What has happened?
Christine Lagarde, the President of the European Central Bank (ECB), has said that stablecoins will be beneficial only if the risks associated with them are mitigated through effective regulation and oversight.
What does this mean?
In a letter to the European Parliament, Lagarde expanded on previous remarks earlier this month before the Parliament's Committee on Economic and Monetary Affairs, stating that the ECB is closely monitoring innovation in the financial and payments sector and assessing the benefits and risks of innovative projects, such as stablecoin initiatives.
Lagarde said that while stablecoin initiatives could overcome shortcomings in cross-border payments, they will bring benefits only if the associated risks are mitigated through effective regulation and oversight.
She highlighted some of the possible risks linked to stablecoins, such as significant market concentration.
“If the entities that govern stablecoin arrangements control large digital platforms, they could impact the level playing field by promoting the use of their own solutions, with possible lock-in effects, and/or blocking other service providers or payment methods from their platforms,” Lagarde said.
In addition, the potential combination of social media and financial data could give stablecoin operators a "strong competitive advantage and undermine market contestability".
According to Lagarde, should stablecoin initiatives achieve scale and retail users treat stablecoins as an alternative to bank deposits, a potentially sizeable amount of retail funds could be transferred from the banking system into non-banks.
Stablecoins may promise "stability" and the possibility of converting coins into fiat currency at any time, but Lagarde warned that their value will depend on their governance and risk management and on the value of the underlying assets or fund portfolio.
"A mere promise that the proceeds from the sales of coins will be invested in low-risk financial instruments will not be enough to ensure the stability of the coin," Lagarde warned.
In that sense, she said that the term "stablecoin" is a misnomer, adding that users should understand that any losses they might incur would not be covered by the traditional financial stability net, such as deposit guarantee schemes and central banks' roles as "lenders of last resort".
"It is critical that the same rules are applied to all activities that give rise to the same risks, irrespective of the technologies used or the identity of the service providers. In other words, 'same business, same risk, same rules' should be a guiding principle in the regulatory approach to stablecoin initiatives and placed at the core of technology-neutral regulation."
The ECB President noted that there is "broad agreement" at EU level that stablecoin arrangements should not start operating in the EU before their public policy and regulatory risks have been evaluated and addressed.
She also agreed with the recent joint statement issued by the Council of the European Union and the European Commission on the need for legal clarity on the status of stablecoin arrangements and for them to be subjected to clear and proportionate regulatory and oversight frameworks.
To finish, Lagarde said that the ECB is reviewing its existing oversight framework for payment instruments, schemes and arrangements to clarify which aspects of stablecoin arrangements that facilitate the transfer of value between end-users fall within the Eurosystem oversight competence.
If you want to take advantage of blockchain's huge potential and disruptive impact, while keeping track of ever-developing regulatory and legal requirements, visit our Hogan Lovells Engage Blockchain Toolkit.