The hidden truth about EMTs — Why we invested in Quantoz Payments

Fabric Ventures
11 min readDec 11, 2024

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There’s a surge of interest in 100% fiat-backed stablecoins, especially after deals like Stripe/Bridge. These digital currencies offer a promising solution to the inefficiencies of traditional fiat systems, including high processing fees, slow cross-border transfers, and suboptimal yields.

However, launching a stablecoin in Europe is a complex endeavour, requiring a deep understanding of regulations and bringing in strategic partnerships for compliance, GTM, investing and banking.

The Regulatory Landscape

The Markets in Crypto-assets regulation (MICAR) for stablecoins in Europe is implemented from June 30, 2024. After this date issuance of stablecoins in the EU is restricted to approved institutions. Only companies complying with the requirements imposed by MICAR will be authorised to issue and offer stablecoins in the EEA. All stablecoin issuers operating in the EU are required to obtain a license as credit institutions or Electronic Money Institutions (EMI) under the MICAR framework. Large issuers operating in offshore jurisdictions will need to establish presence in the EU to remain compliant.

MICAR labels stablecoins as e-money tokens (EMT) when they reference a single official currency. EMT’s business models are restricted by regulation via the prohibition (imposed on centralised/regulated entities) on generating interest yield from holding or staking EMTs. This is because they are intended by the regulator to be primarily a means of payment (with alternative transactional revenue models instead) vs being used as a store of value or use in crypto trading, lending, decentralised finance (DeFi) applications, and other blockchain-based ecosystems where it is possible to earn yield through lending protocols and DeFi applications (and where this yield is an incentive to hold). Note, the EMI or credit institution can earn interest on the fiat reserves backing their EMT but these cannot be directly shared with token holders. These yield limitations for EMTs are however offset by benefits accruing from their aura of high accountability, stability and security standards. To be worthy of the comfort and trust this earns them, they must provide high levels of transparency regarding their reserve assets and undergo regular audits and reporting. In contrast, many other stablecoins have a more diverse landscape when it comes to regulation and they are supported by various asset types, including fiat currencies, cryptocurrencies, algorithms, or commodities, resulting in varying degrees of price stability. This disparity has led to concerns regarding the stability and trustworthiness of certain stablecoins, particularly those needing proper audits and reserve backing. As such these other stablecoins are unlikely to be used in corporate walled gardens or for payments but serve plenty of crypto liquidity and DeFi use cases.

Closed Loop EMTs

Quantoz Payments (QP) has taken the bold steps of launching a series of stable coins for different use cases within the MICAR framework: Their first product, EURD, plays into the closed loop stablecoin space. It’s a Euro stablecoin where you have to be whitelisted to use it and exchanges and MMs are not required participants in the value chain: QP provides the on/off ramp and minting/redemption for the specific KYC’d participants within the walled garden. Examples of this are micro transactions (e.g. public transport), areas of high chargeback use cases (e.g. gaming), capital markets settlement, tokenised asset settlement and SME cash pooling/treasury sweeps. Users that receive EURD can rely on QP’s status an obliged entity to reduce their KYC efforts on the sender.

The closed loop model also has implications for the issuer’s fiat reserve bank relationships. The banks can more easily get comfortable with this setup since they know that the parties involved (e.g. customers using/buying transport services as well as the seller of transport services) were checked by someone. With an open loop EMT it takes a lot more convincing. The bank also looks for significant comfort from the issuer’s regulatory status and where they are regulated (we are a long way from the quality standards of European regulators being equal across the continent in their vigilance and capabilities to monitor as we know from fiat based BaaS scandals, such as in Lithuania for Solaris and others). Under MICAR there is an attempt to harmonise a framework for crypto assets, but this will take some time to demonstrate in practice.

An obvious push back on closed loop EMTs to date is that traditional Web2 enterprise adoption has been slow but over time these closed loop EMTs can offer a hedge against very low-interest rate environments limiting revenue for their counterpart stablecoins. Instead, the closed loop EMT revenue model is more likely to be based on subscription, transaction or account fees.

Before MICAR, every Euro stablecoin was effectively competition to EURD e.g. eurcv, eurc, eurd , eure , euroe, eurs, eurr, eurt, euri etc but after MICAR a stablecoin is either an EMT or not, and if not, issuance can’t happen in Europe. Within EMTs the likely winners will in turn be “AAA” rated EMTs. This rating is highly correlated with the quality of regulator and host bank(s), the tier 1 reserves, the treasury risk management capabilities and the technology performance. Circle’s EMTs are clearly in the leadership position but Circle is a difficult beast to get comfortable for European regulators and corporate clients for several reasons: they currently do not have a European reserve bank account, there are geopolitical issues relating to them being a US company but more importantly there is incredible goodwill for an alternative European based player. We believe that can be QP. In addition EURD use cases, as mentioned, are closed loop and currently Circle, Membrane and others currently do not have a white label closed loop solution so the comparison is not apples to apples (although Paxos acquisition of Membrane might change this). Instead USDC is an open loop play.

Open Loop EMTs

USDC is an open loop EMT after Circle became regulated in Europe. Coinbase (as a regulated exchange) as a consequence of this has recently stopped USDC yield sharing in Europe. These open loop EMTs were clearly originally designed for global crypto liquidity e.g. in trading but the restrictions on yield/staking sharing, although negatively received by users, are really a consequence of the issuer deciding to become a regulated EMT. Circle’s interest is in their stablecoin also being used as a payment token which requires appropriate risk and stability management. As such, success of these open loop EMTs will come in the short term from their depth of liquidity, facilitation of seamless on/off ramping, ease of trading, as well as in the longer term an increasing amount of payment use cases. However, as an open loop EMT, the KYC burden on tokens received and handled by payment processors is much more expensive, as C2B payments require a provenance analysis on the EMTs used for settlement.

As part of this recent funding round, QP has also launched a complimentary pair of EMTs but addressing the open loop liquidity use cases (USDQ and EURQ) to directly take on USDC and EURC in Europe. Building deep liquidity is a substantial hurdle to success in open loop, but QP have brought the right partnerships to the table to do this.

The Quantoz Payments Partnerships Positioning it for Take-off

Stablecoins face issues relating to which exchanges will list them, where is liquidity coming from, how market makers make money on it and many other hurdles for success. The investment and partnership round for QP has been specially designed with this in mind.

The lead investor and active commercial partner in QP, is Tether post their decision NOT to become regulated in Europe with USDT. EU exchanges will have to delist non EMT compliant stables. There is a target date of 31 Dec. 2024 for this, but even if this takes longer it will become a reality — a fine for a regulated European exchange can be 12% of annual revenue. Tether has already decided to discontinue EURT. Without a doubt, Coinbase is likely to delist Tether’s stables. The ambition for QP is that USDT in Europe is redeemed for USDQ for global crypto liquidity use and as store of value alternatives to USDC and EURC. All other EMTs today have subscale liquidity and are likely to remain so.

Kraken has also joined the investment round in QP. Exchanges typically are very selective when deciding what to list and not. Kraken, like Tether, is intent in making QP’s stablecoins successful. Key large market makers (unnamed) are also joining the investment and commercial partnership with QP. As such, deep markets can be built and auto conversion contracts and low/no spread/trading fees for swaps between USDT/USDQ are all possible. At Fabric, we have committed to bring our broad 100+ portfolio companies to the table to explore collaborations where these companies currently use alternative stablecoins or where our market maker connections might be relevant.

Don’t forget the Idea is to Scale Issuance

Having tier 1 partners for GTM out of the gate however is not sufficient and the beauty of the QP investment and partnership round is that the banking and regulatory relationships of QP are equally critical as is understanding of how to navigate and build a credible business plan around the limitations imposed by the European Banking Authority (EBA) and the regulators, as the issuance scales:

  1. According to the EBA, since MICAR concentration limits on fiat reserves should not exceed 1.5% of a reserve bank’s balance sheet, once issuance scales one will require banking partners with a large, aggregated balance sheet. Tether does not even believe there are sufficient European banks able to (if they wanted to) serve its full needs in Europe. This narrows the field of possible partnerships and makes QP’s banking relationships stand out as a USP.
  2. Another reason banks are likely to need large balance sheets for this business is because crypto is treated as a “100% likely outflow”, so it becomes quite negative for a liquidity coverage ratio (LCR) of a bank. 100% outflow is not that extraordinary considering the current liquidity use cases for stablecoins and remembering that SVB (banking small to medium startups) had an 85% outflow in just two days. For example, if a bank starts with $1 billion in retail deposits, its expected outflows in 30 days would be $50 million (assuming say 5%). If it also had $75 million in high quality liquid assets, its LCR is 75/50 or 150%, significantly above the minimum required 100%. If the bank now takes on $100 million in stablecoin deposits, which it parks at the central bank, it now has $175 million in high quality liquid assets. But its 30-day net outflow is $150 million. So, the LCR is now 175/150 or 116%. This is a substantial decline for a 10% bump in deposits. This may still be above the required 100% but is not likely a business most banks will agree to. Host banks need a very healthy buffer in LCR to engage with issuers at scale. It gets worse if the net outflows of the bank are small before engaging, then it does not take a lot of crypto reserves taken out to change this LCR. Let’s take an example tier 1 bank like ABN AMRO or Rabobank in the Netherlands. ABN has an LCR of approximately 1.40 which indeed provides a buffer. According to its public statements, it had 65bnE in net outflows as of 2Q 2024 and 91bnE of high-quality liquid assets. Even with a full scaled 10bnE take on of reserves for stablecoins, this would not change their LCR sufficiently (1.40 -> 1.35) but in contrast small to medium European banks, even those with high LCRs, are very unlikely to play in this game. This further restricts the banking candidates and requires deep/trusted relationships with systemically important host bank(s) built over years, such as QP has earned based on its regulated status and collaboration with EURD.
  3. According to the EBA, at least 30% (60% for those MICAR flags as ‘significant’ or having ‘systematic importance’ based on a number of criteria) of EMT funds must be deposited in segregated accounts (with the same reference currency) with credit institutions with 1–5 days liquidity. Tether has expressed concern about the sheer scale of the counterparty risks they would have on credit institutions, which as we know post 2008, is very different from government exposure. In addition, these instruments simply don’t pay the kind of interest you can currently get from the U.S. Treasury bills. The onus is on the issuer to appropriately manage and generate exciting returns from the remaining 70%/40% and have a hedged business model, such a QP does, in case interest rates fall. There are ECB requirements on market, concentration, credit and liquidity risks for these reserves. Reserve management policy and risk management capabilities are another critical part of an EMT issuer as are relationships with tier 1 managers such as Cantor Fitzgerald.
  4. A partner bank’s risk appetite is further narrowed because only the entity that on or off ramps from the issuer (e.g. Tether, QP) is known to them and KYC’d. After this, banks lose track of what happens in the middle (because there is no whitelisting for open loop EMTs). QP’s success (to date) has been to work with its banks on how to carefully expand the relationship from a close loop model to open loop. Since only a handful parties can mint with QP, the bank still knows who they face: The primary market remains verified customers (typically institutions and regulated crypto asset service providers) that can receive and redeem USDQ/EURQ tokens directly with the issuer. In the secondary market since there are institutions and crypto asset service providers that use the USDQ/EURQ for trading liquidity, the USDQ/EURQ transfer transactions and holdings on the secondary market will be monitored and managed by QP using blockchain analytic tools and leveraging state of the art technology such as Hadron, from their partner Tether, a platform for issuing and managing the full life cycle of digital tokenised assets across compliance, KYC, AML, Risk Management, and secondary market ecosystem monitoring, spanning from blockchains to centralised exchanges. Like Tether, QP can work with law enforcement in freezing wallets and clawing back funds where foul play is suspected.
  5. Any EMT issuer requires to maintain a minimum level of regulatory capital and the amount grows with scale, as it is a function of its AUM. This may not be a hurdle in the early days of AUM but as it grows it can be very challenging as raising regulatory capital via equity (tier 1) is rare and expensive. A certain level of tier 1 capital is however needed as tier 2 capital cannot be more than 1/3rd of tier 1. Funding by dividends is the cheapest route but requires sufficient AUM to generate these dividends in the first place. Having secure sources of regulatory capital that does not dilute investors is a major benefit.

It’s easy to get excited about stablecoins in this day and age, it’s easy to get excited about the tailwinds of regulation clarity and the increasing use payment cases, it’s easy to get excited about partnering with tier 1 players such as Tether, Kraken and top market makers in this endeavour and it’s easy to be impressed by QP successfully obtaining a “AAA” EMI license from Holland, but the above 5 points are perhaps the real hidden considerations for an investor to evaluate an EMT issuer by and consequently lie behind Fabric’s decision to invest into QP as an issuer of EMTs that can actually scale in order to achieve a meaningful return to our fund.

For more information on Fabric’s portfolio, opportunities and our investment thesis please visit our website and follow us on Twitter, LinkedIn, Farcaster & Orb.

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Fabric Ventures
Fabric Ventures

Written by Fabric Ventures

Backing and accelerating the boldest in Web3. Together towards an open and fair economy.

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