The UK government has published a final policy draft concerning the regulation of fiat-backed stablecoins, paving the way for the integration of certain cryptocurrencies into UK payment chains.
Due to be phased in from 2024, the rules aim to bring stablecoins under the purview of existing financial regulation, marking a substantial divergence from the European Union’s decision to create an entirely new framework called the Markets in Crypto-Assets (MiCA).
Stablecoins are a subset of cryptoassets that are pegged in price to a particular asset, typically a fiat currency like the pound sterling or US dollar.
They are a major part of the $1.25 trillion cryptocurrency market, with the largest stablecoin, Tether (USDT), garnering an $84 billion market capitalisation.
“Certain stablecoins have the potential to become a widespread means of retail payment, driving consumer choice and efficiencies,” HM Treasury stated. “In order to deliver this, the government intends to bring the regulation of certain activities relating to fiat-backed stablecoins within the UK’s financial services regulatory perimeter.”
Once implemented, fiat-backed stablecoins will be subject to the Payment Services Regulations 2017 and the Financial Services and Markets Act 2000.
Following the first phase of regulatory implementation, HM Treasury intends to bring fiat-backed stablecoins into the Financial Conduct Authority’s remit via secondary legislation.
The FCA will have the power to require that the backing assets of fiat-backed stablecoins be held in a statutory trust in order to safeguard customer assets in the event of a bank run.
Other types of stablecoins, such as non-fiat-backed stablecoins or unbacked cryptoassets will still be allowed to be used in payment chains, but these transactions will remain unregulated.
Disclosure requirements are being considered to inform users when they are using unregulated payment rails.
Algorithmic stablecoin rules to follow
Despite being provably more volatile, algorithmic stablecoins will not be captured under the initial wave of regulatory standards.
Unlike fiat-back stablecoin issuers, who are meant to have cash and/or cash equivalents held in custody at a 1:1 ratio, algorithmic stablecoin issuers instead use a complex form of arbitrage and algorithmic trading to maintain a dollar or pound sterling peg.
This process proved to be decidedly unstable when, in May 2022, algorithmic stablecoin TerraUSD (UST) collapsed in a $40 billion death spiral as it was unable to sustain its dollar peg.
UST was formerly the second-largest stablecoin behind Tether and its collapse sparked a dramatic downturn in cryptocurrency prices which have yet to recover to this day.
In today’s policy draft, the Treasury stated that algorithmic stablecoins will be captured under a second wave of cryptocurrency regulation currently being consulted on.
“This is because their under-collateralised nature means they share characteristics with unbacked cryptoassets and crypto-backed tokens are only as stable as the underlying cryptoasset,” stated the Treasury.
What analysts say
“Today’s publications largely confirm what we already knew in February – regulation is coming to cryptoassets in a fairly expansive way,” said Albert Weatherill, financial services regulatory partner at Norton Rose Fulbright.
Weatherill contended that the Treasury’s engagement with the industry has seemingly done little to change the core features of the proposals announced earlier this year, though “many unknowns” remain.
Specifically, “when these rules will come into force, how applicants will be able to get authorised and what the substance of the rules will be”.
“The key challenge for the regulators is to provide this certainty as soon as possible, such that the industry can begin to adapt to its new regulatory reality,” said Weatherill.
“Rather than let the crypto wild west develop unchecked, the UK government is appointing the FCA as sheriff of this here town,” remarked Laith Khalaf, head of investment analysis at AJ Bell.
Khalaf called the decision to regulate crypto under existing financial regulatory frameworks “a sensible one”, noting that “the apparatus and resources for supervision are already there and working in tandem with regulators worldwide”.
“It’s also clear that some of the key crypto activities that need regulation mirror existing services provided by mainstream financial services, and so sit better under the scope of the FCA than within gambling regulation,” said Khalaf.