Euro stablecoins could turn sovereign bond markets into contagion channels

Stress in the crypto market can shift into traditional finance if euro stablecoin reserve deposits are concentrated among a small number of lenders. The European Central Bank warns that the growth of euro-denominated stablecoins creates new faultlines in sovereign debt markets as issuers emerge as significant holders of government bonds. Under the Markets in Crypto-Assets Regulation, e-money tokens must invest the remainder of their reserves—after mandatory bank deposits—in low-risk, highly liquid assets such as sovereign bonds.

Demand for government debt varies by the source of funding. The ECB uses a pass-through rate to measure how issuance growth translates to bond holdings. When stablecoins are funded by retail deposits, the pass-through rate ranges from 0.25 to 1.20. When funded by non-operational deposits from financial institutions, the rate can fall below zero, meaning the increase in sovereign bond demand could be offset by the balance sheet effects in the banking system.

Regulatory buffers are designed to mitigate this risk. Under Mica, e-money institutions must hold a portion of reserves as bank deposits. Significant issuers can absorb redemptions of up to 60% of supply through these deposits before forcing the sale of sovereign bonds. However, draft regulatory standards now propose a 25% cap on deposits held with a sleeve of systemically important banks and a 1.5% limit on a bank's exposure to any single stablecoin.