The semantics of becoming a cyptocurrency platypus
If frequency of use is any measure of popularity in etymology, then “sovereignty” has a lot of new best friends in the semantics playground. For many, it is a familiar word in the ongoing matter of the departure of one island nation from a continental economic union where, as is often the case, it means different things to different people.
However, more recently, it has acquired a new meaning as a concept echoing around the corridors of the Berlaymont in the context of crypto assets. Most recently, the informal meeting of the EU’s finance ministers (if anything can be called ‘informal’ when it involves 27 socially distanced politicians and their entourages in a break out meeting) rolled out the preservation of monetary sovereignty as a reason for the regulation of stablecoins within the EU.
Stablecoins, (i.e. crypto assets which are backed by fiat currencies or other assets) have been in the crosshairs of the EU finance ministers and central bankers since the announcement last year by Facebook that it intends to launch its own stablecoin – Libra. Before that, the view of regulators and most politicians was that cryptocurrencies were an amusing but abstract sideshow which posed little threat (or indeed relevance) to the global financial system.
True, there were very valid concerns about the potential for crypto currencies to become a medium for money laundering, financing terrorism and other crimes or defrauding the consumer, but the threat to monetary sovereignty was not top of the list of ills that crypto currencies could unleash. Indeed, central bankers were of the view that even the big fish, such as Bitcoin and Etherium, swam in decentralised pools too small to be of relevance to the global financial system.
Libra changed all that. The potential size of the project and its global reach provoked an elevated response and central bankers and regulators muttered about its threat to ‘sovereignty’.
Admittedly, in their joint statement last week, the EU finance ministers continued to raise consumer protection and the prevention of crime as reasons that stablecoins should be banned in the EU until they could meet the requirements of a yet-to-be-drafted legal and regulatory framework. However, the ministers also flagged monetary sovereignty as a key reason for toughening their stance. As the German finance minister noted, the ministers agreed that it was down to them to ensure that what is a task for states remains a task for states.
It might be considered to be picky to note that the euro is not a state based currency, or that the French finance minister seemed to consider that currency was the responsibility of ‘the’ central bank (by which he meant the ECB) but the call to the barricades to defend monetary sovereignty does raise some interesting issues.
First, even its most ardent advocates would not claim that the euro has yet achieved universal global recognition as a reserve currency, whereas a universally popular and accepted stablecoin might achieve that if it engendered sufficient trust and confidence to democratise it as a currency with its own discreet settlement system.
Furthermore, the increasing politicisation of fiat currencies and their payment systems, as witnessed in US sanctions against Iran, Cuba and Libya and the EU’s reactive anti blocking regulation extending into the US dollar and euro payments and settlement systems, may make some keener to have an apolitical currency that sits outside the increasingly sanction-laden infrastructure of the established fiat currency based financial system.
In this, the EU finance ministers may be playing to stablecoins’ strengths in calling for them to be backed on a non-leveraged basis by fiat currencies, with reserves in the euro or other member states’ currencies.
With ‘fiat’ currencies, the clue to their strength lies in their name – ever since the abandonment of the gold standard and the demise of the Rentenmark, EU currencies (and the currencies of most other nations) have been uncollateralised and rely on the faith of their holders in the strength of their I.O.U. promise of their issuers. It is therefore interesting to note that the EU’s proposal is likely to require stablecoins to be collateralised 1:1 by the uncollateralised currencies of the EU.
In time, this may result in stablecoins being perceived as a better risk than an equivalent holding of the collateralising currencies, on the basis that is a form of portfolio diversification.
Conceivably, this could make stablecoins more attractive than individual holdings of the euro or member states currencies, especially if international political spats and trade wars result in sanctions and other impediments on the use of European fiat currencies, leading investors to seek an alternative to the hegemony of the US dollar in currency reserves. It would be an interesting outcome if EU regulation operated to promote the use of stablecoins over the euro.
Having recently agreed on a euro 1.82 trillion seven-year budget, including borrowing euro 750 billion for the European Recovery Fund, the success of stablecoins may be no bad thing for the EU’s finances. The G20 statement following the Pittsburgh Summit paved the way for an increased consumption of government debt by the financial industry to meet the requirements for the collateralisation of derivatives. The benefit to the treasuries of the G7 of this sort of sustained demand is that it is not transient, nor is it dependent on in DFI flows.
Large as the global derivatives market is, its demand for G7 government debt and currencies pales alongside that which may be needed to support non-leveraged stablecoins. If the EU proposals to require stablecoins circulating in the EU to have EU currency denominated collateral reserves come into effect, the EC may have helped create a market for some of its euro 750 billion of new debt.
However, this is not without risk. If the EU proposals require stablecoins to be backed exclusively by reserves in EU currencies held in EU-approved institutions, there is a danger that stablecoins which meet EU regulatory criteria, will not have the same attraction to investors and users than those which meet less restrictive requirements imposed by other regulatory regimes.
It is a fine balancing act between wanting to be in van of regulatory innovation and getting out of step with the rest of the regulatory world. If EU regulations are out of kilter with other international regulatory initiatives for stablecoins, there is a possibility that this could result in a fragmentation into EU compliant stablecoins and those which meet other regulatory standards.
Whilst some may argue that applying high regulatory standards will lead to a manifestation of Thiers’ law in stablecoins, it may also result in the European equivalent of a duck-billed platypus in the evolution of crypto assets – cute, unique, beautifully adapted to its environment, but not to be found in any other ecosystem.
The views in this article are the opinions of the author, and should not be considered to represent the views of Reed Smith LLP.
Claude Brown is a partner at international law firm Reed Smith in London, and co-heads the Firm’s European Fintech practice. With more than 26 years’ experience as lawyer and banker, Claude has been ranked in both Chambers and Legal 500 for the past 15 years. For more information visit www.reedsmith.com.