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As the UK Sets A Path Towards a Stablecoin Future, Will Other Countries Follow Suit?

The Bank of England (BoE) and the European Banking Authority (EBA) are the latest financial authorities to outline proposals for regulating the use of stablecoins.

The U.K. suggests that stablecoin issuers should be regulated in the same way as commercial banks, while the EBA is consulting on standards for liquidity requirements and stress testing. Financial regulators in Hong Kong and Singapore are also moving forward with stablecoin regulations.

What do these attempts to bring stablecoins closer to the traditional financial system mean for the sector?

UK, Europe Apply Banking Standards to Stablecoins

Stablecoins “are a new form of privately issued digital asset that purport to maintain a stable value against a fiat currency and may offer advantages in terms of cost, convenience, and functionality,” the Bank of England stated in its discussion paper.

“Stablecoins have the potential to be used by many people in the UK for everyday payments. It is important for policymakers to set out the regulatory requirements so innovators can plan ahead and so that innovation can be adopted safely,”

The paper was published alongside a discussion paper from the Financial Conduct Authority (FCA) on their regulatory approach to stablecoin issuers and custodians, a letter from the Prudential Regulation Authority (PRA) to bank Chief Executive Officers on innovations in the way banks could use deposits, e-money, and stablecoins, and a roadmap paper detailing how the various regimes interact.

The proposed environment addresses the risks of stablecoins in terms of their use as a form of money and a means of payment in systemic payment systems. It seeks to accommodate different business models in which other legal entities carry out various functions, including payment systems/transfer, the issuance of stablecoins as settlement assets, and the customer interface and storage of stablecoins. The transfer function or payment system would remain the BoE’s “regulatory hook”.

The paper states:

“To the extent that systemic payment systems using stablecoins pose similar risks as other systemic payment systems, they should be subject to equivalent regulatory standards. And, as a new form of privately issued money, issuers of stablecoins used in systemic payment systems should meet standards that are at least equivalent to those that apply to commercial banks.”

The BoE will require an entity in the payment chain identifiable as the payment system operator, which would need to be able to assess the risks in the different parts of the payment chain and ensure there are appropriate controls.

“Issuers would be required to fully back stablecoins with deposits at the Bank of England. No interest would be paid on these deposits,” the paper states. “Combined with the other protections proposed… this would aim to ensure that the stablecoins maintain their value and can be used for payments with full confidence.”

Wallet providers would be responsible for safeguarding coinholders’ means of control over their stablecoins and would need to ensure that their legal rights and ability to redeem the stablecoins for fiat currency at par are always protected.

These requirements would make issuers more like banks and raise anti-money laundering (AML) and Know Your Customer (KYC) issues.

Examples of stable coin payments

While recognizing the benefits of new forms of payments, the BoE expresses concern that some stablecoin payment chains using public permissionless ledgers do not have centralized governance. Any digital payment system would have to have a legal entity or person who could be held accountable and responsible for risk management and regulatory compliance. The central bank stated clearly that “unbacked crypto assets, or any other unbacked digital settlement assets, would not be suitable for widespread use in retail payments in the U.K.”

While the BoE will regulate “systemic stablecoins” that are circulated widely enough to cause potential disruptions to financial stability, the FCA will oversee the broader cryptocurrency sector.

This approach, while aiming to safeguard consumers from the risks of instability in stablecoins – informed by the collapse of the Terra Luna algorithmic stablecoin ecosystem – introduces a degree of centralization that is opposed to the central ethos of cryptocurrencies.

None of the current stablecoins comply with the proposal, as they are predominantly used for on-ramping and off-ramping between cryptocurrencies and fiat rather than retail payments. However, with a clear regulatory framework in place providing certainty, new issuers could emerge, or existing stablecoin issuers could form partnerships with payment firms.

The EBA is taking a similar approach in applying requirements common to the traditional financial system to stablecoins. The authority has launched three consultations on draft regulatory technical standards (RTS) to specify reserve requirements for stablecoins and the basis for liquidity management policy and procedures of token issuers.

The EBA has also issued draft guidelines to establish the reference parameters for the scenarios to be included in liquidity stress testing to determine issuers’ risk tolerance. The consultations form part of the Markets in Crypto-Assets Regulation (MiCA), which came into effect in June 2023.

The draft standards would require stablecoin issuers to ensure that they hold sufficient asset reserves that meet the market value of the asset referenced for any redemption request “at all times.”

The EBA “does not set any minimum or maximum amount required in the form of the assets referenced within the reserve of assets but considers it as part of the risk management of the issuer to mitigate volatility by ensuring correlation and taking into account its risk appetite.”

An issuer will need to review its risk management policies if its total weighted reserve assets are lower than the weighted amounts of the assets referenced by the tokens.