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27/12/23

Regulating Stablecoins

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Following the collapse of cryptocurrency trader, FTX, the urgent need for the introduction of tighter regulation of crypto currency trading has become apparent.

The UK is determined to be at the forefront of such regulation and proposed legislation is designed to increase transparency in cryptocurrency trading bringing the sector into closer alignment with the regulation of traditional currency.

Additionally, the UK Government has announced plans to introduce a Treasury-backed stablecoin.

A Stablecoin is so named because it is a digital currency which fixes its price to an underlying financial asset and, as such, does not tend to fluctuate in price very much. The use of Stablecoins rose to prominence as a convenient and ‘stable’ place for investors to store their cash in a market that is notoriously volatile.

Before stablecoins were introduced, investors faced a lengthy and expensive process of exchanging their digital assets into fiat currency each time they traded crypto. 

Stablecoins

Fiat-backing

Fiat money is a government issued currency that is not backed by a physical commodity, such as gold or silver, but by the government which issued it.

Stablecoins are described as a more reliable cryptocurrency as the inherent risk attached is tied, or ‘pegged’, to a stable commodity, usually a fiat currency such as GBP in line with the Government’s proposal.

Whilst fiat-backed cryptocurrencies make up the majority of stablecoins currently in use, because of their lack of volatility, they do enjoy the general benefits of cryptocurrencies, such as the opportunity to create faster and cheaper payments for transacting parties and are preferred by the Treasury.

There exist other types of stablecoins such as those pegged to commodities, such as gold and other cryptocurrencies or a combination of such commodities.

However, the Treasury in respect of its own proposed stablecoin, has elected to exclude such commodities in view of their obvious volatility in value, choosing to rely on a fiat backed stablecoin.

How will the UK regulate Stablecoins?

It is intended that the UK will bring fiat-Backed Stablecoins (‘FBSs’) within the control of the Financial Conduct Authority (‘FCA’), the Bank of England (‘BoE’) and Payment Services Regulator (‘PSR’), with the intent of making them more aligned with traditional currency.

Institutions dealing with FBSs will be expected to act transparently and with the same regard for the rules controlling the holding of traditional currencies. The purpose of increased regulation is to improve consumer confidence in FBSs in order to facilitate more everyday transactions using them.

FCA regulation

The FCA will regulate the use of FBSs in payment chains and the way in which they are issued and held. This is intended to make them more traceable, prevent their use in crime and increase consumer confidence in them as an everyday payment method.

Stablecoins will require authorisation from the FCA which will also oversee the fiat-backing of stablecoins. The providers of FBSs will be required to hold an equivalent amount to the value of the circulating stablecoins in the chosen fiat currency in reserve at a regulated financial institution.

An FBSs’ backing assets must be low risk and secure, liquid deposits. This is designed to make FBSs easily redeemable and maintain cashflow for businesses.

As the anticipated use of FBSs increases, the FCA may consider permitting overseas stablecoins for use in the UK payment chains.

BoE regulation

The BoE will also play a role in regulating GBP fiat backed stablecoins, which it considers are likely, in the future, to dominate the UK crypto market, ahead of all other cryptocurrencies.

Its powers under the Banking Act 2009 will empower it to supervise FBSs provider’s systems, Codes of Practice and set parameters to maintain resilience to changes in financial markets. It will require FBSs’ issuers to explain how they will manage redemptions during times of stress in a way which maintains consumer confidence and does not jeopardise their stability.

Payment Services Regulator

The PSR will have an important role overseeing FBSs’ issuers, custodians and exchanges and will liaise with the Treasury and the BoE to consider which of them to monitor.

Such consideration will be based on the value and frequency of the transactions they undertake and their links to other payment systems. The Treasury will then instruct the PSR to oversee their processes and obtain access to their payment systems.

Given that this will add further burden to the operators of the payment systems in question, they will have the opportunity to make representations to the Treasury as to why they should not be regulated by the PSR. Decisions will be made on a case-by-case basis with primary consideration given by the Treasury to stability and confidence in the stablecoin.

Co-operation between the regulators

The FCA, BOE and PSR will co-operate with the Treasury in navigating the new regulatory framework.

It can be envisaged that the FCA will authorise FBSs, which will be supervised by the BoE dependent on the circumstances outlined above. The PSR may also be involved in co-supervision with the BoE.

It is expected that the Government will reveal more details of the inter-regulatory framework in 2024, when its anticipated proposals are announced.

How Can We Help?

he cryptocurrency market is developing rapidly with legislation and regulations constantly evolving.

The Team at KANGS offers clients considerable experience advising on cryptocurrency issues of every nature.

As the cryptocurrency market develops, businesses involved in or contemplating involvement will need to take extreme care to ensure compliance with the demanding regulations and legislation.

If we can be of assistance, our Team will be delighted to hear from you and is contactable as follows:

Telephone 0333 370 4333

Email: info@kangssolicitors.co.uk

We provide initial no obligation discussion at our three offices in London, Birmingham and Manchester. Alternatively, discussions can be held virtually through live conferencing or telephone.

Hamraj Kang

Hamraj Kang
Senior Partner

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Tim Thompson

Tim Thompson
Partner

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Nazaqat Maqsoom

Naz Maqsoom
Associate

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