Since the emergence of Bitcoin in 2009, the crypto-asset market has grown into a global market with more than 20,000 types of currencies. The greatest growth—both in terms of value and the number of coins in circulation—has occurred primarily over the last 5 years, driven by heavy speculation.
Despite warnings from authorities regarding the risks of participating in the market, the monthly average of daily active users has grown from around 100,000 in 2015 to more than 30 million worldwide, and the market valuation reached its all-time high—a capitalization of 2.5 trillion euros—in November 2021.
The current crypto-asset market comprises a wide range of assets of different types and with different risks, as well as related service providers that, for the most part, are not subject to a regulatory and supervisory framework. Therefore, the risks of participating in this market are high, not only due to the high volatility of many of the assets but also, as seen in the past year, due to the existence of fraud and losses resulting from the mismanagement of some of its operators.
At the end of 2021, however, the crypto-asset market began to lose a large part of its value. Rising inflation and the end of low interest rates modified investors’ bullish projections, causing an initial market slowdown that eventually turned into a drastic collapse following two high-profile failures in 2022. First, the collapse of the algorithmic stablecoin TerraUSD—linked to Luna, the native token of the Terra blockchain—which was unable to maintain its dollar parity after the abrupt exit of major investors. Second, the bankruptcy of the FTX cryptocurrency platform following a massive sale of its token, triggered by doubts about its liquidity and solvency. More than $450 billion was lost during the TerraUSD collapse in May 2022 and around $200 billion due to the FTX bankruptcy in November 2022.
Financial authorities closely monitored the progress of this “crypto-winter,” during which there was a widespread collapse in the value of crypto-assets. Beyond the massive losses for many users, there was concern about the potential impact that a collapse of this market could have on the financial system in general and, ultimately, on financial stability.
It should be noted that, for the time being, the crypto-asset market remains small in size compared to the global financial market. Even at its all-time high, its capitalization still represented only 1% of total financial assets. This implies that interconnection with traditional financial markets and, therefore, the transmission of risks remains very limited.
Nevertheless, there is concern that this situation could change in the future, not only due to the growth of the market itself and the exposures—direct or indirect—of traditional financial agents and institutions, but also due to the transmission channel represented by the short-term financial markets in which stablecoin reserves are deposited.
Although the two largest stablecoins pegged to the US dollar, Tether and USD-Coin, rank third and fourth in the cryptocurrency ranking by market capitalization ($65 billion and $55 billion respectively), these stablecoins are not yet used for payments in the real economy on a significant scale.
It cannot be ruled out, however, that one of these or other stablecoins may evolve in the future and have the potential to expand their reach and adoption across multiple jurisdictions, if they are able to maintain a stable value over time and, especially, if their adoption is facilitated by large technology companies seeking to integrate them into their digital ecosystems, which are widely used by millions of users.
To ensure the stability of the financial system, market integrity, and investor protection, should any of these stablecoins reach a significant size, European authorities have intensified their work in recent years to define a regulatory framework for crypto-assets, which also includes the regulation of stablecoins.
Market in Crypto-assets Act (MiCA)
The European Union has been one of the pioneer jurisdictions in establishing a broad and specific regulatory framework for crypto-assets—the Markets in Crypto-assets Regulation (MiCA)—which also harmonizes requirements across Europe, avoiding fragmentation and regulatory arbitrage between different Member States.
MiCA aims to regulate crypto-assets, including so-called stablecoins, not previously covered by the scope of existing EU rules, and establishes minimum requirements for unregulated crypto-asset service providers (e.g., exchange platforms such as FTX), providing clarity and legal certainty to operators, and protection to investors against some of the risks associated with investment and fraud.
Regarding stablecoins, MiCA establishes that stablecoin issuers—including credit institutions themselves—must be authorized and have a solid and segregated reserve of assets to back the parity and, in the case of e-money tokens, allow holders to redeem at par. Furthermore, if a stablecoin is considered significant by the authorities (based on its user base, value of the tokens, size of the asset reserve, cross-border importance, or interconnection with the financial system), capital requirements will be higher and the issuer must have orderly resolution mechanisms and rules for the investment and custody of reserve assets.
The final text of MiCA is expected to be published in the Official Journal of the EU in the spring of 2023 and enter into force after 18 months (12 months for provisions relating to stablecoins).
If a framework like MiCA had been in force in the various jurisdictions, the major collapses that occurred last year could probably have been avoided—especially that of FTX. However, in the coming years, it will be necessary to review the adequacy of the legal text to the changing reality of the crypto-asset market, with new business models and risks constantly emerging.
Digital Euro issuance project
The announcement of the creation of Libra, Facebook’s stablecoin, in July 2019, marked a shift in the stance of international authorities toward the risks of the crypto world, especially stablecoins.
A stablecoin like Libra, with immense user penetration and scalability, could challenge monetary sovereignty and the effectiveness of countries’ monetary policy, especially in those with weaker official currencies. Therefore, following its announcement, the debate on the advisability of issuing central bank digital currencies (CBDCs) accelerated in all jurisdictions and, at the end of 2020, the Eurosystem also published its approach to the possibility of issuing its own CBDC: the digital euro.
Throughout 2022 and during the course of this year, the Eurosystem has continued with the investigation phase of design options for the digital euro, which is scheduled to end in October 2023, when the Governing Council must decide whether to start a “realization” phase to develop and test the digital euro.
The decision to issue it will have profound consequences: it will not only affect millions of people and transactions in the European financial system, but it may also alter funding and payment markets. Therefore, during the investigation process, both the European Commission and the other co-legislators—the Parliament and the Council of the EU—have emphasized the need for this project to be built on a solid and democratic legal basis, given its scale. In this sense, as of May 2023, the Commission is expected to propose a legal framework regulating certain aspects of the issuance of the digital euro (e.g., legal tender status, aspects linked to privacy and AML/CTF measures, or intermediaries for its distribution).
The risks posed by new forms of private money continue to generate alert and concern for central banks. For this reason, retail CBDC projects are moving forward, including that of the digital euro, with one of its main objectives being to preserve the value of public money in new digital ecosystems, guaranteeing its coexistence and convertibility with other forms that money can take. In the case of the euro area, European authorities also see the digital euro as a common project to guarantee Europe’s strategic autonomy and monetary sovereignty against dependence on foreign payment solutions and to resolve the current fragmentation of the European retail payments market.
