The European Central Bank and the national central banks of the European Union are questioning a key assumption behind Europe’s stablecoin regulation: that requiring issuers to keep a fixed portion of their reserves in bank deposits necessarily makes the system safer. Their latest recommendation suggests that the greater priority should be ensuring that reserve assets can be converted into cash quickly without creating additional instability for commercial banks.

The European System of Central Banks, which brings together the ECB and the national central banks of all 27 European Union countries, has proposed removing the existing requirement under the Markets in Crypto Assets framework that stablecoin issuers hold at least 30 percent of their reserves as bank deposits, rising to 60 percent for significant issuers. Instead, the central banks want the rules to specify that a minimum portion of reserves must be invested in assets that mature within one to five working days.

The recommendation is significant because it changes the regulatory focus from where stablecoin reserves are held to how reliably and quickly those reserves can be accessed during periods of heavy redemption. The ECB has previously warned that stablecoins could replace relatively stable retail deposits with more volatile wholesale funding for banks. That concern has become more relevant as digital assets increasingly connect with conventional financial markets.

Why the ECB Is Concerned About Bank Deposits

The existing reserve requirement was intended to strengthen the ability of stablecoin issuers to meet redemption requests. Stablecoins are designed to maintain a stable value against a reference currency, and issuers therefore need assets that can be used when holders exchange their tokens for conventional money. Bank deposits provide immediate access to funds under normal circumstances, making them a logical component of a liquidity framework.

The problem identified by the ECB and other European central banks is that deposits supplied by stablecoin issuers may behave very differently from traditional household and business deposits. Retail customers generally maintain deposits for everyday payments, savings and financial needs, whereas stablecoin holders can collectively change their positions rapidly in response to market developments. A large redemption wave could consequently cause an issuer to withdraw substantial funds from banks at short notice.

That creates a potential two-way channel of instability. If a bank holding stablecoin reserves experiences financial difficulties, doubts about the availability of those reserves can weaken confidence in the stablecoin. Conversely, if confidence in a stablecoin falls sharply, the issuer may need to withdraw large amounts of money from banks to meet redemptions. The ECB has pointed to the events surrounding the failure of Silicon Valley Bank in the United States as an illustration of how banking problems can affect stablecoin stability.

The concern is therefore not that bank deposits are inherently unsafe. The issue is that large amounts of deposits connected to stablecoin activity could make bank funding more sensitive to developments in digital asset markets. The central banks’ proposed approach attempts to reduce that connection without weakening the underlying liquidity requirements for stablecoins.

Why Short Maturity Could Matter More Than Deposits

The alternative proposed by the ECB and other EU central banks focuses on the speed at which reserve assets become available. Instead of prescribing a fixed percentage of bank deposits, the revised approach would require a minimum share of reserves to consist of assets maturing within one to five working days.

This represents a shift towards a more direct measure of liquidity risk. A reserve portfolio can contain high quality assets and still create problems if those assets cannot be converted into usable cash quickly enough to meet redemption requests. Stablecoins operate continuously, while many conventional financial assets still operate according to established settlement and market schedules. The ECB has specifically highlighted the mismatch between around-the-clock stablecoin activity and the settlement timelines of some reserve assets.

A maturity-based requirement could therefore give issuers greater flexibility in deciding how reserves are structured while still requiring sufficient near-term liquidity. It could also reduce the possibility that stablecoin growth simply replaces traditional bank deposits with a more volatile form of bank funding.

The proposed change does not mean that European central banks consider stablecoins harmless. In fact, the wider ECB position suggests the opposite. The central bank has repeatedly warned that significant growth in stablecoins could affect bank funding, monetary policy transmission and financial stability if consumers and businesses begin moving substantial amounts of money away from conventional deposits.

Stablecoin Growth Creates Wider Financial Links

The reserve debate is becoming more important because stablecoins are no longer confined to cryptocurrency trading. They are increasingly being considered for payments, transfers and settlement, which could expand their connection with the wider financial system.

If stablecoins become a significant substitute for bank deposits, the consequences could extend beyond individual issuers. Banks rely heavily on deposits to finance lending to households and companies. A substantial movement of funds into non-bank stablecoins could alter the structure and stability of bank funding, potentially affecting how financial institutions transmit changes in interest rates to the wider economy. The ECB has identified this as a potential long-term concern, particularly because banks remain an important source of credit in the European economy.

Reserve assets themselves can also create links with financial markets. European stablecoin issuers hold substantial portions of their reserves in liquid assets such as government securities and other low-risk instruments. If large numbers of token holders seek redemption simultaneously, issuers may need to liquidate assets quickly. The resulting transactions could become significant if the stablecoin market grows sufficiently large.

This is why the ECB and national central banks are looking beyond the simple question of whether each stablecoin has enough assets behind it. They are examining how those assets behave under stress and how a crisis involving a digital token could spread into banks or financial markets.

Multi Issuance Adds Another Layer of Risk

The ECB and other EU central banks are also concerned about stablecoins that are issued through entities inside and outside the European Union but treated as interchangeable. Such multi issuance structures could create difficulties because European safeguards may apply only to the part of the operation located within the EU.

The problem would become particularly acute during a period of market stress. If holders could redeem what they regard as the same stablecoin through several jurisdictions, they could concentrate redemption demands in the jurisdiction offering the strongest legal protections. The ECB has warned that reserves held within the European Union might not be sufficient to meet such concentrated demand.

For that reason, the European central banking system has argued that any future permission for multi issuance would require a comprehensive set of safeguards. These could include assessing whether the rules of other jurisdictions provide protections equivalent to those available under European regulation. The objective would be to prevent differences between national regulatory systems from becoming a source of instability.

The enforcement of existing rules is another concern. The European Union has been developing its crypto regulatory system through MiCA, which established a harmonised framework for crypto asset issuers and service providers. The European Commission is currently reviewing whether the framework remains suitable as digital asset markets and international regulation evolve.

The ECB and EU national central banks are therefore not simply proposing to remove a restriction. They are seeking to redesign one part of the framework around a different assessment of risk. Their argument is that stablecoin regulation should ensure rapid access to reserves without unnecessarily creating unstable funding links between digital asset issuers and commercial banks.

The broader direction of European policy suggests that stablecoins are being treated increasingly as part of the financial system rather than as an isolated cryptocurrency product. The challenge for regulators will be to preserve the liquidity and redemption guarantees that make stablecoins attractive while preventing their growth from creating new channels of financial contagion.

For the ECB and Europe’s national central banks, the proposed change to deposit requirements is therefore part of a larger effort to make MiCA more responsive to the way digital money interacts with conventional banking. The emphasis on short-maturity assets, stronger safeguards for cross-border issuance and closer attention to enforcement reflects a regulatory shift towards managing the connections between stablecoins and the wider financial system rather than regulating the tokens in isolation.

(Adapted from ChannelNewsAsia.com)

Categories: Economy & Finance, Regulations & Legal, Strategy