What the Bank of England’s Stablecoins Regime Could Look Like

The U.K.’s central bank wants to protect citizens against the collapse of large stablecoin issuers by updating an existing regulatory regime – a move which is imminent.

Global standard setters are working on norms for stablecoins, especially as regulators fear that they will get more entangled with the broader financial system. The U.K. is joining other economies including the U.S., European Union and Hong Kong, which are also working to set up targeted regulations for crypto pegged to the value of other assets.

Following the collapse of Terra’s algorithmic stablecoin terraUSD (UST), which sent the market and companies including crypto fund Three Arrows Capital tumbling, regulators such as the Bank of England (BoE) have sought to make sure they have the right safeguards in place to protect citizens against future stablecoin collapses.

The BoE, like other regulators, is worried that stablecoins could become more interlinked with the financial system over time – as more banks and financial companies adopt crypto – and could pose a risk to financial stability, although many of them acknowledge it isn’t a threat at present. So it is planning to set up a regime to monitor stablecoins that could have an impact on the financial system, and will release its consultation on what this could look like in the coming weeks, before its rules are finalized and put into law.

The BoE’s stablecoin regime is coming.

“With millions of consumers now owning some form of crypto, ensuring high standards of consumer protection must be a top priority for government as well as mitigating any potential market integrity and financial stability risks,” Lisa Cameron, a Member of Parliament and chair of the Crypto and Digital Asset All Parliamentary Group, said in a statement.

So what could the U.K.'s stablecoin regime look like?

The BoE is looking to amend the Financial Market Infrastructure Special Administration Regime (FMI SAR), which gives the bank broad oversight of big U.K.-based payment systems, to also cover large digital settlement assets including stablecoins, it set out in its consultation. DSAs are digital assets used for payments. If the recently introduced Financial Services and Markets Bill passes into law, the BoE will have the power to extend the existing FMI SAR regime to cover certain crypto.

The FMI SAR regime is essentially an insolvency regime, said an official from Fnality International, a blockchain payment system. In the U.K., insolvency or administration regimes are similar to bankruptcy regimes elsewhere. One objective of the regime would be to help certain critical crypto businesses keep running so they do not have an impact on financial stability.

“The failure of a systemic DSA firm could have a wide range of financial stability as well as consumer protection impacts” including disruptions to services critical to the economy and to individuals' access to their own funds, the Treasury’s consultation on the FMI SAR said.

Read more: UK Government Proposes Stablecoin Safeguards After Terra Collapse

The BoE is exploring adding a new objective that ensures funds are returned to investors should a large stablecoin issuer collapse.

“I like ... the additional objective of ensuring the return or transfer of funds because not only does it give added confidence to consumers by directly mitigating their risk, it would also act as a catalyst to increase the adoption of crypto as a means of payment,” said Asim Arshad, a senior associate at Mackrell Solicitors, a London-based law firm, in an interview with CoinDesk.

However, pursuing this objective may mean keeping a company running takes a back seat to facilitating the return of funds to affected lenders or investors should the issuer collapse, Arshad said. Plus, crypto firms under the FMI SAR may pay administration fees like the ones set out under the existing regime. These are paid after the administration order has been made by the court, which the BoE would have had to apply for – under the current rules – when a firm fails and needs help to continue, the official from Fnality said.

Plus some believe returning funds to customers may be difficult to accomplish.

“This objective may pose real issues for many firms, who may struggle to evidence ownership of crypto-assets in the event of an insolvency,” said James Alleyne, the legal director at Kingsley Napley. “This is likely to be compounded by the lack of ownership detail on the underlying ledgers and the pseudo-anonymous nature of the technology.”

Last year several large crypto firms filed for bankruptcy. Collapsed platforms including FTX and Celsius Network are now embroiled in long and complex bankruptcy proceedings, where courts and judges have struggled to decipher who is owed what.

Read more: FTX Has Recovered 'Over $5B' in Assets, Bankruptcy Attorney Says

Without a custody regime, which protects crypto assets from being used toward the cost of insolvency, the owners of such assets may lose money if a firm goes under, Alleyne said.

The U.K. does not currently have a custody regime, though this was discussed at a U.K. regulator Financial Conduct Authority (FCA) event with the crypto community last year.

The BoE’s regime would allow systemic DSA providers to continue operating in a crisis. The BoE may have to consult with the FCA before appointing a qualified liquidator to manage the wind-up of a systemic stablecoin firm that they both regulate. The FCA is currently responsible for registering crypto firms to operate in the U.K. using anti-money laundering rules.

“Whilst having another regulator involved always has the potential to increase process and bureaucracy, in practice there is no reason why this should not work smoothly and it may also help to ensure better outcomes for consumers,” Alleyne said.

A special administration order lets regulators appoint experienced liquidators to oversee companies without their consent in the event of a catastrophic failure, said Kathryn Willis, who previously worked at the FCA and is now the managing director at ONE. These administrators can wind down affected companies with an aim to return as much money to consumers as possible, or take over the running of the business for continuity purposes, Willis said.

The BoE may step in when there are issues with the fiat currency reserves backing a stablecoin, such as if a stablecoin is not fully backed by its reserves when it should be, Willis said.

The regime would be set up to address systemic stablecoins and DSAs and their providers, but no stablecoin or DSA in circulation can currently be deemed systemic.

“This is preemptive legislation, they're anticipating wider adoption and ownership of this particular asset,” said Ryan Shea, an economist at Paris-based crypto trading platform Trakx.

Crypto assets are a small market compared to the broader financial sector but if the pace of growth continues, interlinkages with the financial sector will likely increase and affect the activity in the financial sector, said the BoE in a March report (before the current crypto winter).

“If all the banks moved to deposit stablecoins, then that would definitely be systemic,” said Kene Ezeji-Okoye, co-founder of Millicent, a U.K.-based distributed ledger technology infrastructure provider.

“The bad mortgages that underpinned the 2008 global financial crisis were worth about 15% of U.S. broad money supply, and caused internationally systemic damage,” Ezeji-Okoye said in a statement. “So one would expect the threshold for a stablecoin to be classified as systemic in the U.K. to be far lower than 15% of money supply – the collapse of a stablecoin with a mid 9-figure market cap could well cause ripples in the system.”

UPDATE (April 11, 2023, 14:20 UTC): Updates Fnality comment.