (MiCA), we will zoom in and focus specifically on stablecoins and what the new legislation will mean for them.
Categorisation and Terminology
In the first part of this series, we mentioned that the EU considers ‘crypto assets’ to be electronic tokens, based on Distributed Ledger Technology (DLT), that are used primarily as a means of payment. This definition very clearly includes almost everything that the blockchain industry would currently refer to as a ‘stablecoin’. Interestingly, while MiCA makes frequent use of the phrase ‘stablecoin’ (always in quotation marks) throughout the draft legislation, this word doesn’t have a clear legal definition in the new law.
MiCA lays out specific definitions for items which they call Electronic Money Tokens (EMTs) and Asset-Referenced Tokens (ARTs), both of which are instruments that would normally be referred to as ‘stablecoins’. Since clear definitions have been laid down, and the two types of stablecoins are actually governed by different rules and regulations within MiCA, it therefore makes no sense in a legal context to refer to ‘stablecoins’ within the EU legal framework. This article will only use this word in a non-legal sense from now on, to refer to EMTs and ARTs collectively, and separately from other types of crypto assets.
We also see no place in MiCA for the commonly-used term ‘Asset-Backed Token’ (ABT). While this phrase has been in use for a very long time within the industry, once again, it has no legal definition within the EU regulation. This is important to remember because the EU-defined ART is not a direct substitute for an ABT. Several tokens that may be referred to by people in the industry as ABTs, would actually be EMTs under MiCA, not ARTs. Therefore, once again, we will avoid the use of this phrase for the rest of the article.
Importance
As we discussed in an earlier article in the series, the European Union and its 27 member states are especially concerned about stablecoins and the potential for them to disrupt the right of the state to issue currency, and to use their Keynesian powers when fighting economic troubles. It should, therefore, not be a surprise to us that the overwhelming majority of the draft MiCA regulation is dedicated to regulating and controlling stablecoins. Contrastingly, however, the EU seems to have accepted that stablecoins are a key part of the crypto landscape, and innovation in this field will happen with or without their acquiescence. Creating guidelines and rules for the issuance and trading of stablecoins allows Europe an opportunity to retain talented individuals and companies during the current global talent war, while also permitting TradFi institutions from experimenting with new products, something we welcome here at Dusk Network.
Spot the Difference
Both EMTs and ARTs are distinguished from the third category of crypto assets mentioned in MiCA (‘utility tokens’) by the necessity for them to be backed by assets in the real world. What this means in practice is that MiCA requires issuers of stablecoins to hold in reserve assets equivalent to the tokens placed into circulation. So, for example, an issuer who distributed $1m of a USD-pegged EMT would have to have an actual $1m stored somewhere, such as in a bank account or a vault. This is a core requirement for the EU, and is vital in enforcing the ‘right of redemption’ which we will get into later. Looking at it through the lens of monetary policy, we can see that this requires an equivalent amount of ‘money’ to be removed from the system as an issuer is adding to it. This is a non-negotiable condition, and will be strictly monitored and audited in a post-MiCA Europe. It also leads us to our first distinction between EMTs and ARTs.
An Electronic Money Token, as the name suggests, is similar in concept to Electronic Money, which in the EU is regulated under a different piece of legislation. Electronic Money is effectively a one-for-one equivalence, with one electronic euro holding the same value as a physical euro. EMTs function in the same way, but are distinguished from E-Money by their use of DLT, as explained earlier. Thus, they should represent and be backed by one single fiat currency. An EMT could represent anything from Euros to Dollars, Chinese Yuan or British Pounds, but the reserves held to back it should be in the same currency. Therefore an EMT euro represents exactly one fiat euro, held somewhere in reserve.
By contrast, an Asset-Referenced Token, whilst being denominated in a single fiat currency (1 X-token = 1 USD, for example), is backed by any combination of the following assets:
- Two or more fiat currencies
- One of more cryptocurrencies
- One or more other assets
So in the case of an ART, the assets held in reserve to back the token, may not necessarily be the same as the fiat currency to which its value is referenced, and may not all be the same as each other. An ART may then represent, for example, a combination of Euros and US Dollars, Bitcoin, Japanese Yen and Ether, a collection of diamonds, pieces of rare metals, or pretty much any other combination you can think of. In fact, the easier way to conceptualize what backs an ART is what it can not be backed by: a single fiat currency. Any other combination at all will get the token classified as an ART. And this is important, because following classification, different rules and regulations apply.
Different Coins, Different Rules
Simply speaking, issuers of ARTs have a much easier time under MiCA than issuers of EMTs. This should not be surprising, considering EMTs’ potential to replace a country or region’s fiat currency, traditionally the reserve of national or supranational governments. Firstly, as mentioned earlier, EMTs function much like E-Money, and so while regulated separately, are not immune to the rules for E-Money, namely the Electronic Money Directive 2, which requires issuers of E-Money to get a license. This will also be true of EMT issuers, unless you are already licensed as a credit institution. By contrast, no such rules or additional licenses beyond MiCA apply if you wish to issue an ART.
Capital requirements differ greatly too. Under the latest draft of MiCA, an issuer of an EMT requires 350,000 euros in initial capital, whereas an ART issuer has no such requirement. EMT issuers must maintain their own corporate capital at a ratio of 3 percent of the total reserves held to back the token, meaning that they will have to increase their own capital if they decide to issue more tokens. By contrast, ART issuers need only maintain a ratio of 2 percent of the reserves, or 350,000 euros, whichever is highest.
One of the strangest things in MiCA, however, is that it is clearly stipulated that issuers of ARTs must have their reserves audited every six months, whereas no such provision appears to be denominated for EMT issuers. While it is not clear why this is the case, considering that both the EU and national governments seem much more concerned with EMTs than ARTs, we can surmise this is simply an oversight and something that will get fixed in the final draft.
Rights of Redemption
One of the big things delineated by MiCA is the ‘right of redemption’ that the new law applies to stablecoins under its jurisdiction. This is a relatively unheard of provision in the world of crypto, and adds some interesting dimensions to the future European landscape, but works differently pre-listing and post-listing on an exchange.
The right of redemption for stablecoins in the period after sale, but before being listed on an exchange, is not actually a function of MiCA, but comes instead from the 2014 EU Consumer Rights Directive. This piece of legislation allows for a 14-day ‘cooling off period’ in which any product, bought from any supplier, can be returned for a full refund without any requirement to provide a valid reason, as long as it is in its original form. This law will also apply to crypto assets, and therefore to both EMTs and ARTs equally. Unlike regular products, once an EMT or an ART has been listed on an exchange, the EU considers that consumers now have a valid way of selling their token, and since stablecoins theoretically shouldn’t lose value, the 14-day right of redemption is removed once a coin is listed.
This poses very interesting questions for the industry, since it allows for the possibility of a company to raise millions in a presale of an EMT or ART, and then to have a significant number of the coins returned within two weeks of the token sale. Under the relevant legislation, the issuer would be required by law to return the purchasers’ money and be left sitting on top of a load of tokens. Effectively, money raised in any kind of sale is not guaranteed, which is tough considering that this is when many projects begin to build. To offset this risk, and taking into account the additional costs of issuance when licensing and whitepaper writing is considered, we may well see post-MiCA stablecoin issuers in the EU raise significantly more seed capital than was previously seen.
Alternatively, issuance of stablecoins may only be attractive to large institutions which already sit on large amounts of capital and so would not require presale money in order to build. Another interesting possibility would be the establishment of early-stage agreements between potential stablecoin issuers and MiCA-licensed exchanges, speeding up the listing process to reduce the redemption risk. These companies would still require more seed funding, however, to ensure that most or all of the building was done before issuance, but it does have the potential to dramatically shift power back to the side of exchanges.
Post-listing, the rights of redemption diverge, depending on what kind of stablecoin you are issuing. The rights inherent from the 14-day ‘cooling-off period’, as mentioned, no longer apply once listed on an exchange, but general redemption rights do apply. These redemption rights, stipulated under MiCA, say that issuers of EMTs must always allow one-for-one redemption of tokens, with no exceptions. The EU does allow fees to be charged for this, but they must be clearly outlined in the original whitepaper submitted to the National Competent Authority. ARTs, once again, have an easier time. As the current draft stands, an issuer of an ART can avoid rights of redemption by simply writing in their whitepaper that such a right does not exist. They must remember, though: no mention of redemption rights in a whitepaper will be interpreted by the relevant authorities as acquiescence, and in that case all redemption requests must be honored. However, we should acknowledge that this seems to us as strange of a loophole as it does to you, and we strongly suspect this will change in the final draft of MiCA.
Would you issue a post-MiCA stablecoin?
The EU clearly sees stablecoins as a threat to their control of the money supply, and so much of MiCA is clearly targeted at their regulation within the 27 member states. However, they do not wish to suppress innovation, so in most cases they have allowed enough wiggle-room for true innovators to issue such tokens. It remains to be seen whether enough room has been left.
We mentioned earlier that the reserves that back EMTs and ARTs have to be held in an account or a vault that can be audited. Between audits, it would appear that issuers may invest the reserve funds into other things, but nothing with high risk, and nothing that would tie up the capital for long periods. So, effectively, some kind of ‘high interest’ savings account is your best option. This removes one of the big incentives for companies who might wish to issue stablecoins. From the side of the consumer, one of their big incentives has been removed by MiCA’s strict prohibition on the offering of interest to stablecoin holders. Faced with this, why not simply deposit your money into a bank? Maybe the same savings account that the issuers are using?
Another hurdle is the cap on stablecoins that was implemented in the final agreement made on June 30, 2022. The agreement, which will now be written up as the final draft, limited stablecoins to a daily transaction value of 200m euros. While this may seem like a lot, it is not, and several of the world’s current top stablecons already exceed that by many times. Upon reaching this limit, the issuer is prohibited from issuing more, and depending on the final wording, may be forced to remove some tokens from circulation. This is another upper limit on growth, and may deter some potential issuers from entering the market.
The future will be interesting, to say the least. With clear rules and regulations in place, we can expect increased consumer interest and confidence in stablecoins and other crypto assets. However, are the protections too tight so that they will strangle innovation in the crib? It remains to be seen.
