# ON CHAIN STERLING By [@kingscounselxyz](https://paragraph.com/@web3kc) · 2024-01-22 --- The stable pound is coming. Once it arrives it may well disrupt existing retail and wholesale payments forever. Digital payments need no longer be confined to TradFi rails with their attendant delays and take rates. Sterling payments can move on chain. UK regulatory reform to make this a reality is now closer than ever. In this article I summarize what we know now (January 2024) about the likely shape of the new legal regime. This article does not contain legal advice and is for legal educational purposes only. **ADVANTAGES AND USE CASES** In October 2023 HM Treasury provided an update on its plans for stable coin regulation. In November 2023 the UK’s Financial Conduct Authority issued its own discussion paper. The summary below is based upon a synthesis of those papers. The FCA’s paper recognizes that payments using stablecoins have a number of distinct advantages: * The possibility of payments not being reliant on trusted intermediaries * Increased efficiency, speed and reliability in making payments. * Reducing total costs as the number of parties involved in completing a payment transaction falls. These benefits mean that stablecoins could be used to deliver faster, cheaper, frictionless payments between consumers and merchants. It is also theoretically possible for stablecoins to be used as assets to carry out on-chain settlement in wholesale settings. Stablecoins can fulfil the role of tokenized funds, bringing the “payment leg” of the settlement system on chain. Traditional “Delivery vs. Payment” (DvP) settlement systems (using intermediaries such as clearing houses) can take up to two days to be finalized. By contrast on chain payments can be executed and settled almost simultaneously. All of this is recognized (in terms) by the FCA’s discussion paper. **TIMING** At the time of writing (Jan 2024) we may not have too long to wait long for the new regime. HM Treasury intends to bring forward secondary legislation “**as soon as possible**” and by “**early 2024**”, subject to available parliamentary time. The new legislative provisions will bring activities relating to fiat-backed stablecoins into the regulatory perimeter, enabling the FCA to regulate them. The FCA’s deadline for responses to its own discussion paper is 6 February 2024. **THE STATUTORY PROVISIONS** The Financial Services and Market Act 2023 entered into law on 29 June 2023. It empowered the Treasury to put in place a new regulatory regime for stable coins. HM Treasury is seeking to regulate activities relating to stablecoins in two ways: * Firstly, by regulating the use of fiat-backed stablecoins to make payments; * Secondly, by regulating the activities of issuance and custody of fiat-backed stablecoins when issued “in or from” the UK irrespective of their uses (for example whether they are used for payments, store of value or as a settlement asset). The use of fiat-backed stablecoins in payment chains will be regulated through amendments to the Payment Services Regulations 2017 (PSRs). The activities of issuance and custody of UK issued fiat-backed stablecoin will be included in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (“RAO”). This will enable the FCA to make rules for firms conducting these activities. Firms wishing to apply for authorization to conduct either of those issuance or custody activities will be subject to FCA rules and guidance as is usual for FCA regulated activities. **DEFINITION** HM Treasury expects to define fiat-backed stablecoins as a cryptoasset that seeks or purports to maintain a stable value by reference to a fiat currency and by holding fiat currency, in whole or in part, as backing. This definition of fiat-backed stablecoin will not be limited to particular currencies, nor will it be limited to single currency stablecoins - stablecoins which reference a basket of currencies will be included in this definition. This definition does not include so-called algorithmic or crypto- backed stablecoins. These tokens will be captured by the proposed “Phase 2” of the UK Government’s approach to crypto regulation in due course. This will cover regulation of the crypto industry and crypto assets more broadly. **RISKS AND HARMS** UK regulation of stablecoins is intended to address the following potential risks and harms arising from stablecoins: * The stability and reliability of stablecoins depend on their backing assets. However, there are issues with transparency, as information about these assets is often unavailable, incomplete, or opaque. * Insufficient or inaccessible backing assets pose significant risks to consumers, potentially leading to a loss of confidence and a run on the stablecoin. * Most fiat-backed stablecoin issuers restrict redemption to wholesale users, leaving retail consumers to trade on the secondary market. This can result in significant losses for retail consumers during a de-peg event. * Poor custody arrangements by custodians can lead to risks such as loss or hacking of stablecoins, and delays or complete loss in returning assets. * There is a risk of consumers being misled by false claims about the stability of stablecoins. * Payments: Risks of delays or hidden costs, payment errors and misdirections. **ISSUANCE** HM Treasury intends to create a regulated activity under the RAO for the issuance of fiat-backed stablecoins in or from the UK. This will apply to all issuers of fiat-backed stablecoin located within the UK. Firms providing such activities will need to be authorized by the FCA and comply with the rules in the FCA’s handbook. **BACKING ASSETS** The FCA proposes that issuers will  need to hold backing assets that are (i) sufficient to back all their issued stablecoins; (ii) stable in value; and (iii) sufficiently liquid to support consumers’ right to redeem the regulated stablecoin promptly. Backing assets would also need to be properly identified, recorded, segregated as well as protected in the event of insolvency of the stablecoin issuer. Customers should receive sufficiently clear, non-technical and understandable information about the backing assets, including information about the backing assets’ stability, sufficiency, constitution and how, and where they are held. The FCA plans to place restrictions on the kinds of backing asset that are suitable and appropriate. These will be restricted to low risk, highly liquid and secure instruments and cash deposits. Unsuitable backing assets are likely to include instruments that rely on corporate debt or equity as well as longer term government bonds. **REDEMPTION** The FCA aims to ensure that holders of regulated stablecoins can convert their stablecoin into fiat at par value at all times. Redemption requests will need to be executed in a timely and smooth fashion, not only to protect consumers, but also to help maintain confidence in the regulated stablecoin. This is marked shift from prevailing commercial practice in the stablecoin industry. The FCA notes that restrictions are rarely clearly communicated on corporate websites and are not always reasonable or proportionate. Stablecoin issuers commonly do not commit to specific redemption periods. The right of  “next day” redemption would be subject to a right of temporary suspension: for example where there is run on the regulated stablecoin or a de-peg due to external, unforeseen circumstances. **INFORMATION RIGHTS** Regulated stablecoin issuers would be required to publish key information their websites and main communication channels for consumers to understand. This would need to include: * A description of the regulated stablecoin, details of how the form of stability or links to a fiat currency is maintained and total number of tokens in circulation. * The composition and value of the backing assets, and any relevant evidence to support these claims. * Rights and obligations of the regulated stablecoin issuer and stablecoin holders (eg the terms and conditions). **CUSTODY** The FCA is also planning to regulate the way in which stablecoins are custodied on behalf of consumers. My understanding is that this would not cover custody in self-hosted wallets but is specifically directed at custody services by commercial entities (eg. exchanges). In traditional finance, custodians are required to segregate client assets from their own so that in the event of insolvency, client assets are adequately ring-fenced and protected from any other creditors’ claims to the failed custodian’s estate. The FCA is considering a similar duty to segregate clients’  stable coins from their own assets through clear recording of ownership and wallet labeling. This would help to ensure that beneficial ownership of clients’ coins is protected at all times while held in custody. Clear records of ownership will be required. The FCA may permit custodians to maintain an on-chain record of provided that “adequate measures” are in place to preserve the integrity of the on-chain record. The FCA has not yet decided whether or not to permit the use of by custodians of clients’ cryptoassets held under custody, for example to provide staking services, hold cryptoassets as collateral, or in some instances lend them to other clients. The FCA recognises that cryptoasset custodians may lose revenue if they are no longer permitted to use clients’ cryptoassets for other purposes and so may decide to change their business models. **PAYMENTS: UK STABLECOINS** The model for regulation of stablecoins payments proposed by the FCA distinguishes between two different models of payment: * The hybrid model – this envisages that a stablecoin would be used at the entrance or exit of an existing fiat payment chain, but the actual transfer of value would be in fiat by way of a traditional payment service. For example, services where a consumer uses a stablecoin to make a payment for goods or services, and a Payment Services Provider (PSP) performs a conversion from stablecoin to fiat to enable the payment to be made. * The pure stablecoin model – this envisages that both the payer and payee transact in stablecoin, and the transfer of stablecoins between them occurs on-chain. Regulation of payments by the FCA would apply only where there is a commercial intermediary between the payor and payee. This obviously be the case in the hybrid model above. However, intermediaries might also have a role in a “pure stablecoin” model. This is because direct “wallet to wallet” payments between consumers and vendors could lead to inefficiencies, particularly when the volume of transactions requiring authentication on the blockchain grows. Commercial efficiency might demand the services of an intermediary. This commercial intermediary would hold stablecoins that have been earmarked for transfer for a period of time, before initiating fewer, and potentially larger transactions, on the blockchain in stages. Where commercial intermediaries are involved the full rigours of the UK’s Payment Services Regulations will apply. This would give consumers using stablecoins for payments the same rights as current users of regulated payment services. For example, the PSRs give consumers rights to transparent information (about fees, rates, processing times), refunds for unauthorized payments and a right to rectification of errors in processing transactions. The regulations will not cover peer-to- peer stablecoin transfers where the payment service underpinning or facilitating the transfer is not offered on a commercial basis. Nor will they cover the purchase of stablecoin using fiat currency as this is already regulated under the PSR 2017. Geographically, it is envisaged that the PSRs will cover: (1) payment transactions involving UK consumers, where at least one end of the transaction is in the UK; or (2) UK firms facilitating payment transactions, regardless of whether the transaction takes place in the UK. **PAYMENTS: OVERSEAS STABLECOINS** The intention is that the new regime would cover the use of fiat-backed stablecoin issued in or from the UK (which would be a regulated activity) ensuring that such coins are suitable for use in payments. However, the Treasury is also considering how to create a separate pathway for fiat-backed stablecoins issued outside of the UK (’overseas stablecoins’) to be used for payments within the UK. The FCA is exploring workability of an approach whereby the arranger of the payment (i.e. the entity who facilitates the individual or merchant to pay or be paid using a fiat- backed stablecoin) is authorised by the FCA and is responsible for ensuring an overseas stablecoin meets FCA standards. Under this approach, the firm arranging the stablecoin payment services (the “Payment Arranger”) would only be allowed to initiate/arrange a payment if it was satisfied the stablecoin met the requisite FCA standards. The Payment Arranger would be under a duty to report to the FCA in the event of non-compliance. In this scenario the facilitation of payments in the UK by the Payment Arranger must cease immediately. It is proposed that the FCA will have powers to take action against Payment Arrangers where they have not undertaken adequate checks against its standards. **CONCLUSION** The broad contours of the new regime are now apparent. Whether Sterling will enjoy its own on-chain summer remains to be seen. --- *Originally published on [@kingscounselxyz](https://paragraph.com/@web3kc/on-chain-sterling)*