As a starting point, this discussion paper was the first to be released from the FCA’s Crypto Roadmap. If you want to know more about what has happened in the UK to date in relation to Crypto regulation, please read our blog on the current position. Where are we now with cryptoasset regulation? | Menzies LLP
And before we get into the detail, this discussion paper was originally published in November 2023 and was discussing ‘phase 1’ of the regulation focusing on stablecoins. However, a year later when the next discussion paper on admissions, disclosures and market abuse was released, it started by confirming that:
“The government will no longer pursue a ‘phased approach’ towards crypto legislation. This means that fiat-referenced stablecoin activities (previously ‘phase 1’) will be legislated for at the same time as crypto trading, exchange and other activities (previously ‘phase 2’).”
As such though the wording of DP23/4 does refer specifically to stable coins (and my comments below will refer mainly to these), we can infer that many parts of this will also apply to wider crypto assets including those such bitcoin and ether.
Now we’re talking Crypto – DP23/4 breakdown begins
Stablecoins are dominated by Circle and Tether, which between them have approximately 87% of the market (which is estimated at the end of 2024 to be between $167bn and $200bn). Activities related to these are currently unregulated and risky, however in time (and with appropriate regulation) the benefits would include:
- Faster, cheaper and frictionless payments between consumers and merchants.
- Consumers are better protected against the risks.
- Replace traditional Delivery vs payment (DvP) to eliminate counter-party risk and increase liquidity (typical DvP systems require 2 days to finalise transactions).
- Encouraging innovation as firms will be able to safely explore potential new applications of the technology.
The key to allowing these (and other) potential developments to occur is to ensure that backing assets are held to support the value. i.e. regulating that a stablecoin issuer MUST have assets, ringfenced seperately from the assets of the business in a statutory trust, to the value of the stablecoins in circulation.
The following are some of the key points I noted from my review of the discussion paper (at this stage these are the FCA ideas, nothing is set in stone though subsequent publications indicated there will be little change):
Client assets
- Records must be held by a firm holding regulated stablecoins setting out who owns what value (though they do not need to be linked to a specific coin), this must be seperately maintained from a daily record showing the current value of the backing assets.
- Internal and external reconciliations are expected to be conducted daily, and it is noted that this will likely be in line with the current requirements for investment firms under CASS (Client Assets Sourcebook) with under/overs being corrected within one day.
- Consumers must be able to redeem their stablecoins for fiat (e.g. GBP/EUR/USD) within 1 business day. This is a substantial change from the current situation.
- Holding cryptoassets on behalf of clients (i.e. in custody) will work in a comparable way to holdings assets under CASS 6.
- However, it seems likely that there will some allowances for services such as staking or utilising them as collateral.
- These sorts of services are currently provided by crypto custodians and removing them entirely could reduce the incentives for a competitive market.
- An annual report from an independent external auditor will be required, again similar to the requirements of existing firms applying CASS.
Other
Payments
- The Payment Services Regulations (PSRs) are to be extended to capture stablecoin payments. Potential benefits include speed, accuracy and cost.
- Overseas stablecoins (including Circle and Tether) WILL have to be approved by the UK standards.
- A firm that utilises overseas coins would need to be authorised under the PSRs as a ‘payment arranger’ and carry out checks to assess and approve the overseas coin to be used.
- When payments are being made in stable coins and funds would be held by the Payment Service Provider (PSP) as part of the transaction this would result in client money being held and a CASS type audit being required.
- The initial plan to regulate payments has changed. On the 29th April, HM Treasury released draft statutory provisions to create new regulated activities for cryptoassets, included within this noted:
1“In November 2024, the Government confirmed that it would proceed with implementing these proposals largely unchanged and intended (parliamentary time permitting) to make the associated legislation this year. The exception to this is that the Government has said it will not proceed with amending the PSRs 2017 to bring UK-issued stablecoins into regulated payments at this time. This does not mean that stablecoins cannot be used for payments in the UK, but simply that they will remain unregulated for payments for the time being.”
- Stable coin issuers would make their money from interest on the backing assets, they would not be allowed to pay interest to the holders of the coins.
- The new prudential sourcebook will be named CRYPTOPRU.
- In calculating capital requirements it’ll be the higher of the permanent minimum requirement (PMR), a fixed overhead requirement (FOR), and an activity-based ‘K-factor’ requirement (KFR).
- This is expected to result in higher capital requirements than for an equivalent non-crypto firm to account for the additional risk.
- An ICARA, or similar, will be required.
- FSCS will NOT be extended to cover stable coins.
Crypto regulation is coming… so let’s think pre-emptively!
It is worth re-highlighting that these are notes from the discussion paper and therefore a lot of the above could change. The FCA are due to publish the consultation paper Q1 or Q2 of 2025 which will outline the specific proposals and draft rules. There will certainly be some changes and presumably incorporation of proposals for the formerly known as ‘phase 2’ regarding crypto trading, exchange and other activities.
It’s early(ish) days still, but before we know it the policy statements will be published (I am assuming ‘2026’ per the roadmap means end of 2026) and we’ll all be rushing to work out what we are supposed to do.
In advance of that, if anyone has some ideas or opinions give me a call on +44 3309 129591 – I do not have all the answers, but maybe we can work some out between us!
- 29/04/25 HM Treasury near-final draft legislation ↩︎
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