# Steakhouse Financial Ltd Response to BOE Consultation on Stablecoin Regulation

*Response to [BOE: Regulatory regime for systemic payment systems using stablecoins and related service providers](https://www.bankofengland.co.uk/paper/2023/dp/regulatory-regime-for-systemic-payment-systems-using-stablecoins-and-related-service-providers)*

# Introduction and Commentary

We're responding to the Bank of England Discussion Paper on a proposed regulatory regime for stablecoins. It's open until 6th February 2024, do respond if you have views.

The summary of our response is that it is rife with problems:
- Threatens singleness of money
- Enshrines monopoly power in incumbent financial institutions
- Forces stablecoin holders to subsidize UK Gilts for no particular reason
- Threatens self-custody (a government favorite)

However, we would also like to recognize and acknowledge what appears to be an honest attempt from the BOE to look at stablecoins from first-principles and apply what they believe are common-sense rules to protect consumers.

Where we differ is that we believe some of these rules do not achieve their aims and fail to recognize and allow the innovative nature of stablecoins to flourish.

We believe stablecoins have enormous potential in reducing fee extraction, increasing consumer welfare and improving macroprudential outcomes through greater transparency. Those features of stablecoins must be allowed to evolve positively in a rational and data-driven regulatory approach.

Below are our answers in full-detail. Your comments on these are welcome of course and we would encourage your comments both on this note as well as to the BOE directly.

## What is the name of your organisation?

Steakhouse Financial Limited (KY)

## What industry/sector is your organisation part of?

Consultancy

# Section 1

## 1. Do you agree that, to preserve the singleness of money, systemic payment stablecoins must be fully interchangeable with other forms of money at par?

Yes, we do. Please see our [initial research for DeFi stablecoins](https://cryptobanking.network/singleness-of-money-in-crypto-banking/) which demonstrates this. Singleness of money would require fiat-backed stablecoins issued under common rules to be interchangeable with one another as well.

## 2. Do you have views on further requirements that may be needed to ensure the singleness of money when stablecoins are traded in secondary markets?

Secondary markets are managed by market forces and profit-seeking incentives. Price can deviate from time to time but fluctuations should remain narrow provided arbitrage is possible through primary mint/redemption. As an example, consider where a corner shopkeeper in England refuses to accept a Scottish banknote: this does not mean that the singleness of Sterling is broken; the note is still legal tender in the UK.

What is important is the primary mint/redemption market. Stablecoin issuers should be compelled to issue and redeem at-will to any compliant and identifiable holder without restriction or fees, and should similarly accept at par any stablecoin following the same framework in order to guarantee money-singleness. Banks should be compelled to accept stablecoins following the framework, given that since they would be backed 1-for-1 with Sterling at the BoE, they would be acceptable for deposit at a bank.

# Section 2

## 3. Do you agree that the most likely, and suitable, payment systems using new forms of digital money to become systemic in the UK are sterling-denominated stablecoins which are backed by assets denominated in fiat currency?

The Bank should be open to the idea that people may wish to barter in-kind or use other digital assets as payment if they so desire. It's more likely consumers may exchange other currencies or other currency-referencing assets as payment instead of sterling.

## 4. Do you agree with the Bank’s proposed approach to assessing the systemic importance of stablecoins used for payments?

Broadly speaking yes, provided consumers are unencumbered from choosing what denomination to adopt when transacting for goods and services (Note, with the caveat of having to translate to sterling to report tax obligations, for instance)

## 5. Do you agree with the Bank’s proposed approach to the regulatory framework for systemic payment stablecoins, as set out in Section 2?

No - it is approaching a novel financial primitive with an unsuitable framework. Stablecoins have the potential to be many things at once. Enforcing single use-cases on the grounds that stablecoins are 'mostly for payment' is not congruent with their technical capabilities or, indeed, their use in-action. At time of writing, on Ethereum only, $14bn of USDC, $25bn of USDT and $2.7bn of DAI were simply sitting on user wallets without moving. Reference: https://dune.com/steakhouse/stablecoins

Entrenching this will basically nominate a few market winners and cement an unassailable monopoly situation in the future. Stablecoins should be allowed to compete on multiple angles, including offering an interest-rate. That this makes them more like financial products than payment products is an illustration of the need for a new approach to regulation.

Interest-bearing stablecoins such as USDM (Mountain Protocol), a fiat-backed and fully licensed stablecoin that pays close to the US Federal Funds rate, are equally useful as payment tokens relative to USDC but are also capable of passing through a significant portion of the risk-free asset rate backing the collateral. This rate is bound to fluctuate over time (as money market rates do all the time). There is no benefit in raising barriers to new entrants and allow incumbent players to extract rent from users. Interest-bearing stablecoins should be allowed and encouraged, and therefore regulated with a different approach vs the pure payment systems approach.

We would suggest regulating stablecoins for what they are, something new. Perhaps bring them in under dual-regulation if needed, but let them pay an interest rate and let the free market pick a winner from the competing products on offer.

## 6. Do you agree with the Bank’s assessment of the risks posed by vertical integration of stablecoin functions? Are there other risks that the Bank should consider based on existing business models? What mitigants could be put in place to ensure that risks posed by multi-function entities are addressed?

Stablecoins are more like private cash government money market funds than anything else. This does not of course mean that they cannot do more things at once as well.

Thanks to blockchain smart contracts, Stablecoins are in effect a fusion of bank money (useful as a means of payment) and money market funds (a store of value) at the same time.

## 7. Do you agree with our approach regarding subsidiarisation of non-UK issuers? Do you agree with our approach to other non-UK elements of the payment chain? What alternative policy arrangements could be used to effectively supervise, oversee, and regulate non-UK systemic stablecoin issuers and other non-UK elements of the payment chain?

We believe that this approach would be another example of preventing new players from competing on the market and making it easier to entrench a few current incumbent winners at the expense of better prices or execution for customers, because of resulting lower competition. Stablecoins are something new - they can be created and operated with far fewer people than traditional banks, and therefore their structural advantages should not be eradicated by encumbering stablecoins with more costs than should be required to operate them.

Such regulation might compel UK citizens to use offshore stablecoins outside the reach of the BoE.

# Section 3

## 8. Do you consider that the Bank’s existing binding rules on governance, operational resilience and third-party outsourcing risk management are suitable for systemic payment systems using stablecoins?

Yes, broadly speaking they are suitable

## 9. Do you consider that stablecoin issuers can exercise sufficient control over, and mitigate the risks of, public permissionless ledgers (be it via rule setting and/or the use of innovative solutions)?

On major public permissionless ledgers, no single entity has the ability to guarantee finality other than the operators of the chain itself. In this regard, this is not a meaningful question. For instance, Tether has no more ability to guarantee finality of settlement will occur on Ethereum relative to any other actor using Ethereum.

Interestingly, since fiat-backed stablecoin collateral lives off-chain, stablecoin holders are actually protected from potential worse case scenarios involving blockchain disruptions, such as 51% attacks or other failures. Regulators could jump in if they do not agree on the criteria. It is worth noting that no such failures have happened thus far and the more these networks diversify their validators, the less likely they are to experience such failures in the future.

## 10. How do you consider that existing and emerging stablecoin payment chains operating with a public permissionless ledger may be adapted in order to meet the Bank’s expectations and international standards?

Not being able to exercise centralized control over a permissionless blockchain is actually a feature that makes settlement finality more likely and robust.

# Section 4

## 11. Do you agree with the Bank’s assessment of the important role of backing assets in ensuring the stability of value of the stablecoin?

Yes we do, it broadly makes sense. It is positive to suggest central bank deposits as a viable liquid asset buffer; however, stablecoin issuers should be treated equally with any other reserve account holder and be compensated for holding deposits at the central bank when the interest rate is positive.

We note some odd statements in the BOE paper also:

> “Commercial banks back the money they issue with a variety of assets including long-term loans to households and businesses”

This statement is odd on many levels. Commercial banks do not "back the money they issue", they use depositors funds to lend, and the assets do not "back" the deposit base. This statement makes no sense and does not reflect reality. The last sentence in the paragraph is also suspect. It is the BoE signature on the notes that enables confidence in bank deposits as payment medium

> “An alternative would be for stablecoins to be fully or partly backed by high-quality and highly liquid assets, such as government bonds. This model would introduce at least some elements of credit, liquidity and market risk.”

It would not introduce credit risk. A gilt exhibits no more credit risk than a deposit of cash at the BoE – unless the BOE knows something nobody else knows about UK government credit risk.

## 12. Do you agree that the proposed remuneration policy is consistent with systemic stablecoins being used primarily for payments?

No we do not, as we are unable to determine the logic. In fact there is an inconsistency here that this lack of logic exposes.

Please note our views in response to the following statements:

> “As such, issuers are expected to play a very limited role in the transmission of monetary policy, as they would not engage in lending and would not be significant participants in money markets.”

Earlier the paper stated that Stablecoins introduce a new, additional, means for banks to experience a bank run. If that is the case, then they represent deposits that can flow out into the economy. If that is the case, then they will be, potentially, playing a role in the transmission of monetary policy

> ”Since participation in the transmission of monetary policy is the primary rationale for remunerating central bank reserves held by commercial banks,"

We do not see that this is necessarily the primary rationale for paying the Base Rate on central bank reserves. The primary rationale for so doing is because this recognises that a deposit of cash - anywhere - exhibits time value of money, and since the time value of money is not 0% the BoE pays interest on reserve deposits. It is simply “corporate finance 101”.

> ”The Bank therefore proposes that the central bank deposits held by systemic stablecoins issuers as backing assets should not be remunerated.”

The end result of an entity depositing £100 at the BoE because it has raised £200 in customer deposits and is currently lending £100 (hence Loan-Deposit Ratio of 50%) is conceptually no different to the end result of an entity depositing £100 at the BoE because it has issued 100 Stablecoins and 1 Stablecoin is backed with £1. It is illogical in its inconsistency to pay interest on one and not the other, the end results of both are identical. Both are deposits of cash at the central bank.

We recommend that the Bank regulate stablecoins as something new, bring them in under dual-regulation if needed, but let them pay an interest rate and let the free market pick a winner. We would also recommend allowing all short-duration cash equivalents. If cash equivalents are good enough for other industries, why would they not be good enough for stablecoins? We finally also ask BoE to consider why the proposition for stablecoin is more restrictive than for money markets or banks, thus violating the principle of same-risk same-regulation.

# Section 5

## 13. Do you agree with the Bank’s proposed requirements on the redemption process, including the role of all firms in the payment chain?

Broadly speaking, yes, convertibility should be fluid and legally guaranteed. This likely implies segregating customer assets into bankruptcy remote vehicles or pursuing some form of limited banking license for fiat-backed stablecoin issuers. Managing liquidity risk for stablecoin issuers is a primordial function and should be done by competent and experienced personnel.

## 14. Do you have views on requirements on redemption fees, or prohibiting these, to minimise any frictions across the redemption process?

The BOE should carefully weigh any potential unintended consequences from introducing a blanket redemption fee prohibition, though the intention is certainly good. Redemption process costs should be borne by the stablecoin issuer, if any. Ideally, the simple transmission of Sterling deposits from one UK bank to another should be cost-free anyway.

The market should end up landing on a minimum redemption service-level agreement without fees (e.g. t+2) and leave the door open for value-added services, such as faster redemptions, to be on a fee-basis. Also, gas fee passthroughs to users for minting seems like a fair-use scenario where some fees could be charged, though many issuers don’t at the moment.

## 15. Can you identify any issues with the requirements on systemic stablecoin issuers and other relevant firms within a payment chain to cooperate and support the appointed administrators with a view to facilitating redemption or payout in the event of a firm failure?

Only with respect to sensitive customer information that might be held. Special consideration must be made to maintain the singleness of stablecoin claims even if holders of a token cannot be identified - that is, any properly minted ledger entry representing a stablecoin must be held to be equal.

## 16. Do you agree that issuers should have access to customer information to be able to fulfil redemptions in the case of the failure of an entity providing the customer interface, eg a wallet provider and/or to facilitate a faster payout in insolvency?

Logically, yes.

## 17. Do you have views on the Bank’s proposed safeguarding regime being centred on two key features (statutory trust in favour of coinholders; and safeguarding rules)?

Yes, but another odd statement is worth mentioning:

> “Poor record keeping or inadequate reconciliation practices may lead to a shortfall not being recognised.”

This is not unique to Stablecoin issuers, nor indeed to banks themselves. Any corporate entity is exposed to this risk.

## 18. Do you think there are any other features that need to be reflected in the safeguarding regime for systemic payment stablecoins?

Key features include:
- Singleness of stablecoins among stablecoins
- Protection of the ability to pay interest as a differentiating feature that increases competition in the market and level the playing field
- Segregation of customer assets from operating / issuing entity, i.e. explicit recognition of stablecoin collateral assets as not being company estate in the law
- Explicit statement that in the case of failure of a stablecoin issuer, and upon the identification of collateral assets and redemption capabilities, any holder can request their funds back simply by identifying their wallet and running a KYC process with a service-level agreement maximum of for e.g. 30 days to fulfillment to reduce uncertainty

## 19. Do you agree with the requirements for stablecoins owned by the issuers held in treasury wallets?

Yes, this makes sense. There is no significant marginal cost to minting or burning stablecoin tokens. There is therefore no reason to be issuing unbacked stablecoin tokens at all. The total supply should match at the very least the amount of backing reserves.

## 20. Do you consider that the capital requirements would effectively mitigate risks that may result in a shortfall in the backing assets or that can threaten the ability of issuers to operate as a going concern?

Yes, the use of a minimum capital requirement is an appropriate application of prudential regulation to ensure that the stablecoins held by users are fully-backed at any given time. This pushes stablecoin balance sheets into being invested into positive interest rate holdings at banks, money market funds or central bank deposits. The primary purpose of the surplus assets over issued tokens should be to absorb any tail-event losses and minimise damage to stablecoin holders.

## 21. Do you have views on the approach (including any existing or bespoke methodologies) that should be considered for calibrating capital requirements?

Because the balance sheet structure of an Issuer would be considerably simpler than that observed at a G-SIFI bank, it is perfectly appropriate for Capital requirements to be a function of the original Basel I requirements: to hold an amount of capital against risk-weighted exposure to bank deposits and money-market funds, and 0 risk-weighting against central bank deposits.

Stablecoin issuers are not immune to counterparty risk, as the example of Circle’s mismanagement of bank deposit exposure in March 2023 with respect to its exposure to SVB and Signature shows. To date, Circle continues to be largely undercapitalized, in our view, with a very thin equity margin against $24bn in tokens.

Issuers should be obligated to hold a minimum amount of equity in reserve as Tier-1 capital to prevent such risks to stablecoin users in the future. Private stablecoin issuers should succeed on the basis of offering a better, more widely accepted product with the highest possible risk-adjusted interest rate offered to holders, subject to constraints of liquidity (redemption) and solvency (backing).

## 22. Do you have views on the requirement to hold reserve assets in a statutory trust, to ensure that stablecoins are fully backed and the backing assets are duly protected and available to satisfy coinholders’ redemption requests at all times?

No further comment, we believe this makes sense.

## 23. Do you have views on the range and quality of the assets issuers would be required to hold to mitigate shortfall risks?

These should not be of higher risk than the rest of the reserves.

## 24. Do you agree that, at least during a transition, limits would likely be needed for stablecoins used in systemic payment systems, to mitigate financial stability risks stemming from large and rapid outflows of deposits from the banking sector, and risks posed by newly recognised systemic payment systems as they are scaling up?

We do not agree, because we cannot see its practical benefit. This proposal appears to lack a logical basis. The banking sector should be prepared for a dynamic and competitive business environment. In any event, the BOE does not exist to protect bank shareholders, but rather to protect bank depositors, which it does already.

## 25. Do you have views on the use, calibration and practicalities of limits?

We believe that such limits reflect good intentions but will lead to negative unintended consequences. Well-managed stablecoins offer balance sheet elasticity improvements when compared to banks, and are a source of competition to incumbent banks. There is no reason to erect barriers in the way of the free market.

Individual holding limits are also impractical. A GBP 5000 limit is arbitrary and lacks any basis in foundation. Individual users should be able to dispose of their funds as they wish. Also, there is nothing to prevent a user from holding 50 self-custodied wallets with 5000 GBP each. Enforcing these limits is self-defeating and could not be undertaken to any practical intent.

## 26. Do you have other views on the Bank’s proposals for requirements for systemic stablecoin issuers, as set out in Section 5?

No

## 27. Considering the requirements for issuers in Sections 4 and 5, how might business models need to change in order to retain commercial viability from those in the market today?

In the presence of limits, it is likely that very few stablecoin business models will be profitable unless issued from incumbent bank institutions. This would therefore simply entrench existing market share positions in financial services, and would result in lack of innovative activity in stablecoins and payment systems.

If left as-is, no major business model reinventions are required.

# Section 6

## 28. Do you agree with our proposed expectations for custodial wallet providers for systemic stablecoins (including when provided via exchanges) and how we propose applying them in a systemic stablecoin payment chain?

Custodial services perform very similar functions to modern-day brokers or securities custodians and should be regulated in a similar manner. Customer assets should not be rehypothecated by default, though lending products could be made available.

Exchanges and custodians that hold customer assets should have a minimum capital requirement to operate in order to protect the integrity of customer funds. The advantages of blockchain technology accrue through self-custodying private keys. We already know how to regulate custodial businesses and they should be regulated accordingly.

Performing AML checks at redemption is logical. No amount of self-custodied activity prevents stablecoin issuers from adhering to these basic compliance requirements. Requiring total surveillance over all stablecoin transactions at any given time is not only impractical, it would not minimize or prevent crime or money laundering, would impose prohibitive costs on stablecoin issuers or merchants (creating a new excise tax on financial services borne by consumers) and again entrench a monopoly before an industry has had time to draw in innovation and competition.

## 29. Do you consider that unhosted wallets could operate in a way that the systemic stablecoin payment chains can meet the Bank’s expectations (including for the issuer to deliver against the Bank’s requirements set out in this Discussion Paper)?

The BOE is incorrect in stating that transactions from self-custodied wallets are “difficult to track”. They are, in fact, much easier to track than custodial transactions or traditional financial transactions, as the record of these is made permanently onto a public blockchain. For this reason, and contrary to some views noted in the media, self-custodied wallets are actually very unsuitable for money laundering or terrorist financing.

The BOE’s concerns about illicit activity are unfounded and would not be mitigated by “banning” interaction with self-custodied wallets or by attempting to regulate their use. There is nothing wrong with a basic expectation of privacy and the BOE needs to be comfortable with this in the same way as it might be comfortable with the idea that an individual could hold any amount of money in paper bills.

The pseudonymity (not anonymity) associated with self-custodied wallets is an example of a basic expectation of property rights enshrined in Common Law. It does not interfere with the authority’s ability to do their job competently to prevent and solve crime.

## 30. Do you agree with the Bank’s proposal to regulate off-chain ledgers operated at systemic scale under the same requirements otherwise applicable to systemic payment systems?

For custodial businesses changing their own ledgers from one holder to another - we already know how to do and regulate this and yes it should be regulated accordingly.

We are not sure if the BOE understands what an off-chain transaction is in the context of self-custodied wallets. No off-chain transactions between a self-custodied wallet and a decentralised application are possible. A transfer of stablecoins between two self-custodied wallets is not possible through an “off-chain transaction”. We would therefore suggest that the BOE focuses on custodial and bank-like businesses and assume that self-custodied wallets and their users can function efficiently without additional regulatory oversight.

## 31. Do you agree with the Bank’s approach to regulating service providers to firms operating in systemic stablecoin payment chains?

No, we do not. Service providers shouldn’t be “enshrined” by the government to perpetuate, or create new, unassailable monopolies.

# Section 7

## 32. The Bank will have due regard to the Public Sector Equality Duty, including considering the impact of proposals for the design of the regulatory framework for systemic payment stablecoins on those who share protected characteristics, as provided by the Equality Act 2010. Please indicate if you believe any of the proposals in this Discussion Paper are likely to impact persons who share such protected characteristics and, if so, please explain which groups of persons, what the impact on such groups might be and if you have any views on how any impact could be mitigated.

Over-regulating self-custodied wallets and stablecoins in some of the manners described would in fact likely disproportionately prejudice users who share protected characteristics as provided by the Equality Act. Hewing to our recommendations would therefore offer more social justice and protection to those categories of users than the BOE’s current proposals.

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