The European Central Bank (ECB) on Monday (July 11) published several reports warning that financial stability risks stemming from crypto assets are rising and is calling for the “urgent implementation of appropriate regulatory, supervisory and oversight frameworks.” The message isn’t new, but the regulator is adding a call for action.
These reports followed a similar warning by Federal Reserve Vice Chair Lael Brainard who said on Friday (July 8) that it’s time to add some regulatory teeth to the cryptocurrency industry before it becomes so pervasive that it poses financial stability risks.
“It is important that the foundations for sound regulation of the crypto financial system be established now before the crypto ecosystem becomes so large or interconnected that it might pose risks to the stability of the broader financial system,” Brainard said.
Read also: Fed Vice Chair Brainard: Crypto Sector Needs Strong, Swift Regulation
In its reports, the ECB repeated a similar message. With a focus on stablecoins, the bank argues that the rapid growth, increasing global use cases and potential financial risk contagion channels of these digital assets, the need for new regulation is of utmost importance.
The ECB warns that although stablecoins only account for a small part of the total crypto asset market (around 150 billion euros in the first quarter of 2022) the rise of decentralized finance (DeFi) and the use of stablecoins as collateral and liquidity provider is turning them into a critical part of the crypto asset ecosystem.
This is the main concern for the central bank, the financial stability implications of stablecoins given their current role in the crypto asset ecosystem. Given that the largest stablecoins serve a critical function for crypto-asset markets’ liquidity, this could have wide-ranging implications for crypto-asset markets if there is a run on or failure of one of the largest stablecoins, the bank argues. In her speech, Brainard also warned of the concentration in the stablecoin market, with almost 90% of the transactions controlled by three stablecoins, and the top two accounting for 80% of market capitalization, and the risk of a potential run.
A run on a stablecoin could have contagion effects for the financial system, the bank explains, either if the crypto asset markets pose a risk to financial stability, that the ECB states is not the case yet, or if there are large-scale redemptions of reserve assets.
But after the warning about stablecoins and how important it is to have appropriate regulatory frameworks, the ECB called on policymakers and member states to implement the Markets in Crypto-Assets (MiCA) Regulation “as a matter of urgency.” The ECB is pleased with the “bespoke regime” for the issuance and provision of services related to stablecoins and other crypto assets. MiCA establishes strong requirements for stablecoin issuers if they want to provide the digital asset, even more so, if these stablecoins are of “significant importance.” However, the central bank is worried that member states don’t use a harmonized approach to the registration and authorization of crypto asset providers until MiCA is fully implemented in 2024 and this could increase financial stability risks.
Read more: ECB Says Patchy EU Crypto Regulations Raise Risks
Last, crypto enthusiasts were pleased to see that DeFi was finally left out of the MiCA regulation, but the ECB, also repeating the same message that the Federal Reserve gave on Friday, said that the guiding principle of “same business, same risk, same rule” should apply to DeFi. In this case, given the decentralized nature of DeFi, the ECB called for an internationally coordinated approach to mitigate risks from DeFi, including the identification of regulatory gaps.
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