What’s next for regulating stablecoins in the UK?

It’s nearly a year now since HM Treasury, Financial Conduct Authority (FCA) and the Bank of England (BoE) published their proposed approach towards regulating fiat-backed stablecoins as means of payment.

What are we expecting next, and what questions will they be looking to answer? This next stage will play a major role in setting the UK’s regulatory approach towards this new form of digital money. 

April 2022 saw the Chancellor of the Exchequer (at the time), Rishi Sunak, announce the Conservative government’s plans to make the UK a ‘global hub for cryptoasset technology and investment’, enabled in part through bringing cryptoassets and stablecoins as means of payments into the policy and supervisory scope of the UK’s financial regulators. The aim being to bring certainty and clarity over how the market will develop, and the varying business models that will unfold across token issuers and custodians, banks and payment providers.

Two years later, and with a new Labour government, industry is waiting to see if there will be a major change in stance towards stablecoins, and whether this new machinery of Ministers and advisers hold equivalent perspectives as previous Conservative administrations held when it comes to stablecoin’s potential future contributions to economic growth. There remain some important areas that industry is seeking further clarity on.

Definitions

Clear definitions are needed of what government is trying to regulate, and the subsequent objectives and mechanisms are critical to pinpointing and managing the challenges within the market. This is why we called for the regulators to develop an industry-wide definition for single-currency payment stablecoin and explore the differences between wholesale and retail use cases. This is particularly important for identifying the different models for e-money, tokenised deposits and stablecoin. As the regulators are starting to consider this challenge within the broader context of innovation in money and payments, setting clear definitions remains critical to bringing clarity towards the UK’s developing approach.

Roles of different actors in the ecosystem

The previous round of Discussion Papers delved into the rules and requirements of different actors in the stablecoin and cryptoasset ecosystem. This must be developed further so that the risks and responsibilities are clear for: issuers redeeming tokens to what are known as ‘cryptoasset exchanges’, and who operate effectively as intermediaries between firms holding and safeguarding assets (or, ‘custodians’); the firm ensuring the stablecoin’s value and connection to its backing asset of GPB-sterling (or, ‘issuer’) currency; and the end-users’ (either businesses or consumers) wallet providers. A considerable amount of detail is required from the regulators (particularly within the FCA’s Phase 1 regime) as to how issuers will comply with different expectations and requirements for fulfilling redemptions for either financial institutions and large corporate entities, or retail consumers. 

Wholesale vs retail use cases

The new regulatory regime for payment stablecoin was designed on the premise that stablecoin may start to be used for retail transactions. There is not yet much evidence for this use case becoming dominant. The majority of stablecoin transactions are still for remittances and cryptocurrency transactions. Industry will wait to see if the regulators develop specific guardrails between regulating wholesale and retail redemptions, and how that will impact business models and planning for issuer firms. The new BoE Discussion Paper also suggests that the Bank’s risk appetite for wholesale transactions in stablecoin is low. The paper does not give much detail on what is meant by wholesale transactions, or what risks they perceive (beyond a risk to the important role of central bank money in wholesale settlement). It is hard to pre-judge what future use cases of new forms of digital money might be, it does feel like further joint work between industry and the regulators is required to understand what the near-term opportunities are and how best to regulate for those. 

Holding limits

Measures to mitigate against systemic deposit substitution and runs are crucial details within the regulators’ proposals. Holding limits will be used to avoid risks of financial instability due to disintermediation of commercial bank deposits. When it comes to holding limits for retail stablecoin payments, industry is waiting for further clarity on whether the Phase 1 framework will mirror the BoE’s systemic stablecoin framework. Due to the nature of fiat-backed stablecoins’ backing assets being zero-interest bearing central bank deposits, and the connection to end-users’ commercial bank deposits, we’re also waiting to see how the BoE acknowledges the proposal that fiat-backed stablecoins (within the remit of the systemic stablecoin regulatory framework) perform as a ‘de factor’ synthetic CBDC.

Commercial viability 

Whilst building effective measures to preserve financial stability and singleness is top of policymakers’ minds, it can be assumed that many firms will have responded back to the consultations to observe the challenge of commercial viability under the proposals. This includes seeing both the FCA and BoE’s current workings on allowing firms to make money from redemption fees and, more importantly, interest on assets. A viable commercial model from the holding, exchanging and redemption of stablecoins remains fundamental to building a market for regulated stablecoins as means of payment.

Overseas stablecoins and international equivalence

Whilst there is considerable complexity in managing the opportunities and risks of allowing UK based issuer firms to operate in our payments system, allowing overseas stablecoins as means of payment throws additional challenges and questions into the mix. New challenges call for entirely new solutions, which is perhaps why the Phase 1 framework proposes the concept of a private entity managing and approving overseas fiat-backed stablecoins deemed appropriately aligned to the FCA’s in-scope regulations. More detail and clarity about this novel approach is needed from the regulator on how the system might work in practice. Since November 2023, there has been significant developments internationally within the stablecoin regulatory space. This includes the European Securities and Markets Authority’s Markets progressing it’s Crypto-Assets Regulation (MiCA) regime, which now includes all non-fiat backed stablecoins to be deemed out of scope. This has caused some considerable push towards setting MiCA as the international standard for adequacy, resulting in some leading issuing firms retiring their non-fiat backed stablecoin offerings. 

Changing forces within the market internationally will be an important factor in determining whether ‘Stratford, London’ should set its own course towards setting the global standard for regulating crypto assets. UK Finance looks forward to working with the new government and the regulators on taking their next big step forward in the world of, what will be, regulated stablecoins.