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The Bank of England (BoE) has warned that the use of stablecoins in wholesale payments poses “significant financial stability risks” that ought to be mitigated by future regulation.
In a new discussion paper published on Tuesday (July 30), the BoE argued strongly against the use of stablecoins in wholesale transactions.
In the paper, the BoE expressed concern that the primacy of central bank money in wholesale settlements is threatened by new innovations in private money, such as stablecoins.
Although stablecoins have yet to see significant uptake outside of crypto-asset trading, the BoE said that regulators must be prepared for their usage in systemic payment systems to grow.
In wholesale use cases, the central bank said the risks posed by stablecoins are an “order of magnitude” greater than in retail use cases.
“Absent holding limits, were the financial system to come under stress, stablecoins used for wholesale transactions could become an option which market participants could run to, leading to sudden bank disintermediation,” it said.
“This could take place at scale given the high values of wholesale transactions, and could further destabilise the financial system, with potential disruptions to banks and non-bank financial institutions (NBFIs), such as money market funds.”
The BoE believes that by imposing holding limits on stablecoins, regulators can ensure that this new form of privately issued money is not used in wholesale transactions.
BoE position evolves
Last November, the BoE published an earlier discussion paper in which it considered a potential regulatory regime for systemic payment systems using stablecoins.
In that paper, it also argued in favour of holding limits, but it did not specify what limits it believes are appropriate.
However, the bank suggested that its approach to stablecoin holding limits could be “similar” to its proposed approach to retail central bank digital currency (CBDC) holding limits.
In February 2023, the central bank published its first consultation on a UK retail CBDC, also known as the digital pound.
It suggested that if a digital pound were to be issued, individual holding limits could be set between £10,000 and £20,000, but it also sought views on a lower limit, such as £5,000.
“Applying similar holding limits to stablecoins would allow the bank to learn more about the extent of bank disintermediation associated with their use and the resulting impact on the cost and availability of credit,” the regulator said last year.
“As bank deposits flow to new forms of digital money, including stablecoins, commercial banks could lose retail deposit funding and pass on higher wholesale funding costs to customers. Thus, credit conditions could worsen.”
However, the bank acknowledged in both papers that the financial stability impact of stablecoins will also depend on the speed and scale of their adoption.
As such, the BoE is in favour of applying low limits at first, with the possibility that these limits could be scaled up, or even removed, at a future date.
“Imposing holding limits at a relatively low level, at least in transition, would not rule out the possibility that a payment system using stablecoins could be widely used for payments, given that the volume of transactions could still be high,” it said.
“But some types of payments could become impractical, constraining the use cases for stablecoins to lower value transactions.”
Finally, the bank said it recognises that implementing these holding limits may be “operationally challenging” for payment system participants, given that users may have multiple ways to access a given stablecoin.
In its latest paper, the BoE reiterated its call for potential technical solutions that the UK’s wholesale payments infrastructure could use to address these challenges.
It also asked respondents to provide feedback on what they see as the risks and benefits of the use of stablecoins in wholesale transactions.
Stakeholders have until October 31, 2024 to respond to the discussion paper.
