Newsflash: Monolith responds to the UK Government’s consultation on stablecoins
As the digital asset space has grown, many government officials around the world have started to consider whether cryptocurrencies should be regulated. In most cases, their attention is currently focused on stablecoins. As stablecoins typically track the price of fiat money like USD or GBP, in some cases they have been regarded as a potential threat to traditional currencies.
The UK Government recently consulted on the regulatory environment for stablecoins, and the possibility of introducing new obligations for both coin creators and wallet providers like Monolith. We are concerned that the regulatory proposals will do more harm than good. Excessive and poorly designed for crypto, the proposals may push innovation in DeFi outside of the UK.
Monolith has responded to the consultation to share our thoughts. We also contributed to the DeFi Work Group (DeFi WG) response. It is vital that the industry works together to help the government with its proposals to protect consumers. However, this must take consideration of new technology and architecture, without placing burdens on firms.
DeFi WG is a group led by Benjamin Whitby connecting DeFi industry members, including Maker, Aave and Monolith. It aims to lobby various governmental bodies on the topic of the DeFi economy.
Facebook’s currency and the Risk to Financial Stability
Regulators have been monitoring stablecoins closely since Facebook proposed its own global dollar-pegged currency: Libra. The social media giant’s project received widespread media attention, leading Mark Zuckerberg to appear before US Congress and the European Parliament to discuss the benefits and risks of a global digital currency. Libra sparked fears over the possible effects on the global financial system. Discussions also focused on the state’s ability to dictate monetary policy. Libra in its early iteration was short lived, and Facebook has since rebranded the project to Diem. Nonetheless, it’s been a point of reference for governments across the world considering stablecoin reforms.
The UK’s proposal
The key update in the UK’s proposal is a new category of regulated “Stable token”. According to government guidelines, this category would refer to “tokens which stabilise their value by referencing one or more assets, such as fiat currency or a commodity.” The government excludes algorithmically-backed stablecoins such as RSV and AMPL. Activities that would relate to this group include issuance of coins, fiat-crypto exchanges, and custody services. Moreover, if stablecoins were to hit mass adoption, it’s likely that there would be more supervision and regulation.
Our concerns
One major point of concern lies in the tools the UK Government has proposed. While the consultation doesn’t go into great detail, it proposes regulatory tools like authorisation, supervision, and required custody for wallet providers.
We believe that these tools are a poor match for the cryptocurrency and decentralised finance space. Placing obligations on immutable code, smart contracts, and automated protocols is not viable. It would add costs and do little to address the risks of DeFi. Perhaps most importantly, it would strangle innovation, possibly leaving the UK falling short behind other countries that embrace the technology.
The government must engage with the cryptocurrency industry to develop a framework on crypto assets and ensure that the UK remains at the forefront of innovation.
Our response
Stablecoins such as DAI form a key part of our offering and we see them as a catalyst for DeFi’s rapid development. Stablecoins have exploded as the space has; today they account for almost $40 billion of value on the Ethereum network. DeFi is developing at a breakneck speed, and regulators must be careful not to block the progress with regulatory constraints. Our contribution zooms in on DeFi, sharing our concerns about the framework, and alternative ways to achieve the regulatory objectives. The key headlines from our response are as follows:
1. The proposal presents potential harms with little supporting evidence
The proposal discusses financial stability in a largely theoretical context, referencing Facebook’s Libra plans with little credible evidence to date. The proposed regime does not fit the fast-moving crypto space of today, especially DeFi. There are many risks associated with DeFi, including smart contract risks, slippage, and impermanent loss. The consultation paper offers little consideration on safeguarding, nor the impact on the DeFi economy or non-custodial wallets like ours. We believe that focussing on evidenced risks and understanding the costs of intervening in the space could be a better way to achieve progress.
2. The proposal disproportionately targets smaller firms
We understand the need for enhanced supervision over the stablecoins that hit mass adoption. However, new market entrants should not be viewed in the same way as Facebook, or any other firms developing stablecoins that will be used worldwide. In other words, enhanced supervision should not apply to firms that have no say in how stablecoins are built, issued or stabilised. Placing too much regulation on any company that supports the use of stablecoins poses a threat to the future of the industry.
3. The proposal is harmful to DeFi
Some of the proposed monitoring measures do not make sense for decentralised finance. These include validating transactions, moving funds, or safeguarding obligations related to the custody and administration of stabletokens. It’s unclear how these regulations would work for a non-custodial wallet like Monolith. A non-custodial wallet lets users have full control over their funds and any seed and private key associated with the wallet. As such a wallet does not stay under the control of the provider, it is impractical to suggest ongoing safeguarding obligations. In our view, it makes more sense to apply certain requirements, such as performing due diligence checks, during the onboarding process only. It’s also worth noting that anyone with an Internet connection can create their own non-custodial cryptocurrency wallet — there is no requirement for a crypto custodian. There is therefore no heightened risk in our proposed approach compared to an individual who creates their own wallet.
4. The proposal should look at alternative means to achieve regulatory objectives
It’s possible to monitor stablecoin activity in real time, and regulators could benefit from what the Bank of International Settlement (BIS) called “embedded supervision” in the November 2020 working paper “Stablecoins: risks, potential and regulation.” This supervision suggests monitoring on-chain activity and gathering relevant data without requiring firms to actively collect, verify and report data to authorities. We think that the government should embrace this approach instead of adding a layer of supervision through an expensive authorisation regime.
Finally, we encourage more interaction between the independent regulators and business as a whole, as this will allow the regulator to make more informed decisions. As part of this, we would suggest launching the equivalent of the FCA’s Advice Unit to provide blockchain companies with regulatory feedback.
This would allow businesses, some of which may launch innovations after the rules are drafted, to be able to discuss solutions with the regulator. The regulations could then be adjusted. The government should allow this fast-moving sector to produce technological-based solutions to respond to risks and make more use of the technology.
Conclusion
We believe that decentralised finance will cause a societal shift for the world, and it’s thrilling to see the rate of innovation happening in the space during its infancy. Stablecoins form one of the fastest growing areas of this space. But if DeFi and stablecoins are to grow, it will be necessary to meet certain regulatory standards. We hope that the government follows the advice presented by blockchain-native companies like ours. That way, the UK will have a better chance at staying ahead of the decentralised finance revolution.
Read more about the UK’s regulatory approach to stablecoins here.
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