In another milestone for crypto developments, the United Kingdom has published a detailed strategy for the regulation of cryptocurrencies. The report focused mainly on stablecoins, and the proactivity towards creating a new regulatory strategy seems to highlight a significant shift in the nation's approach towards digital currencies.
Stablecoins themselves come about in an attempt to reduce risk and boost transactional utility, so legitimisation through regulation is a promising step. Though, it’s not without its stringent (and potentially controversial) rules. The plans appear to be in a similar tone to Rishi Sunak’s April 2022 policy, which was designed to make the UK a hub for cryptos.
Before looking at the new plans, let’s first have a look at the historical context of the UK’s relationship with cryptocurrency.
The Historical Context of Stablecoins in the UK
The UK's stance on cryptocurrencies and stablecoins has been both cautious and progressive. The Government's latest initiative to regulate crypto assets comes about from a comprehensive consultation process initiated earlier in the year. This process involved engaging with industry experts and the public to gauge the complexities—and the potential of the crypto domain.
The need for regulation in this sector was accentuated by growing concerns over consumer protection, market integrity, and general stability—particularly for stablecoins, which aspire to mimic fiat currency.
A pivotal moment in the UK's journey towards crypto regulation was the introduction of the Financial Services and Markets Act 2023, passed in June. This Act showed the Government's readiness to treat crypto assets as a regulated financial activity, which helps lay the groundwork for the current regulatory framework.
As the UK’s economy struggles and world governments continue to struggle with crypto regulation, this has been seen as an opportunity for the UK to continue its leadership within the financial sector.
With the newly proposed regulatory framework, the strategy is a phased rollout of crypto rules. This is in line with the past few years, which has seen a drip feed of new rules. Whilst it may sound intentional—to ensure structure and to not be too destabilising for an existing market—it’s more likely a representation of constant learning and understanding of a new technology.
The New Regulatory Framework
The UK Government's regulatory framework for cryptocurrencies, particularly fiat-backed stablecoins, is a response to their growing significance in retail payments and the financial market.
The Financial Services and Markets Act 2023 (FSMA 2023), introduced in Parliament in July 2022, is essentially the foundation for bringing these stablecoins within the financial services regulatory status quo.
Dual Focus of Regulation
There are two main aspects to the UK’s stablecoin regulatory motif. Firstly, it regulates the use of stablecoins (fiat-backed crypto) in payment chains. Secondly, it encompasses the regulation of issuance and custody of these stablecoins, regardless of their specific uses. This dual focus aims to instil confidence in the use of stablecoins as a payment method and ensure stability and security through strong oversight.
Stablecoin Regulation in Payment Chains
The UK Government plans to introduce some new elements to the Payment Services Regulations 2017 (PSR 2017)—namely, to integrate stablecoins into the world of payment chains. This integration will provide a structured and regulated environment for authorised or registered payment institutions handling stablecoins.
Issuance Within the Financial Services and Markets Act 2000
The activities of fiat-backed stablecoins regarding issuance are going to be included in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (“RAO”).
This inclusion will give the Financial Conduct Authority the power to develop and enforce rules for firms engaging in these activities. Firms seeking authorisation for these activities will be subject to the standard FCA regulatory framework.
Treatment of Overseas Stablecoins
The Government intends to welcome stablecoins that are not issued in the UK, despite their use in the UK economy. A proposed approach involves authorising entities that facilitate payments using these overseas stablecoins, ensuring they meet FCA standards for UK payment chains.
Non-fiat-backed stablecoins and unbacked cryptoassets will still be permitted into payment systems, but they will not be regulated, as they are currently deemed unsuitable for regulated payments. The Government and the FCA, however, are considering bringing in some disclosure rules to ensure consumers are properly informed about these unregulated cryptoassets.
Looking Ahead: Phase 2 of Cryptoasset Regulation
The regulatory framework established for fiat-backed stablecoins will remain in place as the Government expands its regulatory reach in phase 2. This next phase will see an expansion of custody activities in the RAO and the creation of new regulated activities, such as operating a cryptoasset trading venue, covering a broader range of cryptoassets.
Implications: How This Impacts Issuers, Participants, and the Market
This tough stance is consistent with the FCA's historical approach to crypto regulation. And, it goes without saying that the FCA is one of the most prestigious, stringent, and respected financial regulators in the world.
Crypto issuers will be required to meet high compliance standards, including maintaining the stable value of their crypto assets and keeping accurate records of regulated stablecoin backing assets.
This ensures consumer protection but also places a significant compliance burden on issuers. The rigorous standards set by the FCA could lead to a consolidation in the market, with only those issuers who can adhere to these strict guidelines being able to operate.
Collaborative Regulation by the FCA and Bank of England
The FCA, in conjunction with the Bank of England, will closely monitor the market for the emergence of wide-use “systemic” stablecoins. The focus will be on stablecoins backed by the British pound, particularly those in wide use that may threaten financial stability.
This collaboration implies a more integrated regulatory approach, combining the FCA's focus on business conduct with the Bank of England’s emphasis on financial stability. This dual oversight could lead to more robust regulation, but may also create complexities for stablecoin issuers navigating two regulatory bodies.
Industry Engagement and Feedback
The FCA is actively seeking industry feedback on its proposed regulations, suggesting an openness to dialogue and potentially adapting regulations based on industry input. This engagement could lead to a regulatory framework that balances the need for oversight with the industry's capacity for innovation.
However, it also indicates that the current proposals may evolve, creating a degree of uncertainty for stablecoin issuers and investors. The industry's ability to adapt to and influence these evolving regulations will be crucial going forward.
Potential for Market Shifts
The new regulations may trigger shifts in the stablecoin market. Firms that can align with the UK's stringent regulations may see increased trust and credibility, potentially attracting more users.
One thing it will not do, of course, is impact the value of such stablecoins, given that they’re pegged to the pound already.
Conversely, those unable to comply may either exit the market or seek jurisdictions with more lenient regulations. This could result in a market dominated by a few large players who can afford the costs of compliance. The downside of this is that innovation may suffer through stifled competition.
Long-term Market Outlook
In the long term, these regulations could set a precedent for other countries, contributing to a more standardised global approach to stablecoin regulation. This could benefit the industry by reducing the current fragmentation in regulatory approaches across jurisdictions.
For the general public and businesses—those that want to buy, sell, and use stablecoins—this will boost sentiment and feelings of security when using these new assets. While some regulations may deter some crypto purists, there are many more non-crypto users, meaning the majority of people will see this as a step in the right direction.
The Specifics of the Enhanced Oversight
In the evolving landscape of digital currencies, the UK Government's framework for regulating stablecoins places a strong emphasis on oversight. This is important for maintaining markets and safeguarding the financial system. Below are some of the more specific ways that the FCA is looking to protect consumers and boost stability.
Safeguarding Reserve Funds
An important aspect of consumer protection in the UK’s stablecoin regulatory framework is the safeguarding of reserve funds. Stablecoin issuers are required to hold reserve assets in compliance with FCA standards. This is designed to ensure stability and trust in stablecoin transactions, particularly in scenarios of issuer failure. By mandating reserve funds to be held in a statutory trust, the framework aligns with traditional financial system protocols, offering a safety net for consumers.
Transparency and Accountability
Transparency and accountability are central to the UK’s approach to regulating stablecoins. The FCA is set to impose stringent admission standards and disclosure requirements for stablecoin issuers and cryptocurrency exchanges.
This is intended to elevate the transparency of transactions and operations within the stablecoin ecosystem. These regulations aim to provide market participants and consumers with clearer information and understanding of the digital assets they are dealing with.
Inclusion of Overseas Stablecoins
Recognising the global nature of digital currencies, the UK framework also addresses the use of overseas stablecoins. The intention is to allow these stablecoins in UK payment systems, provided they meet FCA standards. This approach necessitates a balance between fostering international cooperation and ensuring that these assets do not undermine the integrity and security of the UK's financial system.
Looking Towards Phase 2 Regulations
The introduction of phase 2 regulations will somewhat be more of the same. This phase will see the expansion of regulated activities, including the custody of a broader range of cryptoassets and the operation of cryptoasset trading venues. The aim here is to further extend the regulatory net, capturing a wider spectrum of digital financial activities.
International Context and Industry Response
The UK's initiative to regulate stablecoins is part of a broader global movement towards establishing clear frameworks for digital currencies—even if many countries are lagging behind.
Governments and regulatory bodies worldwide are recognising the importance of balancing innovation with investor protection when it comes to blockchain. The UK's approach, particularly focusing on fiat-backed stablecoins, aligns with this international trend, which aims to integrate these digital assets into the financial ecosystem responsibly.
Industry Reactions and Expectations
The industry's response to the UK's proposed stablecoin regulations has been cautiously optimistic. Nathan Catania, a partner at XReg Consulting, highlights the benefits of stablecoins in terms of cross-border value transfer and their integration with DeFi applications. He underscores the efficiency and stability these digital assets bring to financial transactions.
On the other hand, Adam Berker at Estonian-based Mercuryo, points out the preliminary nature of the current regulatory proposals. “It should be noted that this document only marks a preliminary and surface-level look at how this area will be regulated in the future. The paper even mentions directly that the FCA and the HM Treasury will have to develop their own rules, outlining their areas of responsibility.
In other words, we are still far away from seeing what the final regulations will look like. For now, the main areas of work have simply been highlighted, alongside the main parties responsible for their development.”
The Bank of England and FCA’s Role
In response to the regulatory developments, both the Bank of England and the FCA have published discussion papers focusing on the role of stablecoins in the UK's economy. The Bank of England's paper, in particular, focuses on sterling-denominated stablecoins, analysing their potential as digital settlement assets and outlining the proposed requirements for their regulation. This includes considerations for the safety of money and payments, transfer functions, and requirements for wallet providers.
Looking Towards Comprehensive Regulations
The industry is keenly awaiting the finalisation of these regulations, which are expected to provide clearer guidelines and reaffirm the UK's position as a hub for crypto businesses - as Rishi Sunak previously demanded. This anticipation reflects a broader eagerness within the crypto community to see how the UK’s regulatory landscape will evolve and its potential impact on the global crypto market.
As the UK undergoes its transformative journey in regulating cryptoassets, particularly stablecoins, it sets a precedent on the world stage. The regulatory framework, evolving through a collaborative and phased approach, promises a market that is secure, transparent, and progressive.
This initiative not only enhances consumer protection but also gives stablecoin issuers the platform to follow through with their own unique value proposition. But, there are a lot of challenges that lay ahead. For issuers looking for guidance and training on the upcoming changes, please get in touch with a member of our Englebert team.