Bank of England (BoE) Governor Andrew Bailey has said he recognizes the potential of stablecoins for payment system innovation and to reduce the United Kingdom’s reliance on commercial banks, as long as the digital assets satisfy the conditions for public trust.
In an article written for the Financial Times, Bailey said that it “should be possible to have innovation in the form of money” and that “it would therefore be wrong to be against stablecoins as a matter of principle.”
The BoE governor also said he recognized stablecoin’s potential for “driving innovation in payments systems both at home and across borders.”
When talking about the potential of stablecoins, Bailey said his focus was on using them like traditional currency, i.e., “at scale for payments and settlement in the real economy.” This contrasts with their main use today, as a way to enter and exit digital asset markets. For this reason, digital assets not pegged to a fiat currency, such as Bitcoin and Ethereum, do not meet his definition of money.
Bailey’s apparent enthusiasm for using stablecoins at scale for day-to-day settlements in the real economy demonstrates a departure from previous BoE thinking on stablecoins.
Specifically, in a November 2023 discussion paper, the bank proposed setting individual caps on digital pounds between £10,000 ($13,472) and £20,000 ($26,944), while asking for feedback on a possible lower limit of £5,000 ($6,736).
Such limits would make scaling up a British pound denominated stablecoin for everyday use extremely difficult, if not completely unworkable. The BoE governor’s comments this week suggest that this may have been a point well made in the consultation feedback.
However, while Bailey may have indicated a U-turn from the bank on stablecoins, he was also keen to emphasize that “trust in money is critical to economies.” Therefore, it is critical that any stablecoins satisfy the conditions that enable public trust in money.
Trust in money
Bailey said that for stablecoins to be trusted, they would need to satisfy three criteria.
First, the backing assets should be “free of financial risk in terms of credit, interest and exchange rate.” This ensures that the value of a coin truly can be stable.
Second, even if the backing of the asset could be relied upon, there would remain ‘operational risks,’ for instance, in the case of a successful cyberattack. Thus, trust in stablecoins would also require an insurance scheme (as with bank deposits), and a statutory resolution arrangement that would ensures the holders are “preferred creditors,” i.e. the first in line to be paid in a bankruptcy or insolvency.
Finally, Bailey argued that the terms of exchange of stablecoins must be “known, consistent and enduring.” In other words, they must be the same for all holders (one person’s stablecoin should always be worth exactly the same as anyone else’s); must be “direct into other forms of money” (easily convertible); and not dependent on a digital asset exchange and its terms of business.
“As presently set up, not all stablecoins satisfy this condition,” said Bailey.
With these three factors in place — solid backing/reserve assets, insurance schemes, and clear, consistent exchange — stablecoins could be trusted by the public enough to become a widely used form of money.
If such stablecoins could be trusted, then Bailey would see further benefits in adopting the technology.
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Reducing reliance on banks
The BoE governor noted that another issue raised by stablecoins becoming more integrated into the financial system would be reducing the reliance and dependence on banks, whose lending and credit activities add an element of risk to traditional money.
“Through banks, the system has combined the holding of money with the provision of credit, meaning that deposits directly support lending that underpins economic activity. This has come to be known as fractional reserve banking,” explained Bailey. “In other words, most of the assets backing commercial bank money are not risk free: they are loans to individuals and to companies.”
As previously outlined, trust in money is essential, with one of the three key factors in maintaining that trust being that the money is supported by risk-free assets. The fact that, through lending, banks introduce an element of risk into their reserves/asset backing has meant regulation has had to pick up the slack to ensure trust. One example of this is mandated deposit insurance.
Bailey suggested that the system does not have to be organized like this: “It is possible, at least partially, to separate money from credit provision, with banks and stablecoins coexisting and non-banks carrying out more of the credit provision role.”
However, he also cautioned that “it is important to consider the implications of such a change thoroughly before going ahead.”
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Consultation paper
Bailey’s FT article was timed to precede the BoE’s publication of a consultation paper on the U.K.’s systemic stablecoin regime.
According to Bailey, the regime would apply to stablecoins used on a large scale as money (for everyday payments) and consider what standards they would need to meet.
“We will set out that widely used UK stablecoins should have access to accounts at the BoE in order to reinforce their status as money,” he said. “This will be a critical part of creating an advanced regime for stablecoins, one that ensures the U.K. can reap the benefits while maintaining a stable financial system.”
Stablecoins holding accounts at the BoE would go some way toward the bank’s goal of tokenizing deposits, rather than issuing stablecoins itself.
Bailey didn’t give an exact date for the consultation, other than to say it would be published in the coming months.
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Source: https://coingeek.com/bank-of-england-governor-sees-potential-in-stablecoins/