Christina Segal-Knowles: Stablecoins - what's old is new again
Speech by Ms Christina Segal-Knowles, Executive Director for Financial Markets Infrastructure
of the Bank of England, at the Westminster eForum Policy Conference, 10 June 2021.
* * *
I'm going to focus today on what is sometimes billed as the next big thing in digital payments -
stablecoins - digital tokens issued by the private sector which aim to maintain a stable value at
all times, primarily in relation to existing national currencies.
And to be clear from the start, today I will touch only on those stablecoins that aim to be used
widely as means of payments.
Stablecoins and other new forms of innovation in payments potentially offer benefits. They could
reduce cost and offer new convenience and functionality. They could increase the resilience of
payments - by offering alternative new ways to pay. And there could be potential long term
financial stability gains from new forms of digital money. But these opportunities can only be
realised if new forms of digital money are safe.
So today I am not going to focus on what's new about stablecoins. Instead, I am going to focus
on why - even if the technology they are using is new - the basic elements of a stablecoin are
very old. In fact, as old as money itself.
This means that as financial regulators, stablecoins are not launching us off into some brave
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new world. We know what is required to ensure private money is safe for wide-scale use. The
key here is to ensure that just because something is packaged in shiny technology we don't
somehow treat the risks it poses differently.
Private Money: the basics
Before I turn to stablecoins I want to spend a minute on one of the reasons why the idea of
private money feels innovative and flashy. Even though most money we use every day is already
private money, the vast majority of us don't think about it. Luckily, regulation means we don't have
to.
Popular culture often simplifies our ideas around what form our money takes and can reinforce
the idea that banks are simply storing our sterling issued by the central bank for us, and that
when we pay electronically, what is being moved is central bank-issued money. For example,
remember those iconic scenes from 'Mary Poppins and 'It's a Wonderful Life' which feature
people demanding that banks give them back their money.
But in reality, when you tap your debit card in a shop or pay your friend back via a bank transfer,
the money you are paying with isn't sterling issued by the Bank of England with a promise to pay
the bearer - it's a bank deposit. Those are just a record of how much a private company - here,
the commercial bank - owes its customers. Think of it as an IOU from the bank.
When we say that we are "withdrawing our money" from an ATM - what we are actually doing is
converting our IOUs from our bank, ie commercial bank money, into banknotes issued by the
Bank of England.
So even though we don't think about it, we're already using private money all the time. Ninety-five
percent of the funds households and businesses hold that are typically used to make payments
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are now held as commercial bank deposits rather than cash . The pandemic has prompted a
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further decrease in cash usage, accelerating a longer-term decline that is likely to continue .
Private Money: Why do we care?
Today in the United Kingdom we don't generally pay attention to whether we are using private or
public money. We can assume that the value of the money we use will be more or less stable.
Shops don't need to scrutinize which bank holds your deposit before you pay - and they are
generally as willing to receive private money in the form of card or smartphone wallet payments
as they are cash.
The fact that commonly used private money is interchangeable with cash anchors it to national
currencies and, as a result, promotes financial stability. The fact that bank deposits can be
exchanged for cash on demand guarantees uniformity - ensuring that bank deposits from one
bank can be used interchangeably with cash and with bank deposits from another bank. While
banks do fail, regulation and liquidity backstops makes that relatively rare. And deposit protection
schemes ensure that transactional balances up to £85,000 remain interchangeable with cash
even if that happens.
This model is relatively recent. It was not ever thus.
And as we think about new forms of digital payments, it is important that we do not take this for
granted.
A large number of financial crises of the last century have featured a loss of confidence in the
reliability and safety of the money people rely on for transactions.
Money that is usually considered safe. Money that people normally do not think about very much.
In the emerging market financial crises of the 1990s and early 2000s, people and businesses lost
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faith in the state's ability to maintain the value of their local currency against the dollar .
Other crises have had at their heart a loss of confidence in the ability of private issuers -
commercial banks - to fulfil their IOUs with depositors and lenders and maintain the
interchangeability and reliability of the money they issued. Think of the Great Depression-era
bank run depicted in 'It's a Wonderful Life'. Think of the Northern Rock example - where worries
about the Northern Rock's funding led to a crisis of confidence; first from wholesale lenders and
then from retail depositors - who suddenly worried that their deposits would no longer be
interchangeable with cash or other bank deposits. Remember the queues outside of branches in
2007, as depositors rushed to exchange their deposits before - they believed - it might be too
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late .
Confidence in the credibility and stability of private money are fundamental components of
financial stability.
Innovation
But let's go back to stablecoins and innovation in payments.
Stablecoins are digital tokens that aim to maintain a stable value vis-a-vis existing forms of
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money . Their origin stories generally trace back to the crypto world. Most forms of
cryptoassets, like Bitcoin, are too volatile to be attractive as a widespread means of payment.
We have seen time and time again that if money is not reliably stable most people will not want to
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use or accept it as payment. There is no reason to think this time is different .
To solve this, stablecoins have turned to the age-old solution of anchoring their value to national
currencies, often with a promise to ensure that the value remains 1 for 1 at all times. Stablecoins
therefore could potentially serve as a substitute for a commercial bank deposit. Both stablecoins
and banks are offering a representation of what a private company owes its customers - an IOU
- which can be transferred as a means to pay for things. Both are promising (or at least aspiring
to) stability against and interchangeability with money issued by central banks.
It is possible in this context that stablecoins could scale up and grow rapidly, and become widely
used as a trusted form of sterling-based retail payments. To be clear - I don't know if this will
happen. Stablecoins and other new forms of private non-bank money might be the next big thing.
Or they might be a flash in the pan.
I don't have a bet here - I am a central banker not a venture capitalist.
My job, as a central banker and regulator - in all of this - is to ensure that financial innovations,
including new forms of digital money, do not impair the Bank of England's ability to maintain
monetary and financial stability.
This shouldn't be confused with preserving the status quo. Financial stability isn't about
protecting incumbent banks or other existing firms from competition. Instead financial stability
seeks to ensure that people and businesses can rely on essential financial services - like the
ability to make a payment or the ability to get a loan - in bad times as well as good.
A regulatory framework
Earlier this week, the Bank of England published a Discussion Paper that examines the
implications of stablecoins for its financial and monetary stability mandate. In it we present an
illustrative scenario to examine the implications of the emergence of stablecoins and other new
forms of digital money. The discussion paper models what would happen if a large number of
households and businesses moved their deposits from banks and into a stablecoin or Central
Bank Digital Currency (CBDC). Contrary to some press headlines, even such a dramatic shift
does not inherently constitute a financial stability risk as long as it happens in an orderly manner.
In fact findings show that the implications of this in the long term for the ability of households and
businesses to get a loan are relatively modest - although there is considerable uncertainty
around this result.
As such, while other risks may arise during a transitionary phase, the most significant risk arises
from the potential for stablecoins in particular to undermine confidence in money and payments,
and hence in the wider financial system.
As we discussed a few minutes ago, the risk of a loss of confidence in the credibility and stability
of private money is not theoretical. Loss of confidence in private money can be a major threat to
financial stability.
But it is equally true that private money can be made acceptable as a widespread means of
payment - indeed, as I covered earlier, the vast majority of money held for transactions in the
United Kingdom is already private. So, with the right regulation, a stablecoin could potentially be
made safe for wide-scale use.
Our existing regulatory framework seeks to ensure that the public is able to trust the reliability
and stability of the money it uses every day. Banks are subject to extensive rules and
requirements to ensure that consumers can use privately-issued money with confidence and
interchangeably with cash. These core rules and requirements were developed over time - in
many cases via trial and error, with new rules introduced following financial crises.
Financial market infrastructure firms are also regulated to ensure that the assets they use for
settlement - the underpinnings of our financial transactions, whether we're buying milk or
clearing a derivative - are public money issued by a central bank wherever possible. Where
that's not possible they are permitted to settle in money deemed to be a close substitute -
commercial bank money.
If stablecoins seek to be acceptable widespread substitutes for commercial bank deposits as a
means of payment, it stands to reason that stablecoins will need to meet the core elements of
our existing regulatory framework for private money which underpins confidence that it is
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interchangeable with cash . These are:
A legal claim - to allow for prompt redemption at all times, for the amount initially deposited,
and at no cost to the depositor; In other words - the little boy's right in 'Mary Poppins' to
demand that the bank 'give him back his money.
Capital requirements - to lower the risk of insolvency, these are calculated based on the
nature of the risks issuers undertake (credit, operational, market risks); they act as a
cushion to absorb losses, reducing the chances that a firm fails.
Liquidity requirements - to ensure redemptions can be met in most circumstances -
supported by eligibility for central bank facilities where relevant, to meet firms' liquidity needs
in extremis. This ensures that temporary liquidity issues arising from difficulties selling
assets backing the value of stablecoins don't result in firm failure; and
A backstop to compensate depositors - or in this case coinholders - such as the Financial
Services Compensation Scheme (FSCS) (or in other countries deposit insurance), in case
of failure. This ensures that, even if a firm fails, transactional deposits up to a certain amount
remain exchangeable for central bank money. Notably - one of the key responses to the
Northern Rock episode was to increase FSCS coverage in the United Kingdom.
This is not to say the regulatory model for stablecoins needs to be identical to banks. It could
include different applications of the above features. For example, if stablecoin operators are
restricted to backing themselves in high quality liquid assets they won't need regulation to cover
credit risk. If they only back themselves in central bank reserves, which are inherently liquid, they
don't need liquidity facilities. Ultimately, the specific requirements may well be different from
those applicable to banks, but the outcome will be the same - that systemic stablecoins used as
money will offer the same protection to coin holders as commercial bank money.
Conclusion
The title of this speech is a cliché: Everything that is old is new again. But I am going to end on a
different cliché: the definition of insanity (widely - and inaccurately - attributed to Albert Einstein)
is doing the same thing over and over again but expecting different results.
As I mentioned earlier, stablecoins may be innovative in the technology they use, but the
fundamental questions they pose are not new. We as central bankers and regulators need to
look at them as what they propose to be - a new form of private money.
This means that we will hold them to standards similar to those applicable to existing private
money. It doesn't matter what type of technology you're using or the legal form of the firm. If a
firm is offering private money on a systemic scale then it should be regulated as such.
Our core rules and requirements came through trial and error, often following financial crises.
Our work on a regulatory regime for stablecoins builds on this learning process - rather than
starting at square one and expecting different results.
I recognise that the themes here sound curmudgeonly. But this is not an anti- innovation
message: quite the opposite.
Establishing a secure regulatory environment for new forms of digital money to operate within the
UK will lay a foundation for sustainable innovation. As I said at the outset, if new forms of digital
money can be made safe, they could potentially contribute to faster, cheaper and more efficient
payments with greater functionality. They could increase the resilience of payments. And they
could even have long-term benefits for financial stability.
But these opportunities can only be realised if new forms of digital money are safe - which
means recognising and properly regulating the elements that are age-old.
I am grateful to Morgane Fouche, Matthew Osborne, Stephanie Haffner, Robert Page and James
Pople-Hoskins for their help in preparing these remarks. I am also grateful to Antoine Lallour,
Nicholas Butt, David Copple, Shiv Chowla, Andrew Hauser and Victoria Cleland for their helpful
comments.
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Private money mainly takes the form of deposits held in bank accounts. The only form of public money
accessible to the general public is cash, in the form of coins and notes.
2
This is based on the amount of cash held by the public as a share of total cash and sight deposits. See Part V
of 'A millennium of macroeconomic data', Research dataset, Bank of England.
3
See LINK News and media contact, 'Coronavirus Crisis means cash use down but UK still withdrawing
£1billion from ATMs each week'Opens in a new window; See LINK, 'Statistics and trends'Opens in a new
window; See chart A in 'New forms of Digital money' DP, June 2021. Moreover, in practice, the UK authorities
remain committed to ensuring access to cash to those that need it. The Bank, HMT, FCA and the PSR have
been working together on the Joint Authorities Cash Strategy group to monitor the use of cash, ATM availability,
and ensure cash remains available despite the impacts of Covid.
4
See the example of the Corralito in Argentina. (BBC, 02/12/2002: "Argentina lifts cash restrictionsOpens in a new
window").
5
See: "The financial crisis - 10 years on" (Bank of England, 2018)
6
Stablecoins are different from CBDC. While stablecoins are a privately issued form of digital money, CBDCs are
a form of digital money issued by the central bank. The Bank of England is exploring the case for a CBDC but
has not made a decision yet.
7
In March 2018, the FPC notedOpens in a new window that: " should be considered as assets rather than
currencies. However, as assets, they establish no claim on any future income streams or collateral. They have
no intrinsic value beyond their currently limited potential to be adopted as money in the future, and hence could
prove worthless".
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In December 2019, the FPC noted that: "Where stablecoins are used in systemic payment chains as money-like
instruments they should meet standards equivalent to those expected of commercial bank money in relation to
stability of value, robustness of legal claim and the ability to redeem at par in fiat".