Systemic stablecoins would need to “meet the tests of singleness of money and settlement finality”

Published in association with OMFIF.

In 2019, the Bank of England’s Financial Policy Committee predicted that ‘digital tokens known as stablecoins might increasingly be used to make payments’ in the near future. While this innovation could enable wider access to payments infrastructure, faster transmission of payments transactions and reduced costs for consumers and industrial players, it could also create financial stability risks and pose additional issues for regulation.

Fast forward to 2024 and the government and regulators are considering how these privately issued digital assets – particularly those that aim to maintain a stable value relative to a fiat currency – might impact the economy at large. From the Bank and the Financial Conduct Authority’s proposals, it is clear that categorisation is important. Not all stablecoins, or the way that they are used, are equal.

With a future in view where fiat-backed stablecoins might become a regular means of everyday payments in the UK, the longstanding principle of ‘same risk, same regulatory outcome’ has been guiding the approach. This means that stablecoin-based payment systems and service providers will be subject to an equality of standards similar to other payment systems and forms of money in the UK.

Will stablecoins become systemic?

A key part of the proposed framework will be the UK Treasury’s recognition, by way of a recognition order, of certain systems and providers as systemic. The Treasury will assess whether any deficiencies in the system’s design or operational disruption would be likely to threaten the stability of, or confidence in, the UK financial system. This assessment will also evaluate the likelihood of serious consequences for business or other interests throughout the UK.

In relation to payment systems, the Treasury will look at criteria such as the number, value and nature of transactions – whether they could be handled by other systems, relationships between systems and whether the Bank as a monetary authority uses it. For service providers, focus will be on the value and nature of the services, whether they could be provided by others and the relationships between the service provider and other relevant parties.

As part of the assessment, the Bank would provide the Treasury with its recommendation and may also recommend that a prospective payment system or service provider be recognised as systemic – even if they are not operating at systemic scale at present but are likely to do so in the future.

Given the variance in factors that could lead to a recognition, it remains to be seen whether an operator of such a system, or related service providers, will have sufficient information on which to base their business models. Businesses need to be both profitable and compliant. Planning to be both of those, while also considering proposed regulatory requirements, may prove difficult. Not only will current ambiguities need to be clarified, but there is a real cliff-edge risk of a system or provider becoming systemic at any point. The uncertainty, as well as the burden of obligations, could threaten the viability of nascent and developing business models.

Three aspects demonstrate this. First, backing assets: in order to maintain value stability, systemic stablecoins would have to be fully backed with central bank deposits – the most liquid, risk-free asset in the economy. Second, restrictions on remuneration: systemic stablecoin issuers would neither receive interest on their central bank deposits nor pay interest to holders. Third, capital and shortfall reserve requirements: here, existing international standards would be used as a baseline for calculating capital requirements, with modifications. The combined effect of these three requirements alone will be challenging to even the most robust business, which would need to find profitability through other means.

Avoiding “failure of imagination”

In a speech in July 2023, Andrew Bailey spoke about making decisions ‘drawing on the evidence we have as a guide to the future’. While urging the need to ‘avoid a failure of imagination’, systemic stablecoins would have to ‘meet the tests of singleness of money and settlement finality’. Acknowledgement and guidance by international regulators and standard-setting bodies is exciting.

Recognition of new forms of money and payments in law and regulation validate innovation. But in a bid for safety, we need to be careful not to kill new forms of money and payment altogether. For now, given the ambiguities around what it means to be systemic, it seems that the FCA’s non-systemic stablecoin rules may become more important. The question remains – if proposals are followed, will anyone be using them?