Foreword

Confidence in money is fundamental to UK financial and economic stability. Two forms of money are currently available in the economy.

• The first, fiat or ‘outside money’, is backed by a promise of the state, and includes both cash that is available to the public and central bank reserves that are only available to commercial banks and certain other financial institutions.
• The second, known as ‘inside money’, is issued by the private sector, predominantly commercial banks, and its value is preserved through a combination of strict regulation and issuers’ access to central bank deposits.

Stablecoins used in systemic payment systems would fall into this ‘inside money’ category and would be subject to the Bank’s regulatory regime set out in this discussion paper, including the requirement that they are backed by central bank deposits.

Apart from these forms of money, other assets may be ‘money-like’ in that they are used for payments. Some of these are regulated to support a stable value, but issuers do not have access to central bank deposits and are subject to lighter regulation. These assets include e‐money and stablecoins issued by firms outside the Bank’s remit.

There are also assets that incorrectly purport to be money. These are not suitable for use in payments as they do not have a stable value – they include unbacked cryptoassets.

Rapid innovation over the past few decades has changed the way we pay for goods and services. While cash continues to be available for all, its use has been steadily declining and new technologies are generating new forms of digital assets, some of which take the form of money. Households and businesses already have more choice as to how they make or receive payments. Further innovation could contribute to faster, cheaper and more efficient payments with greater functionality, both domestically and for cross border use. However, for these benefits to be realised, any new forms of digital assets need to be safe.

Ensuring that these innovations meet the evolving needs of households and businesses, while maintaining financial stability, are fundamental responsibilities of the Government and the Bank. There are new digital forms of both public (‘outside’) and private (‘inside’) money. The Bank published a consultation paper on the digital pound in February 2023, in which we discussed the possibility of the Bank issuing a digital currency. We will shortly publish a response to that consultation. This discussion paper focuses on one emerging form of privately-issued digital assets – so called ‘stablecoins’.

Stablecoins are a form of digital assets that purport to maintain a stable value relative to a fiat currency by holding assets (which may be of variable value) as backing. As they operate today, existing stablecoins are mainly used as the asset to settle transactions in the crypto world, and do not meet the standards that we would expect, were they to be used for payments more widely. But, as stablecoins purport to have a stable value, and may offer advantages in terms of cost, convenience and functionality, many people in the UK could quickly start to use stablecoins for everyday payments. It is therefore sensible for regulators to set out the regulatory framework that would be needed were stablecoins to become widely used as money for payments in the economy.

The safety of payments and confidence in money are fundamental to financial and economic stability. The Government has introduced legislation that gives the Bank the power to introduce a new regulatory framework to ensure that stablecoins can be used as a safe means of payment. Setting out a framework within which this type of innovation can flourish in a sustainable way will ensure that the stability of the financial system is safeguarded and the provision of payments services upon which people depend is safe and reliable.

This discussion paper sets out the Bank’s emerging thoughts on the regulatory framework for systemic payment systems using stablecoins, ie those used for everyday payments in the UK. It builds on the Bank’s previous discussion paper on new forms of digital money published in June 2021, and the Financial Policy Committee’s expectations for stablecoins set out in the December 2019 Financial Stability Report.

My hope is that this paper will encourage further research and dialogue between the Bank, the payments industry, technology providers, payments users, financial institutions, academics, other central banks and public authorities, and broader society. I encourage anyone with an interest in the issues covered in this discussion paper to respond.

Andrew Bailey

Part 1: The Bank’s proposed regulatory framework

1: Innovation in payments and money, and the role of the Bank

The Bank’s regulatory regime for systemic payment systems using stablecoins aims to support innovation in money and payments, while safeguarding risks to financial stability.^{footnote [1]}

The financial system is a diverse set of institutions, markets and activities that people and businesses rely on to support their economic activity. Innovation, including in money and payments, plays an important role in improving the provision of the financial services on which people and businesses depend. The past few decades of innovation have transformed the way we use money to make payments and more recent technological developments are likely to transform this even further. This creates exciting new opportunities both for those that innovate and those that will benefit from new financial products. However, to ensure that innovation is safe and supports, rather than poses a risk to, economic activity, it is important that both new and existing financial activities are regulated appropriately.

Stablecoins aim to maintain a stable value relative to a fiat currency. Stablecoin issuers generally maintain the value of the stablecoins by holding a pool of backing assets, which can be sold in order to return customers’ funds to them. As a practical example, if a coinholder paid £100 to the stablecoin issuer, the coinholder would receive an equivalent value of stablecoins in return, ie £100 (minus any potential fees). The stablecoin issuer would then hold the £100 (or remaining amount if fees are deducted) in the form of backing assets. If the coinholder later chose to redeem their stablecoins, the issuer would need to return that amount to the coinholder (minus any potential fees) and take the stablecoins out of circulation.

At present, stablecoins are primarily used to settle transactions, or to store value, in cryptoasset markets. But there are proposals for them to be more widely used for payments in everyday life, competing with cash and commercial bank money, which are the forms of money that are available today.

The Bank’s regulation of firms that operate payments at a systemic scale in the economy is rooted in the risks those firms, and the activities they undertake, pose to UK financial stability. To understand how systemic payment systems using stablecoins should be regulated, it is therefore important to understand the financial stability risks they pose, particularly to the robustness of money and payments and the confidence people and businesses have in them.

1.1: Stablecoins as an innovative means of payment

There has been rapid innovation in payments over recent decades, and the ways we pay for goods and services and what forms of money we use are changing.

Openness to financial innovation and a competitive environment have long been hallmarks of the UK’s success in providing financial services to people and businesses. The UK has one of the largest international banking sectors in the world and is home to a thriving ecosystem of financial services provided by non-banks. These services range from traditional insurance and fund management services to trading activities and derivatives clearing to specialist financial services such as Islamic finance.^{footnote [2]} For this ecosystem to continue to thrive, it is important that the UK continues to welcome and support innovation that can safely improve the efficiency, accessibility, and resilience with which financial services are provided to households and companies, thereby boosting sustainable economic growth.

Making and receiving payments plays a vital role in our everyday lives and is crucial for the economy. We have seen rapid innovation in payments in the UK (and globally) over recent decades. While cash continues to be available for all to use, and the Bank is committed to providing cash as a viable means of payment, its use has been steadily declining. As technology has transformed the way we live and interact, it has changed the way we pay for goods and services and what forms of money we use to do so. Many of us now make digital payments at the tap of a card, mobile phone or other electronic devices for the majority of our day-to-day payments and rely on virtual rather than physical wallets.

New technologies, such as ‘distributed ledger technology’ (DLT), including ‘blockchain’, have enabled the emergence of new forms of digital assets, and digital money.^{footnote [3]} Competition is increasing, as firms other than traditional providers, such as technology companies, are moving into the provision of payment services.^{footnote [4]}

Commercial banks are exploring whether they could issue a tokenised form of bank deposits, while a range of central banks, including the Bank, are exploring how new technologies could be used to issue a digital version of central bank money. In February 2023, the Bank and HM Treasury (HMT) published a consultation paper in which they assessed the case for issuing a ‘digital pound’ and consulted on design choices. This would be digital money for use by households and businesses for their everyday payments, issued by the Bank with digital wallets provided to customers by the private sector.

While these plans by commercial and central banks are still in their early stages, new technologies have already led to the emergence of new non-bank private providers of digital assets that could be used for payments. These are known today as stablecoins. The Bank set out its emerging thoughts on new forms of digital money, including stablecoins, in its 2021 discussion paper.^{footnote [5]}

Stablecoins could be used as a new form of digital money transferring value in new payment systems. They could offer benefits as an innovative way of settling transactions that enables new services and functionality in payments.

Payment systems using stablecoins are a new type of system for transferring value – the essence of any type of payment – which is built on innovative technology. They facilitate payments and the settlement of transactions independently of existing payment systems (albeit with existing payment platforms being used to purchase and redeem the stablecoins – so called on-ramps and off-ramps).

Payment systems using stablecoins might be able to offer significant benefits to users (Box A). For example, the technology means that they could contribute to faster, cheaper and more efficient payments, both domestically and for cross-border use. And they may offer greater functionality and programmability – the ability to automate the transfer of value more extensively and more efficiently via ‘smart contracts’. They could provide greater choice by competing with existing forms of money and payment systems. And they could open the door to future innovations that meet evolving transaction needs. The technology is as yet unproven at the scale and resilience level needed if they were widely used for everyday payments. Nevertheless, payment systems using stablecoin technologies have the potential to be used at greater scale and become a systemic element of payments in the UK economy.

1.2: The new regulatory regime for systemic payment systems using stablecoins

Figure 1.2: Scope of the Bank’s proposed regime

What type of stablecoin is the regime intended for?

For innovation in payments to thrive, regulation is needed to ensure it is safe and sustainable.

For the potential benefits of payment systems using stablecoins to be realised, it is necessary to have clarity about the regulatory framework within which they would need to operate. This will enable innovation to flourish in a sustainable way. Safety of sterling payments and confidence in money are fundamental to UK financial and economic stability. Having a clear regulatory framework will help to ensure that the stability of the financial system is safeguarded and the provision of payment services on which people depend are safe and reliable, even as issuers of new forms of money and operators of payment systems exploit new opportunities made possible by technological change. And it will allow those who want to use innovation to provide better products and services to understand the risks that need to be managed in line with the framework as they develop those products. It also ensures that new, innovative products are not simply gaining a competitive advantage over existing products by taking higher risks.

New technologies may be exploited by existing or new commercial banks by the tokenisation of the bank deposits that constitute the great majority of the ‘money’ used to make payments in the UK today. Equally they might be used by new non-bank entrants to the payments market whose business models are focussed more tightly on the provision of payment services as opposed to wider banking services.

The roadmap paper that accompanies this discussion paper explains how the regimes for these different models fit together, as summarised in Figure 1.3. For banks, the current regulatory regime for banking will need to be applied and tokenised deposits and other new forms of digital money will be subject to the approach set out in the accompanying letter to bank CEOs from the PRA. For non-banks, the Bank of England’s current regulatory regime for systemic payment systems and service providers will need to be extended to capture new technologies and risks, as will the Financial Conduct Authority (FCA) regime for payment providers.

The Government has enacted legislation that will allow the Bank to regulate systemic payment systems using stablecoins, to ensure they can be used as a safe means of payment and store of value.

Figure 1.3: Regulatory landscape for stablecoins issued by non-banks and banks

Footnotes

• Note that banks could issue other forms of money besides deposits, but deposits can only be issued by banks.

Ensuring that modern forms of money and payments meet the evolving needs of individuals and businesses, while maintaining financial stability, are fundamental responsibilities of the Government and the Bank. Reflecting this, under the Financial Services and Markets Act 2023 (FSMA 2023), Parliament^{footnote [6]} has expanded the regulatory remits of the Bank, the FCA, and the Payments Systems Regulator (PSR), to include stablecoins and payment systems using stablecoins.

The Bank’s implementation of its expanded remit is intended for stablecoins that are widely used for payments in the UK and that may pose risks to financial stability – which we refer to as ‘systemic payment systems using stablecoins’. The FCA’s remit will cover all ‘fiat-backed stablecoins’^{footnote [7]} issued in the UK. Stablecoins issued outside the UK will need to be approved for use in payments chains in the UK. This will allow the FCA to set rules to protect consumers and protect and enhance the integrity of the UK financial system, including where UK-issued stablecoins are used for activities other than payments. Further details as to the legislation and the regulators’ expanded remits, including for the PSR, are given in Section 2.

The Bank’s remit will cover systemic payment systems using stablecoins, systemic service providers to payment systems using stablecoins and related service providers. In existing payment systems, payments are made by transferring money that has been issued by central banks or commercial banks. When a stablecoin is used to make a payment, the stablecoin itself is transferred. Hence, an important element of the Bank’s regulatory regime will be to ensure systemic payment systems using stablecoins meet minimum standards in relation to the settlement asset being transferred – the stablecoin – itself. The key terms used in this discussion paper to describe the Bank’s proposed regulatory regime are provided in Table 1.1.

The regulatory standards proposed in this paper focus on sterling-denominated stablecoins used in systemic payment systems for retail payments.^{footnote [8]}

As noted previously, existing stablecoins are primarily used to settle transactions and to store value in cryptoasset markets. These markets have been growing rapidly and have already experienced a number of failures (Box B). However, they remain relatively small and have limited interconnections with the wider financial system. Consequently, the Financial Policy Committee (FPC) of the Bank has judged that, at present, direct risks to the stability of the UK financial system from cryptoassets and decentralised finance (DeFi) are limited, and hence stablecoins used primarily in cryptoasset markets or DeFi would not currently be considered as systemically important. In contrast, sterling-denominated stablecoins that are intended to be used widely for everyday payments by households and businesses in the UK would likely be recognised as systemically important. As such, they would need to be prepared to meet the regulatory standards proposed in this paper.

The Bank is considering the risks and benefits from innovations in wholesale settlement and will set out its views on this in due course.

For stablecoins that could be used for wholesale payments,^{footnote [9]} the Bank noted in its 2021 discussion paper that these raise different risks and issues that go beyond those addressed by the regulatory regime focused on in this paper. The Bank recognises that innovation may have potential benefits for wholesale market transactions. In this vein, Box C sets out the approaches to innovation in wholesale settlement that the Bank is currently pursuing, including the renewal of the RTGS service and a Roadmap for RTGS beyond 2024. The Bank is considering the risks and benefits of further innovations in wholesale settlement, including the use of stablecoins for wholesale purposes, and will set out its views in due course.

1.3: Safeguarding financial stability and the singleness of money

Systemic payment systems using stablecoins may pose risks to financial stability that differ and go beyond those associated with other payment systems and with money issued by commercial banks in the form of bank deposits.

In its 2021 discussion paper on digital money, the Bank examined the implications of new forms of digital money, including stablecoins, which have the potential to scale up and grow rapidly, and to become widely used as a trusted form of sterling-denominated payments.^{footnote [10]} It outlined the potential opportunities and risks presented by such stablecoins for monetary and financial stability (Box A). It noted that the most significant risk to financial stability arises from the potential for stablecoins to undermine public confidence in money and payments, and hence in the wider financial system. The analysis in the 2021 discussion paper and the responses to it, have informed both the Bank’s proposal set out in this paper and the legislation underpinning it.^{footnote [11]}

To maintain confidence in money and payments, all forms of money should have the same value, be generally accepted as a means of payment and be interchangeable without loss of value with all other forms of money used in the economy. This is called the singleness of money.

The ‘singleness’ of money refers to the principle that all forms of money should have the same value, be generally accepted as a means of payment and be interchangeable without loss of value with all other forms of money used in the economy. The stability of the UK economy and monetary system relies on this principle.

In the case of stablecoins, singleness of money could be compromised by frictions (eg delays, costs) in the ability to exchange the stablecoins for other forms of money, disruption to the ability to make payments, or a lack of confidence in the issuer’s ability to fulfil requests for redemption in full. In particularly adverse scenarios, a lack of confidence could cause a run on the stablecoin, involving redemption requests from a large number of coinholders. This, in turn, could overwhelm the issuer’s capacity to redeem the stablecoins, thereby leading to its failure. If this happened to a systemic payment system using stablecoins, it could disrupt the ability of users to make payments and lead to a loss of confidence in money and payments, and in the financial system more broadly.

Following a decline in the use of cash for payments over time, commercial bank money, which is issued by commercial banks in the form of bank deposits, now constitutes the majority of money used to make payments in the economy. For systemic payment stablecoins to be used alongside commercial bank money, the Bank must be satisfied that they provide an equivalent level of protection against loss of value and loss of confidence, in order to safeguard financial stability. This means that they must be regulated to an outcome equivalent to that which applies for commercial bank money in terms of resilience against risks – in other words, ‘same risk, same regulatory outcome’. This does not mean that issuers of stablecoins have to be regulated in exactly the same way as commercial banks. But it does mean they must be regulated in a way that ensures that stablecoins would maintain the same value as, and would always be fully interchangeable with, other forms of money. This speaks to the singleness of money.

To preserve the singleness of money, systemic payment stablecoins must be fully interchangeable with other forms of money.

Today, stablecoins are commonly traded in secondary markets. Their prices frequently deviate from par value and in times of stress these deviations can be significant. Were these stablecoins to be widely used for payments in the economy, such deviations would be a departure from the singleness of money and compromise confidence in them and their general acceptance in payments.

The Bank is not minded at present to prohibit systemic payment stablecoins from being traded on secondary markets. Rather, its proposed regulatory regime seeks to remove incentives for market participants to exchange systemic payment stablecoins at rates that depart from par. In particular, our approach is to require all issuers of sterling-denominated systemic payment stablecoins to ensure that they can be exchanged at par – that is, without loss of value – for other forms of money, including a digital pound (if introduced), on demand. This is consistent with the international standards published in July 2022 by CPMI-IOSCO for payment systems, which state that stablecoins should be convertible into other liquid assets as soon as possible, at a minimum by the end of the day, and ideally intraday.

The Bank recognises, however, that in future further requirements might be needed to maintain the singleness of money. This might include arrangements to ensure that, when coinholders move between stablecoins and commercial bank deposits, or other forms of money, these transactions are settled between the relevant institutions via accounts held at the Bank. This ensures that transactions are settled in central bank money (at par, and with no risk of change in value), which some argue is key to maintaining the singleness of money. The Bank welcomes views on this topic and will outline any further requirements in due course.

1.4: The FPC’s principles and expectations

The FPC has set two expectations for systemic payment stablecoins. These are consistent with a ‘same risk, same regulatory outcome’ approach to regulation.

In 2019 Q4, the FPC considered the risks of stablecoins that could have the potential to become widely used as a means of payments. These were assessed alongside other payment chains and existing forms of private money (ie commercial bank money). In the light of this assessment, the FPC set out two expectations around the regulation of systemic payment stablecoins:

• Payment chains that use stablecoins should be regulated to standards equivalent to those applied to traditional payment systems using commercial bank money. Firms in stablecoin-based systemic payment chains that are critical to the functioning of the chain should be regulated accordingly.
• Where stablecoins are used in systemic payment chains as money-like instruments they should meet standards equivalent to those expected of commercial bank money in relation to stability of value, robustness of legal claim and the ability to redeem at par in fiat.^{footnote [12]}

The FPC has subsequently clarified that systemic payment stablecoins issued by non-banks, which do not benefit from deposit protection or resolution arrangements, could nonetheless meet its expectations as long as regulation is designed to mitigate risks to financial stability to the same degree.

Under the banking regime, the safety of commercial bank money benefits from a backstop deposit guarantee scheme and resolution regime. A similar arrangement would be challenging to develop for systemic payment systems using stablecoins. The UK’s deposit guarantee scheme is funded by the financial services industry with firms paying an annual levy to fund the running of the scheme. At least in the short term, it is likely there will at most be a small number of systemic payment stablecoins in the market, which could limit the ability to pool risks to provide a sufficient guarantee at reasonable cost. And while, in principle, the risks of stablecoins could be pooled together with those of banks, this may not be appropriate given their different business models (both financial and operational), technology and regulatory frameworks. Meanwhile, a resolution regime for systemic payment stablecoins, if required, may take a number of years to design and implement.

In order to meet the FPC’s expectations in the absence of backstop arrangements that are available for banks, other elements of the regulatory regime, such as backing and capital requirements, would need to be more robust than for banks to ensure the necessary overall level of protections. These protections seek to ensure that stablecoin issuers are able to meet redemption requests promptly and in full, in normal times or in stress, so as to mitigate the risk of losses to coinholders.

The figure below summarises the key elements of the proposed regulatory framework, which is described in the remainder of this discussion paper.

Figure 1.4: Key elements of the regulatory framework for systemic payment systems using stablecoins and related service providers

Box C: Approaches to innovation in wholesale markets

The Bank, along with other public authorities and the private sector, has been active in exploring new technologies that could present and deliver on the opportunity to innovate in wholesale financial markets and wholesale settlement. As set out in the digital pound consultation paper, there are three different approaches that could be adopted to deliver enhanced provision of wholesale settlement.

Figure 1.5: Bank’s approach to innovation in wholesale markets

1. Enhance existing systems
RTGS Renewal Programme	The Bank is improving the RTGS service, which in 2024 will deliver a modern, flexible, and efficient core settlement engine. This will be modular, flexible and based on open standards. The renewed RTGS service includes the implementation of the ISO 20022 messaging standard. Its implementation will help to deliver wider interoperability between payment types, making it easier to switch between payment systems should the need arise.
Roadmap for RTGS Service Beyond 2024	The Bank is exploring what innovative services to introduce in RTGS after the new core settlement engine goes live. Following an industry consultation in 2022, the Roadmap for RTGS Service Beyond 2024 is currently focused on exploring new features in two key areas: Resilient channels to connect to RTGS; Innovation and global initiatives (which includes considering extending RTGS operating hours and introducing a synchronisation functionality). Progressing the priority features set out in the Future Roadmap for RTGS will be key to allowing us to offer the highest degree of resilience while facilitating innovation and competition in the fast-changing payments landscape. They will be key to helping the Bank to deliver wholesale enhanced digital money. Synchronisation for RTGS As part of the second Roadmap focus area (ie innovation and global initiatives), the Bank is considering introducing a synchronisation interface to connect RTGS with a wide range of other ledgers. The introduction of synchronised settlement would enable the Bank to integrate central bank digital money in RTGS with innovative technologies (such as Distributed Ledger). Synchronisation for RTGS would help realise and deliver on the opportunities presented by new forms of digital money, as specified in Box A. It would deliver on a number of benefits, including: allowing a wider range of financial market infrastructures to provide innovative settlement with risk-free central bank money, and it would lower liquidity costs and settlement risks associated with different types of transactions (such as housing or foreign exchange). Synchronisation enables ‘atomic settlement’, which allows linking the transfer of two assets in a way that one asset moves if, and only if, the other asset moves. Such conditional settlement is already widely adopted in securities settlement (eg via the CREST service) and foreign exchange settlement (via Continuous Linked Settlement - CLS). Synchronised settlement can be either Delivery versus Payment (DvP) or Payment versus Payment (PvP), depending on whether the other leg is a payment or an asset movement.
2. Enable private sector innovation
RTGS Renewal Programme	Within the RTGS Renewal Programme, the Bank’s focus has been to develop the Roadmap for ongoing improvements to the RTGS service. Some experiments and proofs of concept to deliver on these improvements have included: DLT Proof of Concept (2016): a project to explore and demonstrate basic functions of wholesale settlement using DLT. The Bank built on this work via a second exercise (2018) working with Baton Systems, Clearmatics Technologies Ltd, R3 and Token to ensure our renewed RTGS service could connect with systems based on DLT and other innovative technologies. Cross-border Synchronisation (2017): a joint project with Ripple demonstrating that synchronised FX transactions in two different simulated RTGS systems can be achieved. Project Meridian (2023): a joint project between the Bank for International Settlements (BIS) Innovation Hub London Centre and the Bank of England. The project developed a technical prototype for synchronised settlement, using housing transactions as an exploratory use case.
Extending access to RTGS	In 2017, the Bank broadened access to central bank money, to non-bank payment service providers eligible to apply for a settlement account in RTGS.
Omnibus Accounts Policy	Launched in 2021, the Omnibus Account is a new type of RTGS account, where the funds of different entities are co-mingled in a single account. In RTGS, the omnibus accounts are available to regulated payment system operators to pool participant funds, thus allowing them to fully fund wholesale settlement on their platform with central bank money.
FMI Sandbox	Announced by the Government in April 2021, the new sandbox is intended for firms exploring how to use technologies such as distributed ledger technology to improve FMIs. The sandbox will be delivered jointly by the Bank, HMT and the FCA, and will launch later in 2023. HMT is consulting on the first FMI Sandbox, referred to as the ‘Digital Securities Sandbox’, to be set up under the Financial Services and Markets Act 2023.
3. A new wholesale Central Bank Digital Currency (CBDC) platform
A new wholesale CBDC (wCBDC) platform could enable a wide range of new technological capabilities. However, through the RTGS Renewal Programme the Bank is in a position to realise a number of benefits commonly associated with wCBDC more quickly than it would be possible to launch an entirely new wholesale settlement platform and achieve scale in its usage. The Bank of England has not made any decisions about issuance of a separate wholesale CBDC. As stated in the Consultation Response Paper to the Roadmap for RTGS Service Beyond 2024, the Bank’s view is that the consultation feedback endorses the Bank’s near-term focus on providing enhanced wCBDC functionality via the renewed RTGS service. However, it does not preclude the Bank from continuing to track the findings of other central banks in exploring the merits of creating a separate wCBDC platform, and the Bank is constantly reviewing its wCBDC policy to ensure it accurately reflects the most effective strategy to enhance wholesale payments. The global central banking community continues to experiment with technologies associated with wholesale CBDC (including establishing new infrastructure). The Bank engages closely with such initiatives to evaluate whether wholesale CBDC technologies offer benefits to the UK and, if so, whether they might best be delivered via the renewed RTGS service, or whether new infrastructure might be needed. In particular, the Bank is closely involved with the work of the BIS Innovation Hub, especially its London centre, so is well positioned to understand and learn from the range of experiments and approaches being trialled internationally with regard to wholesale CBDC, and wholesale settlement more broadly.

2: The Bank’s proposed regulatory framework

The regulatory framework set out in this paper focuses on sterling-denominated stablecoins, as the Bank considers these are most likely, and suitable, to become widely used for retail payments. The Bank does not consider that unbacked digital settlement assets would be suitable for widespread use in retail payments in the UK.

As described in Section 1, the Bank’s payments remit has been expanded by FSMA 2023 to reflect innovation in financial technology. The Bank’s expanded powers are broad and capture a range of digital settlement assets used for payments, which could include those that are unbacked or which reference currencies other than sterling (including multiple fiat currencies), if recognised by HM Treasury as systemically important.

The main forms of money currently used in the UK consist of central bank money – reserve accounts held by banks and certain other financial institutions, and banknotes – and commercial bank money – bank deposits held by households and businesses. Importantly, commercial bank money is only acceptable for wide scale use in the UK if it is denominated in sterling, convertible into sterling fiat money at par, and convertible on demand.

The regulatory framework proposed in this paper focuses only on sterling-denominated stablecoins, as the Bank considers these are most likely to become widely used for retail payments. The Bank recognises the possibility that stablecoins referencing currencies other than sterling could become widely used in the UK and will monitor usage of these. If necessary, the Bank will consider how the proposed regulatory framework would need to be adapted for non-sterling referenced stablecoins. The Bank does not consider that unbacked digital settlement assets would be suitable for widespread use in retail payments in the UK.

In exercising its powers, the Bank will work closely with the FCA and other domestic regulators. It will also ensure that the regulatory framework for systemic payment systems using stablecoins is designed to ensure levels of resilience that are at least as great as those conferred by relevant international standards.

2.1: The Bank’s remit for systemic payment systems using stablecoins and related service providers

Systemic payment systems using new forms of digital money and related service providers have been brought into the Bank’s regulatory remit by FSMA 2023.

FSMA 2023 expands the Bank’s powers over payment systems in Part 5 of the Banking Act 2009 (‘the Act’) to include payment systems using new forms of digital money, referred to as digital settlement assets (DSAs). This is a new category of asset that includes stablecoins and other assets that meet the definition of a digital settlement asset.^{footnote [16]} DSAs are defined in the Act as ‘a digital representation of value or rights, whether or not cryptographically secured, that: (a) can be used for the settlement of payment obligations; (b) can be transferred, stored or traded electronically; and (c) uses technology supporting the recording or storage of data (which may include distributed ledger technology)’.^{footnote [17]}

Under the amended Part 5 of the Act, the Bank’s regime applies to DSA payment systems (which facilitate or control the transfer of the digital settlement asset) and DSA service providers (including DSA issuers and custodians) that have been recognised by HMT, via a recognition order, as being systemically important.^{footnote [18]} As set out in Table 1.1, a service provider could be recognised because it is systemic in its own right (for example, a wallet that provides services to multiple non-systemic stablecoins), or because it provides essential services to a systemic payment system or to a systemic service provider. HMT is responsible for deciding which payment systems and service providers are recognised as being systemically important and is required to consult the Bank as part of the recognition process. Further information on HMT’s role in the recognition process is set out in HMT’s latest policy update.

Figure 2.1: The Bank’s remit for systemic payment systems using stablecoins and related service providers

Once recognised by HMT, operators of recognised payment systems using stablecoins and recognised stablecoin service providers will be subject to the Bank’s existing powers under the Act. These include the power to obtain information, to issue principles and binding codes of practice, and to make directions. The Bank also has powers of enforcement over stablecoin firms within its remit that fail to comply with the Bank’s regulatory standards (Box D).

The Bank may amend existing rules set out in relevant codes of practice to apply to operators of recognised payment systems using stablecoins and service providers. The Bank will also make new rules for such entities to reflect the additional requirements set out in this paper. It will consult on these amendments and new rules in due course.^{footnote [19]}

In making a recommendation to HMT that it considers a stablecoin entity to be systemically important, the Bank will assess both the role of the entity in the transfer of payments and the stablecoin as a new form of money. It may make this recommendation where a payment system using stablecoins is not operating at systemic scale at present but is likely to do so in the future.

The systemic importance of payment systems using stablecoins and stablecoin service providers will be assessed according to the criteria for recognition set out in the Act. The Act states that HMT may recognise a payment system as being systemically important if it is satisfied that any deficiencies in the design of the system, or any disruption to its operation, would be likely to threaten the stability of, or confidence in, the UK financial system, or could have serious consequences for business or other interests throughout the UK. A similar recognition criterion applies for service providers.^{footnote [20]}

Before recognising an operator of a payment system using stablecoins or stablecoin service providers, HMT is required to consult the Bank. The Bank will expect to provide HMT with a recommendation comprising its assessment of entities relevant to an existing or prospective payment system using stablecoins against the recognition criteria in the Act (Box E). In doing so, the Bank will take into account the role of the existing or prospective entity both in facilitating payments and as an issuer of a new form of money. It may also recommend that a prospective payment system or service provider be recognised as systemic by HMT if they are not operating at systemic scale at present but are likely to do so in the future – this is referred to as ‘systemic at launch’.

At present, most stablecoins are pegged to the US dollar and are used primarily for investment and trading in cryptoassets or to underpin activity in DeFi applications.^{footnote [21]} As noted in Section 1, the FPC currently judges that direct risks to UK financial stability from cryptoassets and DeFi are limited, reflecting their limited size and interconnectedness with the wider financial system. Therefore, the Bank’s current assessment is that, at present, existing stablecoins (eg USD Coin or Tether), or any new sterling referenced stablecoins similarly focused on transactions in cryptoassets or DeFi, would not be brought under the Bank’s remit, and would not be subject to the proposed regulatory framework set out in this paper.

Other UK regulators have also seen their remit expanded over a range of stablecoin entities and activities.

As set out in HMT’s policy statement, HMT will bring the use of fiat-backed stablecoins in payments, and the activities of issuing and providing custody services to UK-based ‘fiat-backed stablecoins’^{footnote [22]} into the FCA’s regulatory remit. FSMA 2023 further expands the remit of the Payment Systems Regulator (PSR), which is the competition regulator for the payments industry. The PSR ensures that those payment systems and service providers designated under the Financial Services (Banking Reform) Act 2013, and hence added to its remit by HMT, are operated and developed in a way that considers and promotes the interests of all the businesses and consumers that use them. This means that some stablecoin entities – those that are recognised by HMT as being systemically important – may be regulated by the Bank (for prudential purposes), the FCA (for conduct purposes), and the PSR (for competition purposes). As set out in Section 2.3, UK regulators will provide clarity on how the regulatory framework for firms that fall within multiple regimes will work in practice in due course.

2.2: Regulating systemic payment systems using stablecoins and related service providers

The Bank’s regime is for systemic payment systems using stablecoins and related service providers. Activities other than payments, such as lending or investment, pose risks that are better captured within other regulatory regimes.

The Bank’s proposals in this paper are intended for stablecoins used in systemic payment systems that are focused on providing payment services. As such, the regime would prevent stablecoins from performing other functions, such as lending or investment, that would otherwise pose risks to the provision of payments at a systemic scale. Stablecoins that are focused on performing functions other than, or in addition to, payments will be better captured within other regimes.

For example, backing stablecoins with illiquid loans and thus performing credit creation increases the risk to the ability of the issuer to deliver on its obligation to redeem the full value of customers’ stablecoins at all times. Similarly, if complex and structured stablecoin-based products are used for speculative purposes, this may expose issuers and the value of stablecoins to market movements. In both cases, the risks incurred by performing other functions may reduce overall confidence in the stablecoins and, if used for payments at systemic scale, in payments and money more generally.

Other regimes are better able to mitigate the risks of performing these other functions. For example, in the banking regime, capital and liquidity requirements and the protections that apply in the event of failure (deposit guarantee scheme and resolution regime) address the risks of liquidity and maturity mismatch between banks’ loan assets and liabilities. This in turn, ensures the robustness of monies issued by commercial banks, and hence safeguards the singleness of money used in the UK.

The Bank’s regulatory regime would ensure relevant risks are captured no matter how a stablecoin payment chain is structured.

Stablecoin payment chains are typically composed of multiple functions and activities, which may be performed by a single (legal) entity or by separate entities. Broadly, a generic stablecoin payment chain is composed of three main functions (Figure 2.2):

1. The issuance function that creates stablecoins. This also includes redeeming, or destroying, the stablecoins. It may also encompass the management of the backing assets, though this activity may be outsourced to a third party.
2. The transfer function that records transactions and transfers the stablecoins, and the ownership rights and value associated with them, between customers. In existing stablecoins, a significant part of this transfer function is performed by public permissionless ledgers.
3. Store of value/exchange of value usually provided by customer-facing entities such as wallet providers and exchanges. Most stablecoins – or the technological means of exercising control over those stablecoins, such as ‘private keys’ – are held in electronic wallets, which may adopt different models. Exchanges that deal with stablecoins (and cryptoassets more broadly) facilitate customers’ ability to exchange stablecoins for commercial bank money and other cryptoassets.

The integration of several of these functions into one entity may pose financial stability risks that will need to be carefully addressed and managed. The Bank’s approach to mitigating those risks is discussed in Section 2.4.

Figure 2.2: Main functions of a stablecoin payment chain

The three main functions give rise to a number of risks in the payment chain as a whole. Risks can be either operational in nature, for example, due to cyber risk or fraud, or prudential, for example, if insolvency of the issuer means that customers are not able to redeem the full value of their stablecoins. The Bank’s regime aims to adopt an end-to-end approach to regulating systemic payment systems using stablecoins – to ensure that risks in the payment chain are comprehensively assessed and controlled for, and do not disrupt the functioning of the payment system. Reflecting this, the entirety of the stablecoin payment chain, and the entities that comprise it, would be expected to demonstrate robust financial resources, risk management (including risks arising from the use of third parties), and governance.

As the regulator and supervisor of systemic payment systems, the Bank’s objective is to ensure that the system conforms to the FPC’s expectations and international standards. Systemic payment systems using stablecoins will need to determine an entity that should be held responsible for the safe and proper operation of the transfer function.

The Banks’ proposed regulatory regime is flexible and could accommodate different business models and structures. In some cases, however, firms will need to make changes to ensure that they meet the FPC’s expectations and international standards. The starting point for the proposed regime is the international Principles for Financial Market Infrastructure (PFMIs). These aim to ensure the comprehensive risk management of, as well as financial and operational resilience of, all systemic payment systems (Sections 2.3 and 3). Further requirements then relate to the issuance of stablecoins (Sections 4 and 5), the store and exchange of value function (Section 6), and the provision of services to firms in the payment chain (Section 7).

As with its approach to the regulation of other systemic payment systems, and in line with international standards, the Bank’s approach to regulating and supervising systemic payment systems using stablecoins involves determining the entity that is held responsible for performing the transfer function and acts as the payment system operator. That entity – once recognised by HMT – would be responsible for ensuring it can assess and control for all risks that may arise across the entire payment chain (including from the form of infrastructure or ledger used) and may disrupt the functioning of the payment system. In other words, the recognised payment system operator would need to perform the role of ‘systemic risk manager’ across the entire chain. Importantly, the operator of a systemic payment system using stablecoins would also be responsible for ensuring that the settlement asset it uses meets the FPC’s expectations and international standards.

Ensuring the reliability and stability of the settlement asset is critical. At present, systemic payment systems only use central bank or commercial bank money to settle transactions. The former is backed by the central bank; the latter is issued by firms subject to robust requirements that mean it is easily and frictionlessly interchangeable with central bank money. Overall, this means that existing recognised payment system operators do not have to assess or manage risks to the stability and robustness of the settlement asset they use. The Bank’s proposed regime aims to regulate stablecoins to equivalent standards as those applicable to commercial bank money and ensure that they can be used safely in systemic payment systems.

The Bank would expect the recognised payment system operator to choose a settlement asset that complies with the requirements for issuers set out in this paper. In practice, this means either issuing the stablecoin itself and being regulated against our proposed requirements for issuers, or choosing another issuing entity that is regulated as a service provider (subject to HMT recognition) and which meets these requirements.

The entity that the Bank regulates and supervises as a recognised payment system operator, and that will therefore be responsible for overseeing the entire payment chain, will depend on the structure of a systemic payment system using stablecoins (Figure 2.3). This may, for example, be the entity operating a permissioned ledger. Or it may be an issuer that uses a permissionless ledger and sets the rules for transferring stablecoins on top of the consensus mechanism – the rules set out in computer code – under which the ledger operates. Firms will have the flexibility to adopt different business models and structures, and the Bank will, wherever possible, use the flexibility in its regime to accommodate those structures and bring them within the regulatory framework.

The Bank will also be able to regulate any critical entity in a systemic stablecoin payment chain, if recognised by HMT, in light of the activity performed and the risks posed.

The disruption to, or outage of, any activity provided by service providers in a systemic stablecoin payment chain may threaten customers’ ability to access their means of payment and, by extension, pose financial stability risks. Reflecting this, in addition to regulating the recognised payment system operator, the Bank will regulate recognised service providers in the light of the risks those entities pose to the functioning of the payment chain as a whole. These could include, for example, entities such as wallet providers and payment service providers, as well as issuers (if separate from the recognised payment system operator). Such firms, once recognised by HMT, would be subject to the entirety of the Bank’s powers as set out under the Act and our supervisory regime once finalised. This is similar to the Bank’s ability to regulate service providers that provide critical services to other systemic payment systems.

The Bank’s proposed regulatory regime is designed for systemic payment systems using stablecoins for retail payments. Proposed holding limits, if used, will constrain wholesale use of stablecoins, at least initially.

The proposed regulatory regime in this paper is intended for stablecoins that have the potential to become widely used for retail payments by households and non-financial businesses in the UK. As explained in Section 5.6, the Bank is considering imposing holding limits for individual coinholders. These are intended to mitigate risks to financial stability associated with large-scale outflows from bank deposits into stablecoins. These holding limits would also constrain wholesale uses of stablecoins by placing an effective cap on the size of transactions.

Figure 2.3: Examples of stablecoin payment chains

2.3: Joint regulation with other authorities

The Bank will work closely with HMT and other regulators to allow for a smooth transition into the Bank’s regime and to minimise regulatory overlaps for firms that may fall within multiple regulatory regimes.

Dual regulation is common today, for example, for banks and investment firms that are in the remits of the PRA and FCA, and systemic payment systems that are in the remits of the Bank and PSR. As noted in Section 2.1, some entities within stablecoin payment chains may be regulated by multiple regulators. This section outlines a number of possible scenarios by which this may occur.

Direct entry into the Bank’s regime

A payment system that uses stablecoins could be recognised as systemic at launch. This may be the case, for example, if a firm already has a large user base, which could enable rapid growth in use of their proposed stablecoin as a means of payment. In this case, subject to being recognised by HMT, firms forming part of the systemic payment chain that are also within the FCA’s remit (eg issuers) would be dual regulated – by the Bank for prudential purposes and the FCA for conduct purposes. The PSR may also have a remit over such firms, if these are designated by HMT.

Transition from solo FCA regulation into dual regulation

Some stablecoins might start off as non-systemic, and become more widely used for payments progressively, over time. In such cases, subject to HMT’s recognition decision, any firm that is critical to operating the systemic payment system would become subject to the Bank’s prudential regime. If such firms are already regulated by the FCA (eg as an issuer), they would effectively need to transition into the Bank’s regime and be dual regulated by both the Bank and FCA (and, where relevant, the PSR).

The Bank’s regime specifically aims to mitigate the financial stability risks that may arise from systemic payment systems using stablecoins. As a result, some components within the Bank’s regime will differ from the FCA’s regime for stablecoin issuers - for example, in relation to limits, if implemented, and because systemic stablecoins will be required to be backed by central bank deposits whereas a deposit account with the Bank will not be available to non-systemic stablecoin issuers. Stablecoin firms that need to transition into the Bank’s regime may therefore have to make changes to their business models.

Effective information sharing between UK regulators will be critical for the Bank to be able to identify early those issuers that may be systemic or likely to be systemic in the future and to provide a smooth glidepath for stablecoin issuers into the Bank’s prudential regime. Close engagement between the industry and UK regulators will also be needed to enable firms that are close to reaching systemic levels to prepare themselves for (and thus mitigate the costs of) going through HMT recognition and then transitioning into the Bank’s prudential regime.

Service providers might also be dual-regulated

Service providers such as custodians, exchanges (and issuers if separate from the firm recognised as the payment system operator), may be systemic in their own right or provide essential services to systemic payment systems using stablecoins or recognised stablecoin service providers. Such service providers might also be dual regulated by the Bank and the FCA, where they are recognised by HMT.

In implementing its supervisory powers, the Bank will continue to work closely with the FCA, the PRA and the PSR.

The Bank co-operates closely with the FCA, the PRA, and the PSR in relation to the supervision of payment systems. The framework for co-operation is set out in a Memorandum of Understanding (MoU), which is reviewed annually by the parties involved. At this review stage, feedback on the MoU is incorporated from supervised firms. UK regulators will revisit this MoU in the light of the changes to their respective remits under FSMA 2023 and provide further clarity to the industry on how cross-authority regulation and supervision will work in practice.

As part of FSMA 2023, HMT may, via secondary legislation, make provisions relating to the regulation of recognised DSA payment systems and service providers, for example to clarify how dual regulation of systemic stablecoin entities will work in practice. The UK regulators will work closely with HMT to shape any secondary legislation that is needed beyond the cross-authority MoU, aiming to provide further clarity and certainty to the industry.

UK regulatory requirements around systemic payment systems using stablecoins and related service providers will be consistent with recommendations, standards and guidance by international standard setting bodies and the Financial Stability Board

Internationally, the Financial Stability Board (FSB) and international standard setting bodies have developed recommendations, standards and guidance to apply a ‘same risk, same regulatory outcome’ approach to systemically important stablecoins used for payments (Box F). Efforts have aimed to minimise gaps and avoid regulatory arbitrage across sectors and jurisdictions, while ensuring that the emergence of systemic stablecoins used for payments does not threaten financial stability.

The proposed UK regulatory requirements for systemic payment systems using stablecoins and related service providers are consistent with the international recommendations, standards and guidance. The FSB and international standard setters continue working together to ensure that the cryptoassets ecosystem, including stablecoins, is closely monitored and subject to robust regulation, supervision, and oversight, to mitigate potential risks to financial stability.

2.4: Organisational structure

The Bank is examining potential risks around the resilience of systemic payment systems using stablecoins involving entities that undertake multiple functions. It is considering how to mitigate these risks adequately, including via legal separation of activities, if appropriate.

Certain entities in the payment chain, for example, exchanges, may undertake – whether through a single legal entity or an affiliated group of entities – various combinations of functions. Examples of functions may include: facilitating trading, settlement, custody, market-making, lending and borrowing, proprietary trading, broking, onboarding customers, and issuance of stablecoins. This is sometimes referred to as ‘vertical integration’.

Combining certain activities within the same entity or group could create synergies and other opportunities. However, vertical integration can also lead to vulnerabilities, including conflicts of interest, inadequate safeguarding of clients’ funds and assets, as well as complex and potentially reinforcing risk profiles.^{footnote [23]} This has been demonstrated by events of the past year, such as the collapse of FTX.

Risks associated with vertical integration also exist outside the cryptoasset sector, for example, in banking groups, financial conglomerates, as well as large technology firms that undertake a variety of activities not just limited to financial services. In these group structures, unregulated entities can undertake activities that have the potential to create risks for the group as a whole and increase the risk of failure of other regulated entities within that group. Reflecting this, in the UK, banks are subject to regulatory requirements to manage the risks arising from their corporate structures. In addition, ring-fencing provides a broader set of legislative and regulatory requirements for groups within scope to protect the provision of core retail banking services from risks associated with other activities.

Where multi-function entities engage in stablecoin functions, this may pose particular risks for financial stability in the absence of appropriate safeguards. For example, when the issuance of stablecoins is combined with other activities that present risks (eg, facilitating the trading of an issuer’s own stablecoins, engaging in brokerage, market making and proprietary trading), this could increase the risk of failure of the issuer and affect the ability of coinholders to redeem in normal times, in stress and in failure.

The Bank considers that, in line with the PFMIs, systemic payment systems using stablecoins would need to focus particular attention on certain aspects of their governance and risk-management arrangements to address the risks posed by vertical integration. This may include legally separating the non-stablecoin services that a multi-function entity provides, if those services present a distinct risk profile from, and potentially pose significant additional risks to, the activities performed within the stablecoin payment chain. In particular, the Bank may require the issuer to form a legal entity that is sufficiently financially, operationally, and organisationally separate from other entities in the wider group, so that it is bankruptcy remote. This approach is consistent with recommendations, standards and guidance by the Financial Stability Board^{footnote [24]} and international standard-setting bodies.^{footnote [25],footnote [26]}

In addition, the FCA will give further consideration to the risks of vertical integration in the cryptoasset sector more broadly, and the Bank will engage with UK public authorities to consider how the regime for systemic payment stablecoins interacts with other parts of the framework (including the FCA’s regime).^{footnote [27]}

Some parts of a systemic stablecoin payment chain will be subject to subsidiarisation requirements, to ensure capital and liquidity are held locally to support coinholders’ claims and that services provided in the UK are adequately supervised and regulated.

The Bank may use its powers of direction under the Act to set a location requirement on entities within a systemic stablecoin payment chain. The Bank can apply such a requirement as part of its role in overseeing, regulating, and supervising recognised entities, in this case systemic stablecoin issuers. HMT previously noted that it would not pursue an automatic or ex ante location requirement for an entity recognised under the Act.^{footnote [28]} But it further noted that the Bank has the ability to apply such a requirement where it deems this necessary as part of its role in overseeing the risk posed by a particular recognised entity’s operations.^{footnote [29]}

In its role as lead supervisor of systemic FMIs, including systemic payment systems, the Bank needs to ensure that risks to financial stability are mitigated and managed through appropriate regulation and supervision, and in a manner that is consistent with the public interest. To this end, the decentralised model of operations and governance adopted for some digital assets, including systemic payment systems using stablecoins and related service providers, could heighten the risks of creating gaps in the allocation of regulatory, supervisory and oversight responsibilities for authorities. These gaps could weaken the resilience needed for systemic payment systems on which households and businesses rely.

Systemic payment stablecoins could be provided and used digitally without being confined to a specific jurisdiction. If a systemic stablecoin issuer providing services to UK-based consumers operated from a legal entity incorporated and regulated outside the UK, or was a branch of such an entity, it would be impractical for the Bank to impose prudential controls on the entity as a whole. It would therefore, in practice, be reliant on prudential controls operated by the issuer’s home state regulator. Although the Bank could consider the equivalence of such controls with its own regime and obtain visibility over their exercise, we do not consider that this would be sufficient to achieve the Bank’s objectives and to establish a clear overall supervisory responsibility for the systemic UK stablecoin payment chain as a whole.

The Bank therefore proposes that issuers of systemic payment stablecoins should be set up in the UK as subsidiaries in order to carry out business and issuance activities into the UK and with UK-based consumers, both directly and through intermediaries.^{footnote [30]} The backing assets (Section 4) and the issuer’s capital (Section 5) would also need to be held in the UK.

The Bank’s approach for the effective supervision of systemic payment systems using stablecoins that are part of international groups or headquartered overseas is consistent with the PRA’s approach to supervising international banks, under which UK establishment is required where retail deposits exceed a certain threshold.

As regards to other non-UK elements of the payment chain, ie non-issuer systemic entities within stablecoin payment chains, the Bank will take an approach based on the framework applied to those FMIs it currently supervises. The approach will need to consider the risks posed by these recognised entities to the Bank’s objectives, the mitigating factors, and the need to ensure continuity of services in case any of these types of entities fail. Additionally, as it does currently in relation to those FMIs that operate across borders, the Bank will seek co-operation between authorities in different jurisdictions.

In line with this approach, the Bank will have regard to the PFMIs and the agreed responsibilities for central banks, market regulators and other relevant authorities for FMIs. Specifically, the Bank’s approach will be guided by Responsibility E,^{footnote [31]} which states that central banks, market regulators, and other relevant authorities should co-operate with each other, both domestically and internationally, as appropriate, in promoting the safety and efficiency of FMIs. As a result, this approach could allow for the possibility of supervisory and/or regulatory deference, subject to international standards.

Part 2: Further details of the Bank's proposed regulatory framework

3: Requirements for the transfer function

Figure 3.1: Summary of requirements for the transfer function

3.1: The Bank’s ‘same risk, same regulatory outcome’ approach to the transfer function in systemic payment systems using stablecoins

The Bank’s approach to regulating systemic payment systems using stablecoins aims to ensure that they deliver end-to-end financial and operational resilience.

Systemic payment systems carry out a function of settling payment obligations by facilitating the transfer of the settlement asset (predominantly, money) between customers. As outlined in Section 2, the Bank’s approach to the regulation and supervision of systemic payment systems is based on the international standards set out in the CPMI-IOSCO PFMIs. Among other things, those aim to ensure that systemic payment systems: are financially and operationally resilient; can oversee, assess and control for the risks along the entire payment chain that could threaten their operations and ability to meet their regulatory expectations; have processes in place to ensure that transactions that have been completed cannot be arbitrarily cancelled or annulled; and use a settlement asset that is robust and reliable across all participants of the system.

The Bank has used its powers under Part 5 of the Act to set binding rules based on those international standards via Codes of Practice. These include requirements on operational resilience, third-party outsourcing risk management, and governance. The entity recognised by HMT as the payment system operator (the ‘recognised payment system operator’) is in charge of ensuring that those rules are complied with, and that international standards are adequately adhered to. This includes ensuring that end users have clear and transparent information as to the degree of protection against various risks of malfunctions or hacks of their means of payments (eg debit cards).

Requirements for systemic payment systems using stablecoins should reflect their similarities with other payment systems, while accounting for their innovative nature.

Similar to other systemic payment systems, those using stablecoins carry out the function of transferring a settlement asset in order to settle payments obligations. To the extent that the risks in doing so are similar to those of the transfer function performed by other systemic payment systems, we propose to rely on our existing regulatory and supervisory approach to those systems. This is in line with the Bank’s ‘same risk, same regulatory outcome’ approach to regulating systemic payment systems using stablecoins, as reflected in the FPC’s expectations outlined in Section 1.

This means that, in any systemic stablecoin payment chain, the Bank will regulate and supervise (subject to HMT recognition) a central entity (the recognised payment system operator) as being responsible for the robust operation of the transfer function. Alongside demonstrating robust financial and operational resilience, the responsibilities of the recognised payment system operator will include: assessing comprehensively the risks along the chain that could threaten its operations and ability to meet regulatory expectations; and putting adequate controls in place to address those risks. As outlined in Section 2, who that entity is (eg the issuer or another entity) will depend on the nature of the business model.

At the same time, relative to other payment systems, the transfer function of systemic payment systems using stablecoins includes elements that are innovative in nature – for example, the use of external and distributed ledgers (as opposed to in-house ledgers with a centralised entity to record transactions).

In its guidance on the applicability of the PFMIs to stablecoins (Box F), CPMI-IOSCO recognised those novel features and clarified how international standards would apply to systemic stablecoin payment chains – highlighting, in particular, those related to settlement finality, money settlement, governance and risk management. Consistent with this, the Bank recognises that further supervisory guidance may be needed to give additional detail on how systemic payment systems using stablecoins may comply with the Bank’s requirements already applicable to systemic payment systems.

3.2: Leveraging the benefits from, and addressing the risks of, innovative forms of ledgers

Ledgers are critical to performing the transfer function in stablecoin payment chains.

Ledgers form the underlying infrastructure that enables the transfers of stablecoins from one holder to another to be recorded. As such, they are critical to performing the transfer function otherwise performed by the operators of payment system operators or a bank’s internal ledger.

Generally, stablecoin issuers decide on which ledgers to issue their stablecoins guided by the features offered by different ledgers and how much they are already used. Box G provides an overview of the various forms of ledgers. At present, issuers often choose to issue their stablecoins on public permissionless ledgers. Alongside stablecoin issuers, banks and other payment systems have also explored using both permissioned and permissionless ledgers to develop new products, including tokenised deposits and permissionless ledger-based settlement.

The Bank recognises the benefits that new forms of ledgers can bring for payments.

The Bank recognises that new forms of ledgers, both permissioned and permissionless, present benefits in terms of efficiency and operational resilience. For example, they can enable frictionless, real-time cross-border payments. Through the use of open-source code and smart contracts, they enable more agile development of innovative payments features. End-to-end encryption and the sharing of transaction records across a network of participants ensure greater security and limit the risk of a single point of failure inherent in existing payment systems. At the same time, public ledgers and the transparency they offer over the transactions performed allow for traceability of fraudulent and unauthorised transactions. Previous ransomware events, for example, have demonstrated how blockchain analysis technology can be used to identify the private keys to wallets used for illicit transactions, and cancel them accordingly.

However, some stablecoin payment chains using public permissionless ledgers do not evidence a single (set of) entity(ies) that can take full responsibility for ensuring the robust operation and risk management of the transfer function.

For these benefits to be realised, however, it is also important that the payment chains that use new forms of ledgers are resilient. In the case of permissionless ledgers, the entities involved in some existing stablecoin payment chains that rely on them tend to operate independently from each other. And there is not obviously one firm that takes responsibility for ensuring the robust operation of the transfer function and mitigating the risks from the infrastructure (ledger) used to deliver it. More generally, this means that there is no entity in charge of comprehensively assessing the risks of the entire payment chain, as required by international standards, and building the right controls to mitigate them. This contrasts with a payment chain where the transfer function relies on a permissioned ledger managed by one central entity.

The lack of a central entity to govern the safe operation of the transfer function and to assess risk across the entire chain means that failures or outages materialising on the ledger may not be addressed adequately or sufficiently rapidly. Governance arrangements that rely solely on software (eg on the consensus mechanism developed for the operation of permissionless ledgers) are likely to be inflexible in the case of providing contingencies and responding to unforeseen situations that may require expert judgment and human intervention to induce change or enforce corrective action.

This absence of centralised governance arrangements makes it particularly challenging to address one of the core risks from permissionless ledgers – namely, that settlement of transactions may not always be final. As indicated in Section 2 (Box F), the CPMI-IOSCO guidance sets out clearly that, like other systemic payment systems, systemic payment systems using stablecoins should provide ‘clear and certain final settlement’. They should clearly define the point at which settlement becomes irrevocable and unconditional, and there should be a clear legal basis acknowledging and supporting the finality of transfers.

The consensus mechanism used by most existing permissionless ledgers provides probabilistic settlement, where there is always a risk for transactions that have already been approved to be reversed or cancelled. The risk that settlement is not final reduces with each new block of transactions validated and added to the ledger, meaning that it has become common practice for users to wait for a number of such blocks before considering that settlement is, practically, final. However, this does not mitigate the risks of complex and elaborated ‘attacks’ on the ledger by fraudulent actors, of which there have been multiple occurrences in the past, and which may cause disruptions to settlement – for example, if those attacks result in a new ‘chain’ of transactions being created, rendering the previous ones obsolete and, in effect, annulled. In turn, this may mean that customers lose ownership of, and/or means of access to, their stablecoins, thereby preventing them from exercising their legal claim to redeem the full value of their stablecoins from the issuer.

The Bank does not consider that a systemic payment chain operated in such a decentralised way can meet the FPC’s expectations and international standards.

In the light of these concerns, the Bank considers that the presence of a central entity assuming the role of payment system operator and regulated as such (subject to HMT recognition) is necessary to mitigate risks in a comprehensive way. This entity, which could be the issuer, would be responsible for ensuring that risks arising from the choice of ledger can be adequately mitigated, while leveraging the benefits that innovative forms of ledgers can bring. The Bank acknowledges that such an entity may not be able to exercise the degree of control over public permissionless ledgers needed to meet international standards and the FPC’s expectations. At the same time, it is open to the possibility that solutions – be they in the form of technological innovations and/or legal arrangements – may be developed to mitigate the core risks of permissionless ledgers to a degree the Bank deems satisfactory. The Bank recognises that industry is already working actively on these issues and would welcome views on how such changes and/or solutions may be built in the future.

Box G: Different models for distributed ledgers

Ledgers may be categorised along a spectrum, as highlighted in Figure A.

Figure A: Spectrum of models for new forms of ledgers

The distinction between permissioned and permissionless ledgers refers to the different ‘consensus mechanisms’ that govern the process used to enable transactions to be approved and recorded.

Permissionless ledgers are typically open networks relying on consensus mechanisms that allow anyone, without restriction, to contribute to the validation of transactions. They can vary in their design, depending on the type of use they are intended for and features they want to offer. Permissionless ledgers based on ‘proof-of-work’ consensus protocols require the operation of dedicated hardware to enable the participation to the consensus protocol, while ‘proof-of-stake’ consensus protocols rely on the incentives provided by the network's native cryptocurrency in order to operate the consensus protocol. However, at their core, the consensus mechanisms of most permissionless ledgers enable transparent distribution of data, decentralisation of control over the ledger, and make extensive use of cryptography and tokenisation/automation. Some permissionless ledgers may operate in a fully decentralised manner. On the other hand, others may have a centralised entity in charge of overseeing the operation and developments of the ledger, for example, to guide participants through changes in the form of consensus mechanism used.

Permissioned ledgers also provide the innovative technological features offered by permissionless ledgers – indeed, both types of ledgers allow for programmable or ‘smart’ contracts. In fact, the consensus protocol may itself be managed via a smart contract. At the same time, they also allow their operator(s)/administrator(s) to restrict access to a specific set of entities or persons and to the functions these can carry out.

In addition, ledgers may be either public or private. The former allow any participant to see fully the state of the ledger and transactions performed. On the other hand, the latter allow the operator of the ledger to restrict access to the records to a set of selected and verified participants only. Different layers of access can be granted, restricting access to certain information to different types of participants.

4: Requirements on backing assets and restrictions on remuneration for the issuance of stablecoins used in systemic payment systems

Figure 4.1: Stablecoins used as a means of payment should be stable in value

Requirements on backing assets and restrictions on remuneration need to ensure that stablecoins used in systemic payment systems are always stable in value. This is a necessary requirement for money that is used widely as a means of payment in the economy and is fundamental to financial and economic stability.

A necessary requirement for any form of money used with confidence as a means of payment in the UK economy is that it maintains its value at all times and is interchangeable at par for other forms of sterling-denominated money. This includes both cash issued by the Bank of England and money issued by commercial banks in the form of bank deposits.

Commercial banks back the money they issue with a variety of assets including long-term loans to households and businesses. In doing so, they undertake liquidity and maturity transformation, which exposes them to credit, liquidity and market risk. The regulatory and supervisory regime for banks aims to mitigate these risks. Along with deposit protection and other requirements, this ensures that commercial bank money maintains its value and can be used with full confidence as a means of payment in sterling and can be exchanged on demand and at par for other forms of money circulating in the economy.

Stablecoins backed with assets that generate credit, liquidity or market risk are not suitable for use in systemic payment systems under the Bank’s proposed regime. Such business models more closely resemble commercial bank business models would be more appropriately regulated under the banking regime, which can better regulate these risks.

The Bank’s regime is intended for payment system business models that do not involve the payment system exposing itself to credit, liquidity or market risk, and which generate revenue from payment services rather than liquidity and maturity transformation.

4.1: Backing assets

Backing assets are the mechanism through which stablecoins aim to maintain a stable value against fiat currencies. These are assets held by the issuer to provide a value equal to that of the stablecoins in issuance.

Stablecoins aim to maintain a stable value, primarily against existing fiat currencies. To achieve this, stablecoin issuers usually claim to hold assets that are at least equal in value to the stablecoins in issuance. These assets are known as ‘backing’ assets.

As noted previously, the regulatory regime for commercial banks is intended to address the risks that arise from backing commercial bank money with assets that generate credit, liquidity or market risk.

For systemic payment systems using stablecoins under the Bank’s regime, the Bank judges that the stablecoins will need to be backed by assets that do not generate these risks. In the 2021 discussion paper, we outlined three different backing models for non-bank^{footnote [39]} issued stablecoins for use in systemic payment systems: commercial bank deposits; high-quality liquid assets (HQLA), including central bank deposits and high-quality government bonds; and 100% central bank deposits. Of these, the Bank judges that the 100% central bank deposits model is most appropriate for systemic payment systems using stablecoins operating in the UK.