Stablecoins Redefined: EMTs vs ARTs

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.