Recent years have seen the growth of cryptoassets and COVID 19 has added fuel to the fire. But traditional forms of cryptocurrencies remain volatile. For example, in September 2020, 1 Bitcoin was worth just over US$10,000, but on 9 January 2021 that had jumped to US$40,000, and therefore questions remain about their usefulness in making everyday payments. However, stablecoins (which aim to stabilise their value by referencing an asset, such as fiat currency, or by utilising an algorithm which tracks supply and demand) are increasingly being viewed as a more viable alternative to cash payments. Indeed, it has been reported that there was more value in transactions using stablecoins than in Bitcoin for the first time in June 2020.
As cryptoassets, including stablecoins, develop and become more widely used, the risk to consumers and the stability of the financial system will increasingly come into focus.
Against this backdrop, HM Treasury (the “government”) has published a consultation paper (“the paper”) on the regulatory approach to cryptoassets and stablecoins in the UK, which is due to close on 21 March 2021. The proposals set out in the paper give an insight into where the regulatory regime for cryptoassets and stablecoins is heading, but the detail is yet to be seen and further regulatory development is expected. In this post we set out some of the key take-aways.
While acknowledging the opportunities stablecoins present, the government warns that they could pose similar financial stability and consumer risks as traditional regulated payment systems. Ensuring financial stability and protecting consumers while promoting competition and innovation underpin the government’s proposals in the paper. As ever, it’s a tight line to walk.
A recap of the current regulatory regime
For those readers who are already familiar with the current regulatory regime please do skip ahead. But for those that would appreciate a refresher keep reading.
Currently, a significant proportion of cryptoassets fall outside of the regulatory perimeter, meaning that users of such assets do not benefit from the same safeguards and protections available in respect of more traditional services and payments, and are therefore more exposed to risks.
While there is no internationally agreed taxonomy of cryptoassets (also referred to as “tokens” or “coins”), the FCA essentially takes the view that it will not be influenced by the wrapper of technology. So, if a cryptoasset looks like e-money it will be regulated as e-money. Similarly, if a coin or a token meets the definition of a financial instrument (for example, a share, a bond or a derivative) then it will be regulated as such.
Broadly speaking all other types of cryptoasset remain outside the regulatory perimeter (with the exception of certain AML requirements imposed on cryptoasset businesses adopted by the UK as part of its implementation of the Fifth Money Laundering Directive) and this includes tokens which are primarily used as a means of exchange (exchange tokens such as Bitcoin or stablecoins) or used to buy a service or access a distributed ledger platform (so called “utility tokens”).
The paper proposes to introduce a new category of regulated cryptoassets to include stablecoins, which would include tokens which stabilise their value by referencing one or more assets (e.g. fiat currency or commodities), as well as other forms of tokenised payment and settlement assets and forms of central bank money, regardless of the technology underpinning them (i.e. whether using distributed ledger technology or not). It considers that these tokens are currently most likely to take the form of unregulated exchange tokens or e-money tokens.
Other forms of exchange token such as Bitcoin, Ether and Ripple will retain their current status as largely unregulated in respect of conduct and prudential matters. Instead, the proposal is to bring such tokens within the scope of the financial promotions regime, so that such tokens are subject to stricter regulation in respect of any communications made about them to the public. AML/CFT regulation will also apply to core entities facilitating the use of such tokens.
These proposals reflect the government’s view that stablecoins (as opposed to other forms of exchange token) and, in time, central bank digital currencies, have the potential to play an important role in retail and cross-border payments, and may drive efficiencies and enhance resilience whilst recognising that this is not without risk. In particular, the government highlights potential risks to financial stability and market integrity that could arise from system disruption or outages in addition to the well-known concerns about cyber-security and financial crime.
As a result, the government is proposing to bring stablecoins used as a means of payment into the scope of regulation and subject them to minimum requirements and protections as part of a UK authorisation regime. Algorithmic stablecoins (i.e. stablecoins linked to the performance of an algorithm) are excluded on the basis that they too have the potential to be too volatile.
The paper notes that the proposed authorisation regime will provide for exclusions, for example where the stable token is used only within a limited network of service providers or for acquiring a very limited range of goods or services. However, outside of those exclusions, all stablecoins will be subject to some form of regulation, though a lighter regime is being considered for smaller firms which have turnover which falls below a certain level.
Activities in scope
Both firms that issue stablecoins and those that provide direct or indirect services (such as entities involved in value stabilisation or reserve management, system operators, exchanges and wallet providers in relation to them) would fall within the scope of the regime. The government justifies this on the basis that many of these activities are similar to activities which already fall within the scope of the regulatory perimeter for payment and e-money services.
Proposed regulatory requirements
Firms in scope of the regime will be subject to all the usual authorisation requirements and regulatory obligations including in relation to prudential requirements, systems and controls, requirements for the maintenance and management of a reserve of assets, conduct rules, operational resilience and notification and reporting requirements.
The government notes that stablecoin payment systems may also be brought within the supervisory remit of the Payment Systems Regulator, and systemic stablecoin payment systems could also be assessed for recognition by the Bank of England, in the same way as current payment systems and service providers.
Given that stable tokens are generally digital, centralised and typically cross-border in nature, firms which actively market to UK consumers may also be required to have UK establishment and be authorised in the UK, and location requirements for systemic stablecoin arrangements are also being considered further.
The future regulatory landscape
It remains to be seen what the detailed rules will include and where the line will be drawn on the thresholds and exclusions to the proposed regime. There are some important areas that the paper does not touch on, such as the issue of access on a fair, reasonable and non-discriminatory basis for significant stable tokens. However, what is starting to become clear is that the UK and EU are looking at this area rather differently with the EU proposing a more wide-ranging set of regulatory proposals.
The paper is an important development for cryptoassets in the UK and it is clear that these proposals are only the beginning of a series of regulatory initiatives as the industry continues to evolve and cryptoassets, and the technology underpinning them, become increasingly important.