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Stablecoins: What’s old is new again – speech by Christina Segal-Knowles

Bank of England | Christina Segal-Knowles | Jun 10, 2021

Christina Segal Knowles - Stablecoins: What’s old is new again - speech by Christina Segal-KnowlesOverview

Christina Segal-Knowles, Executive Director for Financial Markets Infrastructure (FMI) at the Bank of England, talks about . She looks at how they could be regulated, if they are used as a form of payment.  She says, with the right regulation, digital money like stablecoins could have benefits - including cheaper payments with more functionality. And they could potentially have benefits for financial stability. But that requires regulation to hold new forms of money to the same standards we expect of the money we use today.

A regulatory framework

Earlier this week, the Bank of England published a Discussion Paper that examines the implications of stablecoins for its financial and monetary stability mandate. In it we present an illustrative scenario to examine the implications of the emergence of stablecoins and other new forms of digital money. The discussion paper models what would happen if a large number of households and businesses moved their deposits from banks and into a stablecoin or Central Bank Digital Currency (CBDC). Contrary to some press headlines, even such a dramatic shift does not inherently constitute a financial stability risk as long as it happens in an orderly manner. In fact findings show that the implications of this in the long term for the ability of households and businesses to get a loan are relatively modest – although there is considerable uncertainty around this result.

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As such, while other risks may arise during a transitionary phase, the most significant risk arises from the potential for stablecoins in particular to undermine confidence in money and payments, and hence in the wider financial system.

As we discussed a few minutes ago, the risk of a loss of confidence in the credibility and stability of private money is not theoretical. Loss of confidence in private money can be a major threat to financial stability.

But it is equally true that private money can be made acceptable as a widespread means of payment – indeed, as I covered earlier, the vast majority of money held for transactions in the United Kingdom is already private. So, with the right regulation, a stablecoin could potentially be made safe for wide-scale use.

Our existing regulatory framework seeks to ensure that the public is able to trust the reliability and stability of the money it uses every day. Banks are subject to extensive rules and requirements to ensure that consumers can use privately-issued money with confidence and interchangeably with cash. These core rules and requirements were developed over time – in many cases via trial and error, with new rules introduced following financial crises.

Financial market infrastructure firms are also regulated to ensure that the assets they use for settlement – the underpinnings of our financial transactions, whether we’re buying milk or clearing a derivative – are public money issued by a central bank wherever possible. Where that’s not possible they are permitted to settle in money deemed to be a close substitute – commercial bank money.

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If stablecoins seek to be acceptable widespread substitutes for commercial bank deposits as a means of payment, it stands to reason that stablecoins will need to meet the core elements of our existing regulatory framework for private money which underpins confidence that it is interchangeable with cashfootnote [8]. These are:

  • A legal claim – to allow for prompt redemption at all times, for the amount initially deposited, and at no cost to the depositor; In other words – the little boy’s right in ‘Mary Poppins to demand that the bank ‘give him back his money.
  • Capital requirements – to lower the risk of insolvency, these are calculated based on the nature of the risks issuers undertake (credit, operational, market risks); they act as a cushion to absorb losses, reducing the chances that a firm fails.
  • Liquidity requirements – to ensure redemptions can be met in most circumstances – supported by eligibility for central bank facilities where relevant, to meet firms’ liquidity needs in extremis. This ensures that temporary liquidity issues arising from difficulties selling assets backing the value of stablecoins don’t result in firm failure; and
  • A backstop to compensate depositors – or in this case coinholders – such as the Financial Services Compensation Scheme (FSCS) (or in other countries deposit insurance), in case of failure. This ensures that, even if a firm fails, transactional deposits up to a certain amount remain exchangeable for central bank money. Notably – one of the key responses to the Northern Rock episode was to increase FSCS coverage in the United Kingdom.

This is not to say the regulatory model for stablecoins needs to be identical to banks. It could include different applications of the above features. For example, if stablecoin operators are restricted to backing themselves in high quality liquid assets they won’t need regulation to cover credit risk. If they only back themselves in central bank reserves, which are inherently liquid, they don’t need liquidity facilities. Ultimately, the specific requirements may well be different from those applicable to banks, but the outcome will be the same – that systemic stablecoins used as money will offer the same protection to coin holders as commercial bank money.

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Download the BoE 'New Forms of Digital Money' Discussion Paper --> here

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