Effective Stablecoin Regulation is Key to Financial Stability, ECB says

The European Central Bank (ECB) has called for urgent action in the move to establish effective regulation in the stablecoin market, noting that a lack of such measures could portend risks to financial stability.

While this is not the first time for the European banking regulator to point to this need, it is looking at recent market events as an indicator.

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The ECB’s macroprudential bulletin released on Monday notes that stablecoins are a critical feature of financial innovation. But the bank notes that stablecoins have evolved from that traditional “safe “parking space” for crypto volatility”, with increased use across decentralized finance (DeFi) in liquidity pools and trading giving these assets further adoption within the ecosystem.

For now risks to financial stability maybe limited – yet, they are real.

Financial stability risks from stablecoins are currently still limited in the euro area, but if growth trends continue at their current pace, this may change in the future.”

ECB points to ‘contagion channels’

According to the ECB, stablecoins could threaten financial stability via several “contagion channels”, including exposure within the financial sector, crypto volatility knock-on effect on investor wealth, and diverse usage within the payments and settlements space.

An effective regulatory landscape would help mitigate against potential risks, especially with the collapse of the stablecoin TerraUSD (UST) a clear example of how things can spiral. What does the ECB suggest?

Existing stablecoins urgently need to be brought into the regulatory perimeter, and new ones need a regulatory framework to be established. To cater for their specific risks, algorithmic stablecoins should be treated as unbacked crypto-assets. Where stablecoins are used for payment purposes, regulatory regimes need to provide further clarity with respect to other areas such as data privacy, consumer protection, market integrity, AML/CFT and tax rules.”

These measures need to be undertaken at the international level, the ECB noted, adding that this should help offer a “level playing field” for a global approach that’s “consistent, granular and robust.”

The ECB’s bulletin comes days after the US Treasury called for broader and closer international cooperation in matters of crypto regulation. The department said global organizations like the G7, G20 and FATF have to spearhead this collaboration.