The UK Treasury has published its long-awaited consultation paper on the regulatory framework for crypto assets and stablecoins, following the recommendations of the Crypto assets Taskforce in 2018. The paper sets out the government’s vision for a “safe, transparent and innovative” crypto market that supports innovation and competition, while protecting consumers and financial stability.
The paper proposes a new category of regulated tokens, called “stable tokens”, which are crypto assets that have mechanisms to stabilize their value in relation to an underlying asset or basket of assets. These tokens could include stablecoins, which are often pegged to fiat currencies or other assets, as well as algorithmic tokens, which use smart contracts or other methods to adjust their supply and demand. The paper suggests that stable tokens could pose significant risks to consumers and the financial system, especially if they are used for payment purposes or as a store of value.
The paper proposes that stable tokens that are used as a means of payment, or that have the potential to reach mass adoption, should be subject to the same regulatory standards as traditional payment services and electronic money. This would include requirements on capital, governance, risk management, consumer protection, anti-money laundering and counter-terrorism financing. The paper also proposes that issuers of stable tokens should be authorized by the Financial Conduct Authority (FCA), and that they should provide clear and accurate information to users about the nature and risks of their tokens.
The paper also addresses the regulation of other types of crypto assets, such as exchange tokens (e.g. Bitcoin) and utility tokens (e.g. Ethereum), which do not fall within the existing regulatory perimeter. The paper recognizes that these tokens can offer benefits such as increased efficiency, transparency and resilience, but also pose challenges such as market abuse, fraud, cybercrime and environmental impact. The paper proposes to apply a “proportionate and risk-based” approach to these tokens, depending on their use cases and potential harm.
The paper suggests that some activities involving exchange tokens and utility tokens should be brought within the scope of financial regulation, such as:
The promotion of certain types of crypto assets to retail consumers, which would be subject to the FCA’s rules on financial promotions. The provision of crypto asset services, such as custody, exchange, brokerage and advice, which would be subject to registration and supervision by the FCA. The issuance of security tokens, which are crypto assets that have characteristics of securities or other regulated investments, which would be subject to the existing rules on securities offerings.
The paper also outlines the government’s intention to work with international partners to develop global standards and best practices for crypto regulation, as well as to monitor emerging trends and risks in the crypto market. The paper invites feedback from stakeholders on its proposals by March 2024, with the aim of introducing legislation in the next parliamentary session.
In October 2023, the UK government published an update on its legislative approach for bringing fiat-backed stablecoins into the UK’s regulatory perimeter for financial services. This document provides additional detail following the UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets consultation response published in April 2022.
The UK’s proposed approach also covers other entities involved in stablecoin activities for payments in the UK, such as wallet providers, exchanges, custodians, and intermediaries. These entities would also have to be authorized by the FCA and comply with the relevant rules and obligations applicable to their functions and services, such as:
Conduct: The entities would have to adhere to the conduct of business rules and standards set by the FCA, such as treating customers fairly, acting honestly and professionally, and managing conflicts of interest.
AML/CTF: The entities would have to comply with the AML/CTF regulations and obligations, such as conducting customer due diligence, monitoring transactions, reporting suspicious activities, and keeping records.
Data protection: The entities would have to comply with the data protection laws and regulations, such as obtaining consent, ensuring security, respecting privacy, and notifying breaches.
The UK’s proposed approach does not cover other types of stablecoins that are not backed by fiat currencies, such as those backed by commodities, cryptoassets, or algorithms. These stablecoins would remain outside the UK’s regulatory perimeter for financial services, unless they have the characteristics of a security or a financial instrument. However, the UK government has indicated that it will keep these stablecoins under review and may consider extending the regulation to them in the future if necessary.
The UK’s proposed approach also does not cover stablecoin activities that are not related to payments, such as lending, investing, or trading. These activities would be subject to the existing regulatory framework for cryptoassets and financial services, depending on the nature and features of the stablecoins and their activities.
The UK government has stated that it intends to introduce legislation to implement its proposed approach to stablecoin regulation as soon as parliamentary time allows. The FCA and the BoE will also publish further guidance and consultation papers on their respective approaches for regulating stablecoin issuers and custodians, and systemic digital settlement asset payments systems and service providers respectively.
The Compliance Implications for Stablecoin Issuers and Users
The UK’s proposed approach to stablecoin regulation has significant implications for both stablecoin issuers and users in terms of compliance costs and benefits.
For stablecoin issuers, the proposed approach means that they will have to obtain an e-money license from the FCA and comply with a range of rules and obligations that are similar to those applicable to traditional payment service providers. This will entail significant compliance costs in terms of time, money, and resources. For example, stablecoin issuers will have to:
Apply for an e-money license from the FCA, which may take several months and involve fees and documentation. Safeguard the funds backing their stablecoins in segregated accounts or low-risk assets, which may reduce their returns or profitability.
Ensure that users can redeem their stablecoins at any time at par value in the reference currency, which may expose them to exchange rate or liquidity risks. Maintain adequate capital to cover operational and financial risks, which may limit their leverage or growth potential.
Implement sound governance arrangements, risk management processes, internal controls, and audit mechanisms, which may require hiring qualified staff or consultants. Provide clear and transparent information to users about their rights and obligations, the risks and costs associated with using stablecoins, and how to lodge complaints or seek redress, which may entail developing user-friendly interfaces or materials.
Report regularly to the FCA on their financial situation, risk profile, compliance status, and other relevant information, which may involve collecting and analyzing data or preparing reports.
Moreover, if stablecoin issuers are deemed systemically important by the BoE, they will also have to comply with enhanced prudential supervision and oversight by the BoE. This will entail additional compliance costs in terms of time, money, and resources. For example, systemically important stablecoin issuers will have to:
Maintain sufficient liquid assets to meet redemption requests under normal and stressed conditions, which may reduce their returns or profitability. Maintain adequate capital buffers to absorb losses and ensure continuity of operations, which may limit their leverage or growth potential. Ensure that their systems, processes, and controls are resilient to cyberattacks, frauds.
