Digital cash, a form of electronic currency is a broad term covering several types of assets, each with unique characteristics and different risk profiles. The intended, though not guaranteed, benefits of digital cash include:
- Increased transparency for relevant parties
- Efficiency, including reduced fees in payments
- Innovation, including automation in payments
- Increased controls
At the start of November, the Financial Conduct Authority (FCA) and the Bank of England (BoE) jointly set out the beginning of proposals to bring stablecoins into the real economy, with the intention of providing infrastructure and regulation to support stablecoins, a digital currency—generally tracked against the price of fiat currencies—as a payment option for goods and services.
But what are stablecoins, and how do they compare to other types of digital cash? What regulation can we expect them to be captured by in the United Kingdom (UK), European Union (EU), and globally?
Understanding types of digital cash
Digital cash sits within the broader category of digital assets, which also includes non-fungible tokens (NFTs) and other media artefacts. Different types of digital cash have their own unique features and use cases, but there can be significant overlap.
- Central Bank Digital Currencies (CBDCs)
CBDCs are a digital representation of a country’s fiat currency and are issued and backed by the central bank, or monetary authority, of that country. To participants, they offer the advantages of central bank money—liquidity, settlement finality, and reliability—and to the monetary authority they support the goal of maintaining fiscal stability through risk management and compliance.
A CBDC is introduced alongside traditional cash and bank deposits and will likely be built using distributed ledger technology (DLT).
According to the Atlantic Council’s CBDC Tracker, 130 countries, representing 98% of global GDP are exploring a CBDC, 11 have fully launched a digital currency (Nigeria, plus Caribbean nations), and 19 of the G20 countries are in the advanced stages of CBDC development.
- Deposit Tokens & Tokenised Bank Deposits
Deposit tokens represent the claim on an equivalent amount of a specific fiat currency held in a designated bank account. The difference between deposit tokens and traditional bank deposits, is that the former is issued using distributed ledger technology (DLT) with the intention of improved transparency, security and, crucially, speed.
Deposit tokens are issued by regulated banks, meaning that traditional banking services can be extended to the dynamic and complex markets of digital assets. Currently, traditional payment settlement takes up to two business days (T+2) and can be challenged when multiple financial intermediaries are involved; with DLT, instant and atomic settlement becomes feasible, reducing costs, and more efficiently managing liquidity.
- Electronic Money (e-money)
E-money is digital cash stored in online systems or databases, such as the cash in an online bank account. The use of e-money in a retail context is already adopted: whenever we make a payment online today through a bank or payment system (e.g., Wise) we use electronic money to complete the transaction. Whilst transactions made using e-money in a retail context appear to be immediate, settlement activities can take up to two business days from the perspective of the financial institution.
In the future, financial institutions could leverage DLT to achieve instant and atomic settlement, meaning that an e-money transaction that appears immediate to the consumer is also settled immediately with the banks.
E-money is tied to fiat currency and is backed by the same issuing authority. There are two types: (1) hard currency, where you cannot reverse a transaction (e.g., moving money from one bank account to another) and (2) soft currency, where transfers may be reversible within a certain period (e.g., as with a credit card, or through some providers such as PayPal).
- Cryptocurrencies & Crypto assets
Crypto assets are a broad category of assets that leverage cryptography to securely and digitally represent value or contractual rights. This includes digital assets such as non-fungible tokens (NFTs), and cryptocurrencies.
Cryptocurrencies are virtual currencies operating on decentralised systems built on blockchain technology. This is a type of DLT and the most well-known example of a cryptocurrency is Bitcoin (BTC), founded in 2009.
Though they remain popular, and an important part of the modern economy, many cryptocurrencies are unregulated and continue to suffer from volatility. Whilst this can appeal to some types of traders, it can present inherent risks for retail participants, and as a result regulation is being drafted and—at least in the EU—legislation is expected to be implemented from mid-2024 to 2025.
Stablecoins are a type of cryptocurrency designed to reduce price fluctuations by pegging its value to a reference fiat currency (e.g., the US dollar), or gold, and sometimes maintaining collateral through reserve assets. They can act as a bridge between traditional and cryptocurrency markets, and do not need to be issued by a central regulatory authority.
Depending on how their value is stabilised, stablecoins fall in to three categories:
1. Fiat-collateralised: maintain fiat currency/currencies—generally U.S. dollars—as reserve to assure value. Examples: TrueUSD (TUSD), Tether (USDT)
2. Crypto-collateralised: other cryptocurrencies held in reserve, and as these may be volatile, this type of stablecoin is overcollateralised. Example: MakerDAO Dai (DAI)
3. Algorithmic: control supply through algorithm, so not necessary to hold reserves. Example: TerraUSD (UST)
Stablecoin regulation in the UK, Europe, and beyond
According to the Financial Stability Board (FSB), there remains a lack of universal consensus on how to legally or regulatorily define stablecoins. There are, however, distinct efforts—particularly in the UK and the EU—to implement sensible frameworks in the next 12-18 months.
Legislative amendments to the Financial Services and Markets Act 2023 (FSMA 2023) have made it possible for UK regulators to take steps towards providing a framework for Stablecoins. Therefore, on the 6th November, The Bank of England (BoE), Financial Conduct Authority (FCA), and Prudential Regulation Authority (PRA) jointly published discussion papers introducing an exploratory period inviting feedback from key stakeholders with a view to implement stablecoin regulation by 2025.
The intention of the FCA is to regulate all UK-based issuers of stablecoins, as well as custodians based anywhere that provide custody services to UK-based customers. Consideration is being given to how to use non-UK issued stablecoins in the UK payments ecosystem, and some firms may additionally fall under the remit of the Payment System Regulator (PSR).
Providers of services in crypto assets that are not financial instruments as per the Markets in Financial Instruments Directive (MiFID II)—such as stablecoins—are also captured by Markets in Crypto Assets (MiCA) regulation. This is an EU-based framework aimed at regulating crypto assets and their markets; it builds on the EU’s Digital Finance Strategy in 2022, aimed at fostering innovation and ensuring a secure and competitive environment in the digital financial sector.
Beyond the UK and the EU, countries have taken varied approaches to stablecoins, generally trying to answer the question: do issuers of stablecoins have sufficient assets to back them?
- In April this year, the United States published a draft Stablecoin bill, which included a proposed moratorium on crypto-collateralised stablecoins.
- In Asia, Japan has taken the lead. Having previously effectively banned issuance of stablecoins, in June this year they implemented a comprehensive stablecoin law that encourages a fresh, innovative start for these currencies.
Summary
Digital cash is rapidly evolving, offering many potential benefits and challenges for the financial sector and society at large. Among the different types of digital cash, stablecoins are a promising innovation that aim to combine the advantages of cryptocurrencies and fiat currencies.
However, they also pose significant risks and require appropriate regulation to assure stability. The UK, the EU, and other jurisdictions are taking steps to develop a comprehensive and harmonised framework for stablecoins, and responding to these recommendations and requirements will be essential for market participants in the next few months and years.
How Delta Capita can help
Delta Capita has a wealth of experience across Payments, Digital Assets, and Distributed Ledger Technology (DLT). Our proprietary DLT product ecosystem provides solutions to help financial institutions in regulated Capital Markets improve their efficiency and security.
Whether you are looking to engage with digital cash, explore new opportunities with DLT, or navigate the complexities of payment compliance, we’re here to provide the support and solutions you need.
To find out more and speak to one of our experts, contact us today.
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