UK Treasury Creates New Proposal to Limit Effects of Stablecoin Collapses

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Fol­low­ing the fall­out of the crash of the algo­rith­mic sta­ble­coin Ter­ra this month, the U.K. Trea­sury tables a new insol­ven­cy regime designed to pro­tect con­sumers’ assets.

The now infa­mous crash of the sta­ble­coin Ter­ra ear­li­er this month fol­low­ing a series of seem­ing­ly unco­or­di­nat­ed deposits and with­drawals wreak­ing hav­oc with the algo­rith­mic sta­ble­coin has been met with a new U.K. pro­pos­al to lim­it the fall­out of future sta­ble­coin crashes.

In the new pro­pos­al, the U.K. Trea­sury assigns main­tain­ing busi­ness con­ti­nu­ity and lim­it­ing the effects of a sta­ble­coin crash to the cen­tral bank, the Bank of Eng­land. This pro­pos­al comes after announce­ments last month to reg­u­late reserve-backed sta­ble­coins in the wake of the Queen’s speech.

Unlike Bit­coin, which is not pegged to any­thing, sta­ble­coins are tied to the val­ue of a fiat cur­ren­cy, rely­ing on liq­uid reserves, includ­ing cash and short-term gov­ern­ment debt, to main­tain their peg to fiat. Or, in the case of Ter­ra, a soft­ware algo­rithm with­out guardrails. They are often an on-ramp into the cryp­to ecosys­tem, allow­ing peo­ple to buy oth­er cryp­tocur­ren­cies with­out leav­ing the dig­i­tal asset ecosys­tem. Famous sta­ble­coins include USDT, issued by Teth­er, and USDC, issued by Cir­cle. The mar­ket cap­i­tal­iza­tion of sta­ble­coins is almost $160B, accord­ing to Coingecko.

Recent­ly, Ter­ra lost its peg with the U.S. dol­lar due to a series of large with­drawals and deposits that pushed the algo­rithm to cre­ate more and more of a sis­ter token, Luna, send­ing its price spi­ral­ing. The broad­er cryp­to mar­ket was shak­en to its core as oth­er dig­i­tal assets plum­met­ed amidst mas­sive bit­coin sell-offs by the Luna Foun­da­tion Guard, an orga­ni­za­tion hold­ing bit­coin designed to prop up the Ter­ra stablecoin.

The close cor­re­la­tion between sta­ble­coins and tra­di­tion­al assets has stoked glob­al con­cern from reg­u­la­tors, prompt­ing a nar­row­er focus on reg­u­lat­ing this niche with­in the broad­er dig­i­tal asset mar­ket. “Events in cryp­to-asset mar­kets have fur­ther high­light­ed the need for appro­pri­ate reg­u­la­tion to help mit­i­gate con­sumer mar­ket integri­ty and finan­cial sta­bil­i­ty,“ Her Majesty’s Trea­sury told the Finan­cial Times on May 31, 2022.

Essential to follow oversight holdings

The gov­ern­ment depart­ment believes that it is essen­tial for sta­ble­coins to fol­low over­sight mech­a­nisms to mit­i­gate poten­tial risks. Fol­low­ing the 2008 finan­cial cri­sis, the Trea­sury called on lead­ing banks to devel­op “liv­ing wills,” or instruc­tions on pos­si­ble action that can be tak­en when an insti­tu­tion is distressed.

Lenders need to keep min­i­mum hold­ings of reserves to shore up their bal­ances and pre­vent a “bank-run” sit­u­a­tion where banks hold insuf­fi­cient cash to meet all their with­draw­al require­ments, caus­ing the bank to default.

The U.K. gov­ern­ment is also con­sid­er­ing cre­at­ing new laws on sta­ble­coin col­laps­es that pose risks to pay­ment ser­vices, fol­low­ing announce­ments that it would adapt exist­ing laws gov­ern­ing elec­tron­ic mon­ey to sta­ble­coins. At the same time, the Trea­sury pro­pos­es mod­i­fi­ca­tions to insol­ven­cy rules for pay­ments net­works should an impor­tant sta­ble­coin fail.

Stablecoin holders must be reimbursed in the event of a collapse

Cur­rent laws gov­ern­ing pay­ment net­works are designed to ensure busi­ness con­ti­nu­ity should the net­work fail. How­ev­er, since peo­ple hold sta­ble­coins, laws must also deal with recoup­ing cus­tomer funds and return­ing pri­vate keys when the net­work fails. Keys are long strings of num­bers that essen­tial­ly func­tion as pass­words for trans­act­ing in cryp­to. When cus­tomers open an account with a cus­to­di­al cryp­to exchange, they entrust the keys for their wal­lets to the insti­tu­tion in exchange for a more tra­di­tion­al password.

Last month, Chan­cel­lor of the Exche­quer Rishi Sunak com­mis­sioned the Roy­al Mint to cre­ate an NFT as part of a broad­er push to make the U.K. a “glob­al hub” for crypto.

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