On 7 January 2021, HM Treasury published its consultation paper on the UK regulatory approach to cryptoassets and stablecoins. The paper aims to promote financial stability, market integrity and competition, and protect consumers by recommending the creation of a regulatory regime for “stablecoins” or “stable tokens. It paves the way for the future regulation of other types of cryptoassets. Stakeholders, including cryptoasset issuers, exchanges and wallet providers, have until 21 March 2021 to consider and respond to the consultation.
What are stablecoins?
Although “stablecoins” or “stable tokens” are not precisely defined, it is clear that the Treasury is targeting tokens that hold their value and can be reliably used to make retail or wholesale payments.
This will include: (i) tokens linked to a single fiat currency (e.g. GBP, USD) and (ii) tokens linked to certain other assets (e.g. gold or multi-currency). This will not include: (i) unregulated exchange or utility tokens, (ii) security tokens (i.e. tokens that have the characteristics of securities and are already regulated under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001) or (iii) algorithmic stablecoins (i.e. tokens that maintain a stable value through the use of algorithms to control supply, without any backing by a reference asset).
The Treasury recognises that whilst stable tokens are typically underpinned by DLT, they could be designed using other types of technology. The definition of “stable tokens” is therefore intended to be agnostic on the technology underpinning its use (e.g. whether it relies on DLT or not).
What activities will be regulated?
The following activities will be regulated under the new proposals:
- issuing, creating or destroying stable tokens (minting and burning tokens)
- value stabilisation and reserve management (managing the reserve assets that are backing the value of a stable token and providing custody/trust services for those assets to ensure stabilisation of the stable token)
- authorising or verifying the validity of transactions and records
- providing services or support to facilitate access to the network or underlying infrastructure;
- transmission of funds (ensuring the correct and final settlement of transactions while limiting counterparty and default risk)
- providing custody and administration of a stable token for a third party (managing tokens on behalf of owners, including the storage of private keys)
- executing transactions in stable tokens and exchanging tokens for fiat money and vice versa.
Regulatory requirements are likely to include: authorisation requirements; prudential requirements (including capital and liquidity requirements, accounting and audit requirements; insolvency requirements; asset reserve requirements (i.e. the requirement to have reserve assets underlying the token’s value and requirements to ensure the quality and safekeeping on those assets); safeguarding requirements (principally impose on wallets and exchanges to ensure those entities are appropriately protecting users’ tokens and the privacy and security of keys to those tokens); systems, controls, risk management and governance requirements; conduct of business, notification and reporting, and record keeping requirements; financial crime requirements and outsourcing requirements, resilience and continuity requirements and security requirements.
See Table 1 here set out below which sets out Anticipated activities, entities and requirements.
The consultation notes that, where a stablecoin plays a similar function to existing payment systems, it may be appropriate for it to be regulated by the Payment Systems Regulator (“PSR”) and is considering whether legislative adjustments are required to clarify this. Designation of a system for regulation by the PSR gives the PSR powers to place requirements or take action on the participants in that system.
How will this impact me? What do I have to gain /lose?
The proposals are likely to impact a wide range of stakeholders including cryptoasset issuers, systems operators, exchanges, transmitters, stabilisers, wallet providers and custody and administration service providers. This area of regulation is in its infancy and there are still a number of potential issues to be considered and resolved (see below). Early involvement will provide an opportunity for firms to influence the future of their regulatory landscape: firms must engage in dialogue with the regulator to ensure that incoming regulations make sense from a technical perspective, but may even gain a competitive advantage by encouraging legislation that suits their business and (in some cases) basking in the legitimacy that regulation confers. Considering and responding to the consultation is likely to pay dividends in the long term.
Are there any potential difficulties that arise in the proposals?
The proposals are likely to create different issues for different firms, but there are a number of core areas for consideration
Definition of “stablecoin” or “stable token”
- The Treasury is planning to bring certain activities relating to stable tokens into the FCA’s regulatory perimeter, whilst leaving those who do similar things with utility and exchange tokens outside. This will bring challenges for some, opportunities for others and, most likely, arbitrage.
- In addition, the Treasury proposes to exclude algorithmic stable tokens from the scope of these proposals: “the government judges that these [algorithmic] tokens more closely resemble unbacked exchange tokens and may pose similar risks in relation to their ability to maintain stability of value, so may not be suitable for retail or wholesale transactions.” This seems to create a loophole in the proposals and will likely create winners and losers following the implementation of the new regulations.
- The FCA has previously made clear that tokens can take a hybrid form and fall into different categories at different points in time (e.g. a token may initially be used to raise capital, then later be used primarily as a means of exchange). This could mean that some tokens are eventually subject to multiple regulatory regimes, increasing the burden on cryptoasset issuers, exchanges and wallet providers. It is not clear whether or how the Treasury propose to deal with this.
- It is even possible that certain tokens may fall under multiple regulatory regimes at the same time. For example, the Treasury notes that some tokens may constitute regulated electronic money and fall within the definition of a stable token and is questioning whether stable tokens that are linked to a single fiat currency should meet the requirements applicable to e-money. It is not clear whether there could be a scenario where a token falls under multiple regulatory regimes at the same time. This should be clarified to avoid scope for arbitrage and confusion for consumers.
Identity of regulated entities
- The Treasury is proposing to regulate firms that issue or create stable tokens. However, in decentralised models there will not be a central entity responsible for issuing or burning tokens. It is unclear how the Treasury will deal with this issue.
The regulatory proposals
- The Treasury proposes to draw on existing rules “as far as possible” and refers in particular to Electronic Money Regulations 2011, Payments Services Regulations 2017 and the existing powers of the Payment Systems Regulator and the Financial Conduct Authority. However, there is certainly a question as to whether the government should primarily use existing payments regulations as the basis of the requirements for a new stable token regime or whether other existing or new legislation should also be considered.
- The scope of exclusions to the regime is not yet clear. The Treasury considers that certain lower risk activities (e.g. where tokens are provided for use within a limited network or for acquiring a limited range of goods or service) might be excluded from the scope of the rules. Additionally, a lighter regime for firms with low turnover is being considered.
- Due to the digital, decentralised and cross-border nature of stable tokens, the territorial scope of the regulations is still under consideration. The Treasury is considering whether firms actively marketing to UK consumers should be required to have a UK establishment and be authorised in the UK. Options include: (i) requiring UK presence and UK authorisation for stable token issuers, system operators and service providers when marketed in the UK; (ii) defining the activity conducted in the UK and determining whether UK authorisation is required as a result; or (iii) having “no location requirements” (although it is not clear exactly what this final option would entail).
- The Treasury also requests evidence for the future regulation of other types of cryptoassets, including security tokens, and distributed ledger technology used in financial markets infrastructure and considers whether marketing cryptoassets should be considered a financial promotion.
Where can I get further information?
Please do get in touch if you require further information or if you have concerns on how the proposals could affect your business. You can contact the payments and fintech regulatory team at MMacGregor@FoxWilliams.com or CFinney@FoxWilliams.com.
Trainee solicitor Millie Pierce contributed to this article.
Table 1 – Anticipated activites, entities and requirements