On the 7th of January 2021, HM Treasury published a consultation paper titled “UK regulatory approach to cryptoassets and stablecoins: consultation and call for evidence” (Consultation).
The Consultation represents the first stage in the government’s consultative process with industry and stakeholders on the broader regulatory approach to cryptoassets and stablecoins. It seeks views on how the UK can ensure that its regulatory framework is equipped to harness the benefits of new technologies, supporting innovation and competition, while mitigating risks to consumers and stability.
The government established the Cryptoassets Taskforce in 2018 (Taskforce) with senior representatives from the Bank of England, the Financial Conduct Authority (FCA) and HM Treasury with attendance by the Payments Systems Regulator. The mandate of the Taskforce is to consider the risks and benefits posed by cryptoassets and DLT in the UK, and to advise on the appropriate regulatory response. In 2018, the Taskforce found that DLT could have a significant impact across a range of industries, with the potential to deliver real benefits for financial services. It also judged that the cryptoasset market was at an immature stage of development, and that there was limited evidence of the current generation of cryptoassets delivering benefits.
However, two years on and the landscape is changing rapidly. Stablecoins could well pave the way for faster, cheaper payments, making it easier for people to pay for things or store their money. There is also increasing evidence that DLT could have significant benefits for capital markets, potentially fundamentally changing the way they operate. This is also further evidenced by industry bodies such as the International Capital Markets Association (ICMA) having FinTech initiatives.
The Consultation reflects advice from the Taskforce and since the Taskforce’s 2018 report, the UK authorities have taken a number of actions to address risks and support innovation developing from cryptoassets. The Taskforce has concluded that strong action should be taken to address the risks associated with cryptoassets that fall within existing regulatory frameworks. Further consultation and international coordination is required for those cryptoassets that pose new challenges to traditional forms of financial regulation and fall outside the existing regulatory framework which has been designed for traditional financial instruments and market infrastructure. The authorities plan to engage with international bodies to ensure a comprehensive response.
So what are “stablecoins” in the cryptoasset universe ? A cryptoasset is understood to be a digital representation of value or contractual rights that can be transferred, stored or traded electronically, and which may (though does not necessarily) utilise cryptography, DLT or similar technology. The term ‘token’ is used by many in the industry interchangeably with ‘cryptoasset’. In 2019 the FCA published its ‘Guidance on cryptoassets’ which described three broad categories of token in relation to how they fit within existing FCA regulation: (i) e-money tokens, (ii) security tokens; and (iii) unregulated tokens (utility tokens and exchange tokens). This classification was discussed in some detail in a previous CrptoAM Talking Legal article on 26 May 2020.
Cyptoassets can be subject to volatile market values. ‘Stablecoins’ are an evolution of cryptoassets, which seek to minimise volatility in value. Depending on design, stablecoins can currently fall into any of the categories set out above. Stablecoins aim to maintain stability in their price, typically in relation to stable assets such as fiat currency – examples include Tether, Paxos or USD coin to name some. Stablecoins aim to stabilise their value by referencing one or more assets, such as fiat currency or a commodity and could for that reason more reliably be used as a means of exchange or store of value. The Covid-19 pandemic has accelerated the use of digital forms of payments, which could increase the uptake of stablecoins for transactions and remittances in the future.
It is clear that the government has recognised the importance and potential of cryptoassets and that they will play a critical role in the future of the financial system. So why the focus on stablecoins in the Consultation ?
It is clear from the Consultation that the government takes the position that appropriately designed regulation can promote innovation and industry growth, enabling responsible industry actors to innovate and supporting consumer confidence. However, the view has correctly been taken that in the absence of appropriate regulation and oversight, stablecoins could pose a range of risks, which include:
– Risk to financial stability and market integrity: where such coins are used widely as a means of payment, they may pose risks to financial stability and to the real economy. The ability of individuals and businesses to make and receive payments safely and smoothly with confidence is critical to stability. Disruption or outage within the stablecoin chain could lead to consumers being unable to access their funds and make payments. Stablecoins could also be used to store value. Uncertainty in the value of the asset could give rise to similar risks to financial stability;
– Risks to consumers: there is concern for consumers losing money through volatility of the value of the stablecoin or firm failure. The risks are likely to be increased where protections are limited – for example, due to uncertainty or failure of a claim for redemption. Consumers may also not understand the product or service. In addition, there are concerns as to risks of fraud, crime, cyber-vulnerabilities or mismanagement, with potential for harm if there is inaccessibility or inefficiencies ;
– Risks to competition: some initiatives could increase competition by challenging the market dominance of existing financial institutions. However, due to their ability to scale, and plug into existing online services, some stablecoin arrangements could achieve market dominance, providing a similar service to a regulated service despite not yet having the same regulatory and compliance oversight and obligations. This would create an unlevel playing field giving an unfair advantage.
The Consultation discusses a number of potential regulatory changes that could deal with these issues including authorisation from the FCA, prudential requirements, maintenance and management of a reserve of assets, conduct requirements, system controls, reporting (including notifications requirements, e.g. if value of reserve falls below par), fair and open access, security requirements, payment system type regulation and so on.
The Consultation will close on 21 March 2021. HM Treasury are inviting stakeholders from various sectors including cryptoasset firms, tech firms, financial institutions, trade associations, consumer groups, academics and legal firms to provide responses to the questions set out in the Consultation and share views on our proposed future approach.
Cryptoassets and in particular, stablecoins have surged in use, regulatory protection that ensures financial stability and reduces risks to ultimate consumers, can only be beneficial to the future of the industry. The Consultation aims to achieve that and keep the UK at the forefront of financial innovation and regulation.
By Abradat Kamalpour, Partner Ashurst LLP and Architect of FinTech Legal Labs (www.fintechlegallabs.com) and Ida Mokhtassi, Associate Ashurst LLP