UK Treasury proposes insolvency regime to manage stablecoins’ failures

The UK Treasury is proposing an insolvency regime to manage the failure of major crypto stablecoins after the collapse of terra earlier this month sent shockwaves through the global crypto market.

The Bank of England would take the lead in managing the collapse of a stablecoin that had systemic importance to the financial system under a plan the Treasury proposed in a consultation published on Tuesday.

Stablecoins such as tether and USD coin offer investors a gateway into the crypto market by providing what should be a stable store of value against traditional currencies in contrast to other, more volatile crypto tokens including bitcoin.

The Treasury said on Tuesday that the failure of a systemic stablecoin could endanger the “continuity of services critical to the operation of the economy and access of individuals to their funds or assets”.

Regulators have focused on stablecoins as a potential risk to the broader financial system because the biggest coins say they are backed by traditional assets. Financial watchdogs also anticipate that these tokens could become more widely used in transactions, given that they are often quicker and easier than established methods of sending money.

The collapse of terra, a so-called algorithmic stablecoin that was designed to track the value of $1 without the backing of a portfolio of reserves, has amplified the concerns of many regulators over the opacity and potential fragility of the market.

“Events in cryptoasset markets have further highlighted the need for appropriate regulation to help mitigate consumer, market integrity and financial stability risks,” the Treasury said on Tuesday.

The potential risks have also been magnified since most stablecoins operate without the type of oversight that would be standard, either among banks or other systemically important financial institutions.

In the wake of the 2008 financial crisis, UK regulators began requiring banks deemed “too big to fail” to produce living wills, which provide a roadmap of how to safely wind down their businesses if they fall into a distressed situation.

Lenders are also required to maintain certain levels of reserves and meet measures of balance sheet strength to prevent potentially catastrophic bank “runs”.

The UK government said it would consider whether a new legal framework was required to manage the collapse of stablecoins that are systemically important payment systems or service providers. In the meantime, the Treasury has proposed changes to the insolvency rules for payments networks to create a system to handle the breakdown of crucial stablecoins in the future.

The Treasury said the current system to manage the collapse of a major payments network is focused on keeping these key pieces of financial infrastructure operating to avoid disruption in day-to-day business. For stablecoins, however, the rules also need to take into account that people often hold balances in these tokens. The government said the new rules for stablecoins would “allow administrators to take into account the return of customer funds and private keys as well as continuity of service”.

The UK has this year set its sights on becoming a global hub for the burgeoning crypto industry. The government has announced that it intends to incorporate stablecoins into the broader regulatory framework for payments. Last month, chancellor Rishi Sunak asked the Royal Mint to create a government-backed non-fungible token.