A detailed explanation of the MiCA-compliant custodial stablecoin EUROe and its issuer Membrane Finance

EUROe / Membrane Finance

EUROe is a MiCA-compliant custodial stablecoin issued by Membrane Finance, a subsidiary of blockchain development organization Equilibrium Group. It officially launched on the Ethereum mainnet on February 1, 2023, and has been deployed to Polygon, Arbitrum, Avalanche, and some testnets. To date, approximately 1.64 million EUROe have been issued, distributed across four chains: Ethereum mainnet (982,777 EUROe), Arbitrum (96,873 EUROe), Polygon (560,235 EUROe) and Avalanche (25 EUROe).

EUROe On-Chain Supply - May 26, 2023 EUROe is an electronic currency issued under a standard regulatory framework recognized by the European Union. It is regulated by the Finnish Financial Supervisory Authority (FIN-FSA), which can be confirmed by verifying the status of Membrane Finance Oy. Furthermore, EUROe is fully MiCA compliant in response to new regulations coming into force in summer 2024.

Currently, Membrane Finance only provides institutions with direct issuance and destruction of EUROe, but anyone can acquire and use EUROe in the secondary market without permission. These channels include DeFi, brokers, OTC or centralized exchanges. This decision was made to reduce the cost and security risk of storing large amounts of customer KYC data, as well as reduce the cost of processing issuance/redemption requests.

Release overview

Membrane is the sole issuer of EUROe. Membrane's "clients" are institutions that have accounts with Membrane and have gone through the due diligence process (including KYB, AML, CTF and KYC audits). "End User" means any person using EUROe without an Account. The diagram below shows the issuance/destruction process for whitelisted clients of Membrane:

The issuance/burn mechanism is similar to other centralized stablecoins, the difference is that corporate clients can use personal IBANs.

Issuance/burning operations are handled by EUROe's MINTER_ROLE and BURNER_ROLE and can be monitored via designated addresses on each chain (Ethereum, Polygon, Arbitrum and Avalanche). The graph below shows issuance/burn events on all chains over time:

Several Ethereum-based burn events occurred concurrently with equivalent issuance events, most likely cross-chain operations facilitated by Membrane (eg: 60,000 EUROe to Polygon on March 20, 60,000 EUROe to Arbitrum on April 14, 10,848 EUROe were issued to Arbitrum on April 25). According to the pricing page, cross-chain operations (except issuance/burn operations) are free services provided by Membrane.

A handful of addresses have so far been responsible for the majority of EUROe issuance. Approximately 95% of all EUROe in circulation are issued by 3 addresses. The image below is color-coded according to the chain (gray=Ethereum, purple=Polygon, blue=Arbitrum).

Reserve Management

According to European e-money regulations, the reserves backing e-money must be carefully managed by an Electronic Money Institution (EMI). Key requirements include maintaining a minimum capital of €350,000 or a buffer of 2% based on the average outstanding e-money (whichever is higher), separating the EMI's own funds from reserves, and investing in safe, low-risk assets Protect reserves.

Reserves can be kept in dedicated bank accounts or invested in safe, low-risk debt securities issued or guaranteed by central governments, central banks, international organizations, multilateral development banks, or regional or local authorities within member states. In addition, invest in debt securities issued by AAA to A-rated financial institutions or corporations. In addition, reserves can be covered by insurance policies or other comparable guarantees, providing an additional layer of security.

As an alternative, EMIs can invest in collective investment transfer securities (UCITS) funds that invest exclusively in the aforementioned assets. These funds, managed by institutions such as BlackRock, offer a way to "outsource" reserve management operations. For a more detailed overview of the reserve requirements facing e-money issuers, see the e-money section of our Monerium EURe assessment.

Membrane publishes its reserve support monthly on its website and commits to third-party reviews on a quarterly basis. According to their documentation, they plan to implement “public on-chain proof of reserve data” as soon as possible. According to the latest reserve inspection report, reserves are kept in cash at two different banks within the EEA, Bank Frick (Liechtenstein) and Osuuspankki (Finland).

Regulatory and Legal Matters

Membrane Finance is an authorized electronic money institution authorized to issue electronic money under Finnish legislation implementing Directive 2009/110/EC. Membrane Finance Oy has its registered office in Finland at Meritullinkatu 1, 00170, Helsinki, Finland (trade registration number 3236886-2). The company is regulated by the Finnish Financial Supervisory Authority (FIN-FSA).

According to the "Legal Framework for Client Funds Security" document provided by Membrane, clients are protected by Finnish law in the following respects:

1. EUROe reserves are legally considered client funds - Article 26 of the Finnish Payment Institutions Act (297/2010).

2Client funds must not be mixed and must be protected in accordance with applicable law - Article 26 of the Finnish Payment Institutions Act (297/2010).

3Client funds are protected in case of Membrane insolvency - Chapter 5, Section 6 of the Finnish Bankruptcy Code (120/2004) and Chapter 4, Section 9 of the Finnish Enforcement Code (705/2007).

4Client funds are protected in case of insolvency of Membrane's custodian bank - Chapter 5, Section 6 of the Finnish Insolvency Code (120/2004) and Chapter 4, Section 9 of the Finnish Enforcement Code (705/2007) .

5 Investments in low-risk and liquid securities shall be considered the property of the client in the event of insolvency – general provisions related to the aforementioned regulations.

6** Each Membrane client enjoys a deposit protection of up to EUR 100,000** with a custodian bank - regulated by the EU Deposit Protection Scheme Directive.

It is worth noting that client funds are only exempt from the foregoing in the event of criminal conduct by Membrane or its custodian bank, willful negligence in protecting client funds, or if regulators in relevant jurisdictions change regulations and established practices suddenly and unpredictably. legal protection.

Additional regulatory requirements (Crypto Asset Market Regulation - MiCA) are currently being developed, which will impose further obligations on fiat currency-based tokens (electronic currency tokens). According to the regulations of MiCA, these Tokens must not only comply with the e-money directive, but also comply with requirements such as prudent marketing, risk disclosure, interest prohibition, etc. Currently, MiCA is not yet in force and is expected to be implemented by EU member states by mid-2024. In this regard, Membrane is preparing to comply with future regulatory requirements by issuing their Euro stablecoin under an e-money token.

Like other custodial stablecoins, Membrane Finance is subject to legal and regulatory requirements and therefore reserves the right to block individual EOAs or contracts. In accordance with its access denial policy, Membrane will not deny account access unless for the following reasons:

· Receive a request from a competent government agency, authority or regulatory body;

· Receive a request from the owner and controller of the address, with sufficient evidence; or

· Membrane considers that the denial of access is necessary to comply with laws, regulations or legal orders recognized by Finland or the European Union.

Security and Control Mechanisms

Membrane employs a range of control mechanisms to maintain its operations, enhance security, and respond to emergencies. These mechanisms are determined by a series of defined roles, each of which is granted a different level of access to the EUROe stablecoin smart contracts. Key roles include PROXYOWNER_ROLE (responsible for contract upgrades), BLOCKLISTER_ROLE (can assign and remove BLOCKED_ROLE, which is equivalent to a blacklist), and MINTER_ROLE (the only role with minting authority). There are also contingency roles PAUSER_ROLE and UNPAUSER_ROLE for emergencies, and DEFAULT_ADMIN_ROLE oversees all others.

The addresses of role holders on each chain can be found here.

EUROe's smart contracts are managed internally, employing security protocols to limit unauthorized access to key actors. As part of these security measures, Membrane utilizes Multi-Party Computation (MPC) technology provided by Fireblocks. Therefore, privileged roles appear on-chain as EOA accounts.

Contracts are designed to be upgradeable for potential improvements and modifications. Although there are no timelocks at the smart contract level to enable fast adaptability, EUROe may use timelocks in its internal operations for added security (we cannot verify this).

Contingency procedures are in place where assigning BLOCKED_ROLE is the most common response to an emergency or black swan event. The drastic measure of suspending the EUROe stablecoin is a response to the impending threat. The governance of EUROe is fully in the hands of Membrane Finance, there is currently no on-chain governance or voting mechanism.

External dependencies

In order to improve operational efficiency, Membrane utilizes MPC for contract interaction. Since this service is provided by an external party and the MP computation is done off-chain, it is not possible to publicly verify and assess the robustness of this system. However, Fireblocks is known to be one of the largest infrastructure providers in the Crypto industry. Fireblocks employs multiple layers of security and conducts regular penetration testing with third-party companies ComSec and NCC Group to identify and eliminate vulnerabilities. In addition, Fireblocks has received SOC 2 Type II certification from Ernst & Young.

Smart Contract Audit

The smart contract of the EUROe stablecoin has been audited twice. The first audit, conducted by PeckShield in July 2022, found one medium severity and one informational finding, both of which have been addressed. The contract was then updated and the name changed from "eEURO Token" to "EUROe Stablecoin". A second audit, conducted by Runtime Verification in December 2022, found one high severity and four informational findings, which were also addressed.

The full audit report can be found on PeckShield's GitHub and Runtime Verification's GitHub. See here for details on committed and resolved findings.

in conclusion

In conclusion, Membrane Finance operates under a sound regulatory framework, complies with Finnish law and is well prepared for the upcoming MiCA requirements. The company has demonstrated transparency in the management of its reserves, which are held at two well-known banks within the European Economic Area. Operational security measures are also on par with current industry leaders.

The fact that EUROe is not yet open to retail clients does not pose too much of a problem for pool occupancy risk assessments. As long as EUROe is paired with another freely available asset with sufficient liquidity and balance, taking risk is next to impossible. Furthermore, it can be assumed that the existence of multiple market makers (recruited by Membrane), or more precisely competition, would naturally prevent this from happening.

From a more general perspective, we believe that incentivizing EUROe pools could be a good step towards enriching and diversifying EUR liquidity in DeFi.