EU raises alarm over potential bank threats posed by stablecoins

The European Systemic Risk Board has recommended increased disclosures and monitoring as measures to combat the risks associated with the cryptocurrency market.

This alarm follows concerns have been raised about the potential impact of a sudden crisis in the crypto sector on the global economy.

Findings span 77 pages

The European Systemic Risk Board (ESRB), an oversight body operating under the European Central Bank, released a comprehensive report on May 25, delving into the realm of crypto assets and decentralized finance (DeFi).

Spanning 77 pages, the report emphasizes the rapid growth of the volatile crypto industry and its deepening integration with the traditional financial market. 

Despite the fact that the shocks experienced by the crypto sector in 2022 did not cause significant harm to traditional finance (TradFi), the report argues that the existing risk monitoring system is inadequate in detecting potential concerning trends that may emerge in the future.

The report also highlights the financial stability risk posed by reserve-backed stablecoins, which have connections to the traditional financial system due to their underlying assets in conventional fixed income instruments.

Unlike regulated money market funds, these stablecoins lack regulatory oversight, a clear legal framework, and access to a lender of last resort. Transparency in their accounting practices also varies, raising concerns about the quality of reserves backing the tokens. 

The ESRB goes on to state that previous shocks in the crypto market demonstrated a preference for more secure stablecoin issuers, mentioning Tether’s fluctuating market as an example.

To reduce the possibility of a run, the report points to the U.S. President’s Working Group on Financial Markets report which proposed limiting the issuance of reserve-backed stablecoins to chartered banks could transform them into traditional demand deposit liabilities.

This would subject the issuers to banking regulation, supervision, and deposit insurance, aligning them with the current banking system and reducing the likelihood of panic-induced runs.

By implementing these measures, the aim would effectively be to enhance stability and instill greater confidence in the functioning of reserve-backed stablecoins.

Enhanced monitoring

In relation to the systemic significance of crypto-asset markets, the recently published report emphasizes the critical necessity for enhanced monitoring and evaluation of market developments.

Recognizing the evolving nature of these markets, the report underscores the importance of closely scrutinizing and assessing their dynamics to ensure appropriate regulatory measures and safeguard financial stability.

This release comes just one month after the approval of MiCa, the first regulatory framework of its kind across the globe.