UK Discussion Paper on Systemic Stablecoins Published

The Bank of England has published a discussion paper on new forms of digital money that are potentially systemically important, focusing on systemic stablecoins. HM Treasury recently consulted on bringing certain crypto-assets into the U.K. regulatory perimeter and proposed that the BoE would regulate systemic stablecoins (under the Banking Act 2009) and that the Financial Conduct Authority would be responsible for consumer protection and conduct regulation. Feedback to the discussion paper can be submitted until September 7, 2021. The feedback will inform the BoE's next steps and it will consult on a specific regulatory framework for stablecoins, pending the finalization of the anticipated legislation.

According to the BoE, systemic stablecoins would be those that have the potential to scale up and grow rapidly and become widely used for payments by individuals and non-financial businesses. Non-systemic stablecoins would be those that are not widely used for payments and would not be subject to regulation by the BoE. Systemic stablecoins would be: (i) denominated in sterling; (ii) backed by assets that make them stable in value, unlike crypto-assets that have no safeguard, such as Bitcoin; and (iii) would not be created by lending to the real economy, unlike commercial bank money.

The BoE recognizes that stablecoins (and other new forms of digital money) could lead to changes in the financial system, including affecting the cost and availability of credit. However, there are also potential opportunities, such as offering alternative means of payments and of storing wealth. The BoE considers that a regulatory framework needs to be established before a stablecoin can safely operate in the U.K., and that any regulatory framework must be grounded in the Financial Policy Committee's expectations, which are:

• Payment chains that use stablecoins should be regulated to standards equivalent to those applied to traditional payment chains. Firms in stablecoin-based systemic payment chains that are critical to their functioning should be regulated accordingly.
• Where stablecoins are used in systemic payment chains as money-like instruments, they should meet standards equivalent to those expected of commercial bank money in relation to stability of value, robustness of legal claim and the ability to redeem at par in fiat.

The BoE's view is that it's current approach to the regulation of payment systems is fit for purpose, which is based on the Principles for Financial Market Infrastructure and focuses on operational risks and ensuring resilience. The BoE notes that it may need to regulate other entities that provide services through the payments process and that pose systemic risk (e.g. based on the volume and value of transactions that they process or the degree to which their services are substitutable in a timely way). For stablecoins, the functions of issuance and redemption, payments infrastructure and store of value could be split across different entities. The discussion paper focuses on the regulation of the issuer/operator of the stablecoin. However, the BoE could seek to regulate other entities, potentially requiring them to comply with the same requirements as would apply to the issuer. The ability for the BoE to do so will depend on how far the regulatory perimeter is expanded and the powers it is given.

The discussion paper sets out four regulatory models which would meet the FPC's second expectation. Under any of the models, the BoE would not take on any liability to "make good" any shortfall in backing assets, and it is highlighted that clear and robust messaging to consumers would be required to ensure consumer protection. The four models discussed are:

1. The bank model: this would subject stablecoins to the same regime as banks. Authorized banks are able to back their liabilities with three types of assets: (i) non-liquid assets like loans; (ii) liquid assets such as government bonds and certain types of highly liquid corporate securities; and (iii) reserves held at the central bank. While this model would meet the FPC's expectation, its focus on maturity transformation may mean that it is not the best approach because, for example, it could lead stablecoin operators to focus on risks that are smaller for them than they are for banks.
2. HQLA model: this model would adapt the bank model to require stablecoins to only hold high quality liquid assets (i.e. highly liquid bonds or central bank reserves). The BoE's view is that this model would be more proportionate than the pure bank model (see point 1 above) and that it would ensure that the focus of both the regulator and the stablecoin issuer is on those risks most relevant to the stablecoin, including operational and outsourcing risks.
3. Central bank liability reserve backing: In this model, the liabilities of a stablecoin issuer would be backed with central bank reserves. This would eliminate many risks for the coinholders but would still expose stablecoins to operational risk.
4. The deposit-backed model: this is different to any of the models above, which are all forms of the bank model. Stablecoins would be fully backed with deposits placed with commercial bank(s), which would safeguard these deposits by holding them in a trust (on behalf of the stablecoin customers) in reserve accounts or other highly liquid assets. The main difference between this model and the other three models is that the stablecoin issuer would have no direct relationship with the central bank. Instead, it would benefit indirectly from the custodian banks' liquidity and access to the BoE's facilities. It would be similar to the existing e-money regime in the U.K. A disadvantage is that the viability of the stablecoin and the custodian bank would be linked.

The BoE also believes that there is merit in establishing precautionary transitional arrangements and the use of limits during a transitional period, which would both aim to ensure that new forms of digital money can emerge without jeopardizing monetary and financial stability. Limits could be imposed on aggregate holdings, transactions, eligibility and remuneration.

View the Discussion Paper on New Forms of Digital Money.

View details of HM Treasury's consultation on regulating crypto-assets.

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