What Is a Stablecoin?
A stablecoin is a cryptocurrency where the value is pegged to fiat currency. In theory, stablecoins are more stable than other crypto assets as it's similar to traditional payment instruments. Some stablecoins may already be subject to UK financial services regulation, depending on their design, although many are not currently in scope.
How Are Stablecoins Regulated?
There is no legislation in place that dictates how digital assets should be regulated or treated. However, the English High Court has accepted the UK Jurisdiction Task Force's views that cryptocurrencies and non-fungible tokens (NFTs) are classed as a type of property and, therefore, can be protected accordingly.
Regardless, there is still a lot of confusion among companies and consumers regarding how to treat digital assets. Businesses may be unsure whether or not their activities fall under the regulator perimeter, and individuals who have fallen victim to crypto fraud have limited recourse.
To provide greater clarity, the HM Treasury launched a Consultation and Call for Evidence on the regulatory approach to stablecoins and other assets in January 2021. The intention was to source views on how the regulatory framework within the UK can be structured to harness the benefit of the new technology, support innovation and mitigate risks to consumers. A staged and proportionate approach to regulation was proposed, and the government is developing a Financial Markets Infrastructure (FMI) Sandbox to support firms that want to use tokenization and DLT (Distributed Ledger Technology) to provide FMI services.
In April 2022, HM Treasury published its Response to the Consultation and Call for Evidence which set out its approach to stablecoin regulation, which clearly shows the government's commitment to protecting consumers against systemic risks by filling prudential regulatory gaps and addressing market abuse.
Amendments were proposed to the Electronic Money Regulations 2011 and Payment Services Regulation 2017. It does not provide an explicit regime for regulating stablecoins, but there is a focus on adopting an amended e-money framework that emphasizes stablecoin issuance, wallets, and custody services.
Some of the important recommendations include:
- A requirement for issuers of stablecoins or payment crypto assets referring to fiat currencies to seek authorization from the FCA;
- Regulation of custodial wallet providers under the current e-money and payment services regimes,
- Regulation of exchanges in as far as they provide/arrange for custody of payment crypto assets, which means that operating an exchange itself will not require authorization,
The compliance requirements themselves are thorough and onerous. They will include prudential requirements for the maintenance and management of reserves, safeguarding, systems and controls and the conduct of business requirements.
The anticipated stablecoin activities that will be subject to FCA regulation include:
- Issuing, creating or destroying asset-linked tokens;
- Issuing, creating or destroying single fiat-linked tokens;
- The activity of token issuers and payment systems operations when managing the reserve assets backing a stable token as well as providing custody/trust services for those assets;
- Providing custody and administration of a stable token for a third party, including managing tokens on behalf of owners and storing private keys carried by wallets;
- The activity of conducting transactions on behalf of another by token issuers, wallets and exchanges;
- The activity of purchasing or exchanging stable tokens with fiat money by token issuers, wallets and exchanges.
There are some activities associated with stablecoin operators that will not fall under the FCA authorization regime, including the validation of transactions, providing services or support to grant participants access to the network or technology, or the transmission of funds (by designated dealers, payment system operators, wallets, etc.).
There is also a proposed extension of Part 5 of the Banking Act 2009 to include stablecoin payment systems and capturing arrangements that control and facilitate the transfer of digital settlement assets. The definition of a DSA is extremely broad and includes any digital representation of value, regardless of whether they are cryptographically secured or not, that can be used to settle payment obligations, that is stored or traded digitally, or that uses technology that supports the recording or storage of data. This potentially does mean that the bill will include all digital assets, including cryptocurrency and NFTs, as well as assets not recorded on a blockchain.
By extending the existing criteria for payment systems to stablecoins that perform retail or wholesale functions, the Bank of England and the FCA may directly supervise such systems. A stablecoin with the potential to be systemic at lunch would need to be captured by the enhanced requirements that apply to firms that have reached systemic status and the Principles for Financial Market Infrastructures.
Stablecoin payment systems may also become subject to appropriate competition regulation by the Payment Systems Regulator (PSR) under an extended version of the Financial Services (Banking Reform) Act 2013.
Given the increasing regulatory scrutiny that stablecoins and crypto-firms are subjected to, it's become vitally important for firms dealing with or expanding into digital asset classes to review their licensing requirements and structure. An important part of any AML compliance program is a comprehensive Sanctions screening process. If you need assistance with implementing Sanctions screening in your business, connect with our sanctions.io team or sign up for a 7-day free trial of our AML screening API.