Italian MEP Irene Tenagli and German MEP Damian Boeselager are unhappy with how MiCA stablecoin regulations are being interpreted. During the negotiations for MiCA, the topic of whether to recognize foreign stablecoins as equivalent in the EU was explicitly debated and rejected. Yet from their viewpoint, it’s now happening via the backdoor.
Circle’s USDC stablecoin illustrates their concern. The token is issued in both the United States and Europe, with Circle registered as an electronic money institution in France under ACPR supervision, allowing passporting across the EU. USDC issued in the US and France use the same smart contract for full fungibility.
One of the major concerns for any multi issuance stablecoin is that non European token holders might favor the EU for stablecoin redemptions. Especially in a crisis or de-peg event, that could be detrimental for EU stablecoin holders, who could end up losing more money than they should.
The preference to off-ramp in the EU would be motivated by diverging regional regulations, including those governing redemption. EU stablecoin reserve requirements differ from other jurisdictions, requiring a large proportion of reserves to be held with banks – 30% for smaller stablecoins and 60% for large ones. Reserves backing USDC in the EU have to be located in Europe, with Circle rebalancing between jurisdictions based on EU issuance estimates, though it lacks visibility into self hosted wallet balances. We explored the stablecoin fungibility topic more broadly last month.
Regulator concerns over fungibility risks
More than a year ago, the French regulator ACPR posed questions about this arrangement to the European Banking Authority, which forwarded them to the European Commission. The Commission is preparing to publish an answer that likely endorses Circle’s treatment, given the MEPs’ concerns.
The issue emerged during a parliamentary committee hearing with European Central Bank President Christine Lagarde, who sees problems if the “fungibility principle” is applied too broadly. She noted that the current iteration of the US GENIUS Act allows stablecoin issuers to charge for redemptions, whereas MiCA requires them to be free. A non EU resident wanting to avoid these costs might redeem via the EU.
Her concern is that as stablecoins grow, if an issuer gets into trouble, EU stablecoin reserves could be depleted, defeating the purpose of safeguards. On fungibility, she prefers “a narrow interpretation in order to eliminate that potential risk.”
MEP Tenagli responded: “This is exactly the reason why, as co-legislators when we were negotiating MiCA, we deliberately excluded a third country equivalence regime.” She added that “the European Commission is about to actually permit all of this with a Q&A.”
Lagarde said she thinks third country equivalence is likely to be the case now, but suggested the Commission should discuss the original intention with co-legislators. “We know the threats. We know the risks and the hazards that would result from an extensive interpretation of the concept of fungibility. And I think it’s important to go back to it and to do that with open eyes, appreciating the risk that is taken.”
What does MiCA say?
The European Commission might take a more relaxed view based on MiCA regulation wording. Paragraph 54 of the preamble states that issuers marketing tokens “both in the Union and in third countries” should ensure reserves are available to cover liability towards Union holders “in proportion to the share of asset-referenced tokens that is expected to be marketed in the Union.”
While MiCA distinguishes between e-money tokens and asset referenced tokens, most rules apply to both. The ACPR has questioned whether this clause applies to e-money tokens.
Lagarde said the multi issuance clause was intended for coins issued in multiple EU countries, but the clause’s wording appears to contradict this interpretation.
The crisis scenario is worse than legislators realize
The situation could be more serious than it sounds. Retail EU stablecoin holders have the right to redeem directly from the issuer, whereas they can’t in the US. Additionally, some stablecoins are used more for off-ramping than others. Many holders of Tether or DeFi stablecoins will switch to USDC to off ramp, meaning USDC will face disproportionate redemptions in turbulent markets.
If a large stablecoin was subject to major redemption pressure with US selling funneled via the EU, it could potentially deplete 100% of the EU stablecoin reserves before the issuer has a chance to rebalance. That’s disastrous for EU holders and bad for the banks holding the reserves.
Some possible solutions
Given that multi jurisdiction stablecoin issuers use daily reports from European crypto exchanges to determine rebalancing, one solution might be requiring crypto providers to provide real time reporting. If there’s a spike in redemptions, that provides data for issuers to rebalance intraday.
Requiring redemptions to be from EU residents obviously helps to restrict regulatory arbitrage. But in a crisis, people will think up workarounds. Some EU providers will doubtless enter into transactions so that redemptions appear EU based and take a hefty cut as compensation.
Another potential solution is to borrow ideas from bankruptcy provisions that invalidate certain transactions in the previous 90 days. This could be applied to EU providers found to deliberately redeem coins for foreign stablecoin holders during a crisis, leaving them on the hook. A different tack during turbulent times would be to give redemption preference to coins that have been held in the same wallet for more than seven days. But given stablecoins are meant for payments, this might not be reasonable.
Why eliminating fungibility would be bad
While legislators might not be keen on fungibility, it’s an important feature for stablecoin users. The whole point is that you can send a dollar from the EU to Africa or vice versa, and it just arrives without intermediaries. If you start having separate coins such as USDC-US and USDC-EU, it undermines the utility of stablecoins for cross border payments.
Before regulators latch onto this idea as a tool to stifle stablecoins, they should think twice. Forcing stablecoins into jurisdictional silos will strongly favor the largest stablecoin issuers who have the infrastructure. The network effects of stablecoins already tend toward oligopoly and monopoly. For a company like Circle this would be merely an inconvenience. For smaller competitors it could be game over.
That’s because Circle already has a cross chain protocol that allows users to swap USDC on Ethereum to Solana or other chains. It effectively redeems the stablecoin on Ethereum and issues new coins on Solana. If there were US and EU versions of the token, it could do something similar, but Circle would be involved as an intermediary in every transaction crossing the EU boundary.
EU stablecoin users will not be happy. Many will assume the reason for creating an obstruction is to reduce stablecoin utility to remove potential competition for a digital euro CBDC.