On Tuesday, the British Treasury published a call for comments on a proposal for rescuing stablecoin issuers large enough to pose a systemic risk to economic stability.
Stablecoins are crypto tokens pegged to a more stable asset, typically the US dollar. From January to March 2021, HM Treasury’s consultation asked for responses and feedback about what its regulatory framework for crypto assets and stablecoins should be “to harness the benefits of new technologies, supporting innovation and competition, while mitigating risks to consumers and stability."
In April 2022, the government published a response to the consultation saying it intended to push forward legislation that would regulate stablecoins by “amending existing electronic money and payments legislation.” This response also acknowledged, however, that any framework would need to account for the risks posed by the collapse of a stablecoin firm that served as a "systemic payment system" or was a "service provider of systemic importance.”
The Treasury's new consultation document directly tackles the possibility of a stablecoin failure that poses a systemic risk to the wider economy, and proposes government involvement to mitigate instability.
The document defines stablecoins as "digital settlement assets" (DSA) and a "systemic DSA firm" as the issuer of a stablecoin with "systemic importance."
"The failure of a systemic DSA firm could have a wide range of financial stability as well as consumer protection impacts," the document states. "This could be both in terms of continuity of services critical to the operation of the economy and access of individuals to their funds or assets."
The Treasury says that an amended Financial Market Infrastructure Special Administration Regime (FMI SAR) would be the most appropriate way to deal with such a failure. In short, FMI SAR gives the Bank of England the power to oversee and direct the actions of a payment firm to ensure that their services continue in the event of a failure that could destabilize the economy. Here's how the Treasury document describes it:
The FMI SAR was established to address the risks posed by the possible failure of payment systems recognised as systemic (for instance, Faster Payments or Bacs) where the government judged that disruption to or the discontinuity of such a system due to insolvency would not best serve the public interest given potential impacts on financial stability. In particular, severe disruption to the functioning of the wider financial sector and the real economy might ensue due to the volume and value of transactions processed by such systems on behalf of households and businesses.
Notably, the Treasury states that simply continuing service may not be enough in the event of a stablecoin failure, where people may have lost access to their funds for any number of reasons. The government intends to add to the FMI SAR "an additional objective covering the return or transfer of funds and custody assets," according to the document. "This would allow administrators to take in to account the return of customer funds and private keys as well as continuity of service," the document states.
The investor bloodbath that followed the aftermath of Terra’s algorithmic stablecoin UST collapsing its ecosystem has attracted the attention of countless regulators now. In the midst of the run on UST, Treasury Secretary Janet Yellen warned Congress of the danger such tokens posed to investors, called for new regulations, and said the Treasury would be issuing a report on stablecoins soon.
"I wouldn't characterize it at this scale as a real threat to financial stability, but they're growing very rapidly and they represent the same kind of risks that we have known for centuries in connection with bank runs," Yellen told the House Financial Services Committee.
In November, a group of federal agencies including Treasury, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, issued a report on stablecoins that warned there were "key gaps" in regulatory authority that could prevent the federal government from mitigating risks associated with volatility, compliance with anti-money laundering laws, or fraud. This March, the President went on to sign an executive order directing federal agencies to help research, develop, and design the potential framework for a U.S. central bank digital currency.
In April 2021, the Bank of England and HM Treasury launched a CBDC task force also looking to explore the framework for a potential U.K digital pound. And for years now, the Bank of England’s governor Andrew Bailey has been railing on Bitcoin while praising the potential of stablecoins and CBDCs to expand payment systems. The European Commission, by contrast, has proposed an outright ban on stablecoins, lifting a regulatory approach for Facebook's failed Libra stablecoin for application towards stablecoins that exceed 200 million euros and 1 million daily transactions.
According to the HM Treasury document, the government intends to legislate on the regulatory regime that stablecoins operate under "when parliamentary time allows." The consultation period will end on Aug. 2, 2022.