‘Crypto’ was born in unregulated space: indeed, part of the objectives of its early developers was to create a financial system outside regulation. While not yet of systemic scale, the crypto ecosystem has grown very rapidly in recent years and broadened to encompass a range of financial services. The experience of the past year has demonstrated that it is not a stable ecosystem. Part of this is because, its foundation is completely unbacked instruments of extreme volatility that can swing wildly in value. But part is also because the crypto institutions at the centre of the much of the system exist in largely unregulated space and are very prone to the risks that regulation in the conventional financial sector is designed to avoid. It is in part for this reason that, since September, the FCA has warned publically on FTX that “this firm may be providing financial services or products in the UK without our authorisation… you are unlikely to get your money back if things go wrong”[3]. Some, of course, would argue that the answer is not proper regulation of the risks in centralised crypto platforms, like FTX, but rather the development of decentralised finance in which functions like lending, trading, clearing etc. take place through software protocols built on the permissionless blockchain. In such a world, it is effectively the ‘code’ that manages the risks rather than intermediaries. And indeed, there is some tentative and limited evidence that the failure of FTX has stimulated some transfer of activity to decentralised platforms.
The FPC made clear last year that to deliver that regulatory outcome “regulatory safeguards will be needed for a non-bank systemic stablecoin to ensure that the coin issuance is fully backed with high quality and liquid assets, alongside loss absorbing capital as necessary, to compensate coinholders in the event that the stablecoin fails”[9]. It also made clear that in the absence of deposit protection for coinholders, other elements of the regime would need to be strengthened to deliver the necessary level of assurance. The consultation will set out in more detail how the coinholders’ claims on the stablecoin issuer and wallets should be structured to deliver redemption at par in line with commercial bank money, how the backing assets should need to be managed to ensure they are always available to meet redemptions and, more generally the requirements for corporate structure, governance, accountability and transparency necessary to meet the standards we expect in other parts of the financial system that carry out the same functions. The FTX example underlines how important these aspects are. The legislation covers the use of crypto technologies for the payments function. The Treasury intends to consult in the near future on extending the investor protection, market integrity and other regulatory frameworks that cover the promotion and trading of financial products to activities and entities involving crypto assets. At present, in the UK, it is, to a large extent, only the anti-monetary laundering regulatory framework which applies to these activities and entities.