{"id":15904,"date":"2024-05-01T10:07:47","date_gmt":"2024-05-01T10:07:47","guid":{"rendered":"https:\/\/iqeq.com\/?p=15904"},"modified":"2024-05-13T09:17:10","modified_gmt":"2024-05-13T09:17:10","slug":"stablecoin-regulation-what-does-it-mean-for-issuers-and-custodians","status":"publish","type":"post","link":"https:\/\/iqeq.com\/insights\/stablecoin-regulation-what-does-it-mean-for-issuers-and-custodians\/","title":{"rendered":"Stablecoin regulation: what does it mean for issuers and custodians?"},"content":{"rendered":"
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By Angus Irvine, Principal Consultant<\/em><\/p>\n

We recently discussed<\/a> Phase 1 of cryptoasset regulation in the UK and the importance of stablecoins. To recap, on 6 November 2023, the Financial Conduct Authority (FCA) published DP23\/4: Regulating cryptoassets. This regulation proposes two new activities relating to fiat-backed stablecoins: the issuance in or from the UK with custody activities carried out from the UK, and UK-based consumers for UK-issued fiat-backed stablecoins.<\/strong><\/p>\n

In this article, we discuss what the regulation means for stablecoins and how issuers and custodians may be subject to Consumer Duty.<\/p>\n

The impact of DP23\/4 crypto regulation<\/h2>\n

Under the proposed regime, stablecoin issuers will need to seek a new Part 4a permission from the FCA to issue fiat-backed stablecoins in or from the UK. This includes issuing stablecoins that are not marketed to UK consumers. A regulated stablecoin issuer would also be able to mint and issue its own coins. The FCA would require these to be backed.<\/p>\n

The proposed Part 4a permission to carry out custodian services will only apply to the safeguarding of regulated stablecoins that are issued by an authorised person, and cryptoassets that already meet the definition of a specified investment, such as security tokens.<\/p>\n

Regarding the reconciliation requirement, a firm would compare its own records of what regulated stablecoin backing assets it\u2019s holding for consumers against the number of coins in issuance. It would then calculate the number of stablecoins in issuance and whether those values match.<\/p>\n

Are stablecoin issuers and custodians subject to the Consumer Duty?<\/h2>\n

In line with the Consumer Duty and the Cryptoasset Financial Promotion Rules, the FCA expects regulated stablecoin issuers to make key information regarding their regulated stablecoins to consumers available on their website and other main communication channels.<\/p>\n

Custody of cryptoassets is conceptually similar to the custody of traditional client assets. The custodian is responsible for the safekeeping of a cryptoasset on behalf of another. Due to the differences between custody of cryptoassets and those of traditional financial assets, the FCA has yet to fix on a new regime. They are certainly, however, considering both International Organisation of Securities Commissions (IOSCO) publications and the existing CASS rules as a basis to produce bespoke custody regulations for cryptoassets.<\/p>\n

As with other cryptoassets, harm associated with stablecoin custody primarily arises due to poor safeguarding arrangements by the custodian. Without robust custody protections in place, there\u2019s a risk that consumer rights aren\u2019t protected. A deficiency in the safeguarding controls increases the chance of client stablecoins being lost or hacked. In the event of the custodian winding down, the return of client money could be delayed. In the worst-case scenario, client assets will be dissipated once liquidation or administration fees are debited.<\/p>\n

Cryptoasset custody vs traditional finance custody<\/h2>\n

Cryptoasset custody operates differently from traditional finance custody arrangements in some important ways.<\/p>\n

Backing assets would help to ring-fence client stablecoins and shield misappropriation or dissipation thereof. The DP23\/4 discussion paper proposes that the backing assets for regulated stablecoins are held in a statutory trust. The terms of such trust arrangements would be set out in the final rules.<\/p>\n

The industry has therefore adopted a range of business models to address such risks.<\/p>\n

Omnibus wallets<\/h2>\n

Omnibus wallet structures can create operational efficiencies and reduce costs for custodians who are safeguarding client cryptoassets, particularly for high frequency transactions. The FCA intends to permit the use of omnibus wallets for carrying out cryptoasset custody services, provided that client ownership rights are preserved at all times.<\/p>\n

The generally irreversible and immutable nature of cryptoasset transactions contained in \u2018finalised blocks\u2019 means that shielding against unauthorised access to these private keys is especially important. In particular, it will be critical that stablecoin custodians maintain the following:<\/p>\n