15
Examination of witness
Professor Simon Gleeson.
Q21 The Chair: Welcome to today’s meeting, which is the third oral evidence session as part of the committee’s inquiry into the growth and proposed regulation of stablecoins. We are very grateful to Professor Gleeson for attending this session and assisting us with our inquiry. Professor Gleeson, I believe that you will make a few opening remarks before we move on to questions, so I will hand over to you.
Professor Simon Gleeson: Thank you. Legally and economically, there is nothing new about stablecoins. If you think about the way that banks in Scotland and Hong Kong work today, they issue transferable pieces of paper that pass from hand to hand as a form of currency. This is just a technological way of doing that. The difference in what is developing as the stablecoin environment is that the issuers of these things are not banks.
The experience in South Korea with TerraLuna demonstrates that allowing completely unregulated entities to issue things that circulate as money is potentially disastrous, and there is a universal regulatory practice in the EU, the US, here and a number of other places to regulate the assets that stand behind anything that is capable of circulating as money.
Conceptually, that is exactly the same job that bank regulation does. One way of looking at stablecoin issuance is that it is just a form of very narrow banking, which is exactly what it is, but the issue here is that these things are half way between banks and funds. For example, if you look at money market funds, you will see that they are regulated in almost exactly the same way as it is proposed that stablecoin issuers are in terms of the restrictions on the portfolio of assets that they can hold to back their instruments.
This takes us on to the crux of the difference between the two. The reason we do not use money market fund units in transactions is that they are extremely hard to transfer from one person to another; you have to register units and all the rest of it. If you look at a stablecoin as a money market fund unit that is established using a mechanism that makes the units easy to transfer, then that is the correct mental model of the asset.
That takes us to the biggest issue here, which is that there are two separate regulatory issues that have to be thought of separately. One is the composition of the thing itself: what it is and what is behind it. The other is the payment mechanism by which it is transferred. The regulatory question is: how do we regulate the payment mechanism that is created here?
The fundamental problem with these things—in a way, the issue that poses the greatest difficulty for trying to envisage how this market will develop—is that a crypto asset sits half way between money and securities. But the biggest single issue is that, whereas money can be placed on deposit, a crypto asset, in effect, has to be custodied; somebody has to look after it. One way of looking at crypto asset custody is that you could say, “Well, this is the service for crypto assets that banks provide in the context of banking services”, and ask who does it, and even more importantly who pays for it. I am sure that is very old hat to most of the members of this committee, but none the less I just wanted to do a little scene setting.
Q22 The Chair: Could you characterise the significant advantages and risks associated with stablecoin and perhaps comment on whether you think the regulatory approach that is being proposed is getting the balance right?
Professor Simon Gleeson: It is probably correct to say that there are four different markets for stablecoins. The biggest and most important one—where they are most desperately needed—is actually foreign exchange settlement. The trouble is that that is only going to work if we get central bank digital currencies issued by multiple central banks, which is what Project Agorá is doing, but that is really outside the scope of this inquiry.
The place where they are most desperately needed is in the context of cross-border payments, basically because we still have the leftover correspondent bank model, which takes for ever and costs a fortune. That is the obvious win and falls under two separate heads. One is financial market settlement. The financial markets still contain far too much settlement risk arising out of time than they should, and that is a threat to global financial stability. If we could eliminate that, that would be splendid. There is a quirk to that, which is that the reason the international financial markets nowadays rely on CCPs and financial market infrastructures is precisely that this is the best way of eliminating those time delays. If it were possible to settle financial markets instantaneously by the exchange of stablecoins, that would be a major benefit to global financial stability.
The second aspect of that is settlement of cross-border payment between commercial entities, and again, the costs of international payment at the moment are breathtaking. We are told in this country that it will cost you 3.5% to make a big dollar payment. If you were trying to make a payment between, say, Japan and South Korea, it would take the best part of a week and cost breathtaking amounts of money. So there is a very substantial benefit there.
Finally, there is the issue of retail or broad market, if you like. It is a slight mistake to talk about retail crypto because most retail transactions are actually affected with a commercial body of some form or another. You think about people going to buy groceries at Sainsbury’s—well, yes, it is a retail transaction, but the participants are pretty big. The retail market is perceived as being expensive, but the issue there—you can see this most clearly if you look at the policy of the European Central Bank in this area—is that the ECB’s approach to retail payments does not appear to be primarily centred on reducing costs. What it appears to be primarily centred on is creating a third alternative to what is perceived as the Visa-MasterCard duopoly. The question of whether it is worth spending government money to build a third set of rails to that duopoly is very much outside my scope. But the question of whether there is a potential benefit to UK consumers in building that is an open one.
The thing I would say on that point is if you look at the Swedish experience with Swish—where what happened was basically the Swedish Government sponsored a project between the Swedish banks to develop a retail payment mechanism that was effectively account-to-account—the Riksbank says that has put serious downward pressure on the cost of retail payments in Sweden, which is what you would expect: develop a third competitor and there will be downward price pressure. What is interesting is that although the use of Swish among Swedish consumers has grown very fast, the use of MasterCard and Visa cards in Sweden is also increasing, so that seems to give you the best of both worlds. The one-line answer to your question is that there are at least four different markets here, each one of which has to be regarded separately for regulatory purposes in order to determine the optimal regulatory approach.
The Chair: Do they have the balance right?
Professor Simon Gleeson: Here?
The Chair: Yes.
Professor Simon Gleeson: In terms of regulating the products themselves, the remarkable thing is that the GENIUS Act in the US, MiCA in Europe and the proposals here all end up in almost exactly the same place, and that is not a million miles away from where the money market fund legislation already is. In that regard, it would seem that they have that balance right. There are issues that we will come to later, but the basic issue of what happens to the interest on the bonds held to back the assets remains slightly in nubibus. But there seems to be a consensus that there should not be interest paid on these instruments and that again seems to be believed everywhere. To that extent, it seems that there is a global consensus developing, which the UK is in line with.
Where the answer to your question may well be no is when you move away from the regulation of the products themselves and look at the regulation of the way in which they are dealt with and the system in which they are operating, which is the FCA’s bailiwick rather than the Bank of England’s. The problem to my mind is that the FCA has dealt with this effectively by trying to extend the securities law regime in order to apply to these instruments, and that creates some substantial fundamental problems.
First is the whole issue of custody. Who does it? Who is allowed to do it? What do they charge? The second is intermediation. In very broad terms, intermediation of money payments is not regulated but intermediation of securities transactions is. If you want these things to do the job of money, you really cannot regulate intermediation. But that creates policy difficulties for the FCA because it has to make a clear distinction between things like Bitcoin—effectively investment products—on one hand, and these things, which are very much not investment products. There is a significant flaw in the UK approach to regulation at the moment, which is that the application of securities regulation to stablecoins potentially kills them as a useful product.
Lord Sharkey: Can I follow up a little on disintermediation? Given that stablecoins are primarily for cross-border payments and on and off-ramps for crypto assets, how great is the risk of disintermediation? How great is the risk attached to draining the system of liquidity, which I do not think we have touched on at this point? I also noticed that in MiCA they explicitly make the point that the right of redemption will exist at all times, the redemption shall not be subject to a fee and you cannot pay interest. Given all that, how are these token issuers making money at a reasonable margin?
Professor Simon Gleeson: The answer to the last of those questions is through what they hope will be the positive carry between the instruments they issue, which do not bear interest, and the assets they hold, some of which will bear interest. This actually goes back to the debate that we were all having 20-odd years ago about bank liquidity. It is all very well to specify what you want the credit quality of a bank’s assets to be, but there is an entirely different question about how much physical cash they have to hold in order to ensure they can redeem on demand.
Something we learned after Basel II from LCR and NSFR was that maintaining high liquidity balances in order to manage those potential outflows is an enormous cost to the institution concerned. The challenge is that if you talk to UK banks about free banking, what they will say is that there are times when retail banking loses money just because rates are low and there is no income, and sometimes you make out like bandits because rates are very high and the spread is enormous. The question is not whether they will make money over the medium term; they will. The question is: what is the impact of them at the nadir of interest rates when they are loss-making, and how do they continue? I do not know the answer to that but it is one of these classic things: regulation in advance tends to set a reasonable level but the scope for crisis is very great.
Just following up on that, the other point is that when you look at what actually happens in crises, it is always a run of some form or another. An area where the Bank of England has this slightly wrong is that it is very focused on the risk of runs from banks to stablecoins. Think about how it would work the other way around if there were a loss of confidence in the stablecoin. The point about the stablecoin issuers is that—by definition—they are full up with short-term government paper. So if there were a run on a stablecoin issuer, you would then have a substantial impact on the government bond market, and we saw the potential impact of those sorts of short-term shocks a couple of years ago.
The question of what regulation needs to look like on a day-by-day basis is a different thing from the sort of issues you are raising, which focus on what could happen in the depths of a crisis. On the disintermediation point, it is clear that there is substantial scope for disintermediation here and the point is just that commercial and financial users do not hold deposits because they want to; they hold them as a way of enabling themselves to make payments immediately at a time when they need to make them.
If there were an option that did not involve locking up their money in banks and taking the credit risk on those banks, they would unquestionably do so. If you think about a large corporate thinking about its exposure to its bank, that is a non-trivial credit risk. If it could hold that value in a form that did not carry that credit risk, that would be a benefit. The osmotic gradient, if you like, is very much towards a degree of disintermediation.
Baroness Bowles of Berkhamsted: Can you just follow up on that a bit further? Are you saying that rather than hold something on deposit and get some interest, companies would rather have no interest or credit risk?
Professor Simon Gleeson: This all gets a bit painful. There is an issue. Part of the reason corporates do not hold as much in money market funds as they ought to—something they could do today—is that current accounting practice is that bank deposits do not fluctuate in value. A bank deposit of £100 is carried as an asset worth £100 that does not vary despite the fact that in real life the credit risk on the deposit taken might fluctuate substantially.
That is not currently true of crypto assets of any form so you would face a risk of having unexpected profits and losses where you really did not want them. So there are collateral advantages to holding money in banks at the moment, but as a general rule, the larger the corporate, the more sensitive it is to the credit risk of its bank exposures.
Q23 Baroness Bowles of Berkhamsted: Those things might change over time. Are the risks of the proposed regulatory approach from the Bank of England right, in particular looking at the holding limits and the exemption regime limits? Do you have any views on the Bank of England’s proposals on the assets that are backing?
Professor Simon Gleeson: The holding limits strike me as being absolutely bonkers, to be honest. There are a number of different circumstances in which you can imagine a consumer wanting to hold different amounts of stablecoin for different purposes. The obvious example is house purchases. At a time when you are massively exposed to finance, that is exactly the point where you think the rational consumer might actually want a risk-free asset. It is a whole business we used to do with bank drafts back in the day.
I am afraid the holding limits issue is a wonderful example of the intellectual failing that our legislative system is prone to, which is writing very impactful rules to address problems that nobody knows will actually happen or not. This is one of those things that could be dealt with perfectly happily on an ad hoc basis by rulemaking if an issue were to appear. The problem you have is that once you have decided to go down the route of holding limits, any limit that you choose will be the wrong limit in goodness knows how many different circumstances. So as an approach, I do not understand it. Quite a lot of people have balances from time to time of those sorts of amounts and the business of imposing a £10 million limit on commercial operators seems crazy. Why would we want to regulate that market at all?
Baroness Bowles of Berkhamsted: If you are looking at individuals, could they solve it in the same way that they do with temporary large deposits in banks?
Professor Simon Gleeson: Oh, absolutely, but I would say that is exactly the wrong approach to legislation.
Baroness Bowles of Berkhamsted: Because it is bitty?
Professor Simon Gleeson: Yes. You start off with a general prohibition, end up with a load of specific permissions and then discover you need to keep adding to those. Why consume all that resource?
Q24 Lord Hollick: Can we just look at the competitive dynamics? There are two areas. One is: if I put some money in a money fund, I get an interest payment. Some stablecoins might pay interest; others do not. The concern is that if they did pay interest, that would drain some deposits away from the banking sector, which would actually reduce the amount of credit going into the economy. I suppose an adjunct to that is the opportunity to have a token deposit as another form of digitisation that could actually enter the fray.
The second thing that you touched on is the impact on the existing MasterCard and Visa payments. You said that in fact when stablecoins were introduced, there was no sign of any diminution in their market share. Is that because they have not yet become universal or does it represent a real competitive threat, and will that competitive threat be essentially coped with by a welcome deduction in the charges by MasterCard and Visa?
Professor Simon Gleeson: Those are two entirely different questions. If I start with the second one—the impact on MasterCard and Visa—that very much depends on what the stablecoin market ecosystem looks like. Just to explain that, if you think about a consumer using a Visa card to buy something, say over the internet, virtually no UK consumer has ever heard of Section 75 of the Consumer Credit Act 1974 but they have this very vague awareness that if they use a credit card then the credit card operator is on the hook to some extent, and if something goes badly wrong then they have somebody to talk to about it.
The same is true for direct payments out of bank accounts. You feel if something goes badly wrong, you potentially have some recourse against your bank. If you look at what the Swedes did, what Swish is—which is fascinating in this regard—is a parallel set of rails to MasterCard and Visa but it is a bank account to bank account transfer system. To some extent, the user of Swish has the same degree of confidence that he would have if he were making a bank payment that there is somebody there.
The whole point of the distributed ledger stuff in the early days was precisely that, “This isn’t intermediated, there are no intermediaries; that’s where we’re saving all the money”. But the consequence of that is you do not have any of that protective infrastructure to fall back on. The argument is that if that were how the market developed—that consumers were either paying money to have the warm fuzzy feeling that they could sue the card company if something went wrong, against the cold windswept idea that once you had instructed the transfer you were on your own—then I believe the card companies think that consumers would opt for the comforting ecosystem over the cold winds of market payment. It is very hard to read.
The third point about that is, as I said: no real-life consumer is going to operate their own node and hold their own crypto tokens. In order for this to be widely held by retail, there will have to be wide custody providers whose services will be available to those retail investors. That actually takes you straight back to the profitability point because a custodian has to charge for his services; he is not allowed to make money out of the assets he holds. You then get the issue for those retail investors of whether they are actually going to pay fees for something that they perceive they get for free from their bank. Trying to understand how that would work in a competitive market is something I must say I find almost impossible to do. I do not think there is a clear cost advantage that would drive an almost inevitable flow from one to the other; it is a lot harder to read than that.
On your other point, it is absolutely right that when you hold a bank deposit, what you hold is a token backed by the portfolio of loans made by that bank. If you hold a crypto stablecoin, what you hold is something backed by the credit of the UK Government. It is effectively an electronic banknote. Money that was previously going into the real economy is now going into the pocket of Government.
Something that has been floated—an idea that I must say I find absolutely appalling—is that Government could rectify that by becoming a credit lender to the real economy in order to recycle the money back into the system, which causes one to put one’s head in one’s hands in despair. It is absolutely right that the result of this would be a drain of credit from the real economy. The question of what you could do about that lies in the realms of fiscal and monetary policy rather than regulation.
Q25 Lord Turnbull: Can I come back to the term “stablecoins”? Is this a nice, friendly title dreamed up by some marketing man for something that is not actually stable? Like exchange rates, they are fixed until the day they are not. Are stablecoins stable until the day that they are not? What are the risks of a system that lacks protective infrastructure to fall back on—I think that was the phrase you used—or lender of last resort? Is the risk that there would be a huge movement of people rushing to get out of stablecoins back into money sufficiently important that we should not allow something that does not actually have a protective mechanism to handle that?
Professor Simon Gleeson: It is not an argument for not allowing it. As a matter of fact, weirdly, there are stablecoin-like things circulating in the UK today. The Bristol pound is an obvious example. The reason the Bank of England does not worry about it is that it is not big enough to care about. To some extent, the issue is that you need powers in reserve, for want of a better word. What do you do when these things become big enough to care about?
If we look back to the financial crisis, what drove the market crisis in 2008 was basically a mass run on money market funds. What that meant was that effectively the Government had to step in in order to provide liquidity support to those money market funds. It is not difficult to see exactly the same thing happening with stablecoins. If stablecoin became sufficiently widely integrated into the economy and there was a crisis, the reality is that there would have to be state action. For exactly the same reason as back in 2007, you cannot allow your circulating medium of payment to collapse. That is a hard rule. It is absolutely the case that there are real risks here and the justification for regulation—in good part—is precisely because of the risk of forced government interaction.
But the answer to the question, “Are they stable?” to some extent goes back to a point that we were talking about earlier. They are certainly stable in the sense that the assets that back them are equal to the value of what they are issuing. If you are issuing a pound stablecoin backed by UK short-term government paper or Bank of England debt for the same value, then that is certainly stable on a credit basis. The thing we have to worry about is, on any given day, can you actually raise enough money to meet the redemptions? It is perfectly possible to be solvent but illiquid, and that is the threat.
Lord Turnbull: You said in 2008 the central banks stood ready to intervene. Was one of the problems not that for a time we did not really know that?
Professor Simon Gleeson: Yes.
Lord Turnbull: Hank Paulson had to come and say, “I know this is what should happen but I can’t get Congress to agree to it”. Something that might happen but you have to negotiate it on the day is not a very good mechanism to have. Something that is known about and provided for in advance would be superior.
Professor Simon Gleeson: A big learning point from the crisis is the overwhelming importance of requiring any bank—or for that matter financial entity—to do detailed planning about what we would do in a crisis. Where would we go? Who would we ask? You then talk to the people who would be asked and say, “What would you do if this happened?” What it demonstrates is the overwhelming importance of crisis planning as well as just making sure that you are flat in credit terms.
Q26 Lord Davies of Brixton: We heard at the previous meeting that the main function of stablecoins is primarily for getting money in and out of crypto assets. There was some foreign exchange but the other big users were bad actors, and that is going to pose a challenge for the authorities. To what extent should that feature in the form of regulation that we have for stablecoins so that we know this is where bad money is going?
Professor Simon Gleeson: Yes. A point that I have been talking to certainly folk in the banking industry about for nearly 10 years is that the current anti-money laundering terrorist finance structures were set up 20 to 30 years ago and are thoroughly outdated. The burden of money laundering compliance on institutions is enormous and the benefits seem to be trivial. There is a very broad set of beliefs that what we ought to be doing is trying to redesign the entire money laundering system in order to make it better at what it is supposed to be doing, which is identifying and preventing these uses.
There are certainly ways in which you could deal with stablecoins that would make them considerably easier to track and identify where money laundering or terrorist financing was potentially going on, but you would need a fairly substantial revision of the existing AML framework in order to make that effective. As a matter of fact, there are people out there who take the view that this could be the greatest benefit to AML policy there has ever been because tracking this stuff is not as hard as you think, but none of that is covered by the existing AML regime.
Lord Davies of Brixton: For honest actors, would the tracking not be of benefit in any way?
Professor Simon Gleeson: It happens today anyway but the banks know exactly where money goes when you pay it out of your bank account.
Q27 Lord Griffiths of Fforestfach: I have two questions. Just so that I am clear in my own mind: you take a stablecoin company that invests in some assets—even Treasury bills or something—makes a profit from that and is not allowed to pay interest. Let us assume every person here owned a company like that. If you were a businessperson, the first thing you would think of is, “What can I do to get business from somebody else?” If I went to Tesco or Waitrose, I would say to them, “Can I make the following deal? I’ll pay you so much, but if somebody has more than X of these stablecoins, they can come here and you give them a discount of 3% up to a certain amount”, et cetera. Basically, my question is: if you have a genuine competitive system, which is competitive, despite what the regulatory authorities may intend and do, it is very hard in the end not to have entrepreneurs creating something that will undo what the regulatory authorities want.
Professor Simon Gleeson: Yes, that is absolutely right. You have that dynamic today with card companies, which is why card companies have reward programmes that are basically saying to the user, “The more you use your card, the higher my profits will be and I will give some back to you”. Again this is certainly something that was gone over in some detail immediately after the crisis, when time was spent thinking about free banking, which is the same idea to some extent. The problem the economists identified—they were entirely right to do so—is that retail consumers are incredibly price-insensitive to all this stuff because they never see the prices. The number of retail card users who know that the card company gets 2% of their spending must be negligible, and then they get excited because the card company gives them free benefits. You are absolutely right that in theory a cost advantage is by no means always going to be passed on to consumers.
Lord Griffiths of Fforestfach: It is right that the regulatory authorities—the central bank in particular—should be rather conservative institutions because we want financial stability. I am no expert in the field but my impression is that America is moving faster than we are. If I look at the BRICS, they are thinking of creating an international payment system among themselves, which is really quite attractive for countries like India and maybe China.
If you look at the advent of competition in banking in this country over the last 50 years, it is true to say that the Bank of England was dragged along because of developments over which it had limited control. In designing a regulatory system, we cannot really do it on our own. We are part of a global system. My second question then is: to what extent at present are we potentially out of sync with what is happening in the rest of the world? Whatever the documents that the regulatory authorities come out with today say, international competition will force us.
Professor Simon Gleeson: Yes, that is necessarily and exactly right. The only thing that we can use regulatory tools to do is to try to put up walls to stop it coming to the UK—an exercise which is invariably unsuccessful and likely to do economic damage. There is quite a lot going on at the international level on this now. Agustín Carstens spent most of his last year in office at the Bank for International Settlements basically promoting a global crypto stablecoin interchange project, which would be a massive benefit if it could be created.
The point you have is that if you look at what is going on in America, it is perfectly right that there are all sorts of crypto businesses starting up and there is real interest in the products. There is also massive pushback from the American banks, which are extremely influential and very powerful. Almost wherever you turn, you realise that the domestic banks have very strong views on the development of something that will undercut the core of their profitability. I am not as convinced as I perhaps should be that America will necessarily be the torchbearer on this domestically, but it takes you to the other point that, if you look at global trade, it is denominated in dollars. Global trade needs US dollar stablecoins if it is to progress down this.
Q28 Lord Hill of Oareford: I need to declare an interest as a board member at Intercontinental Exchange and an adviser to Santander and Visa Europe, all of which are businesses that could be affected by the growth of stablecoin and tokenised assets.
I wonder if I could take you back to what you said right at the beginning about your four buckets, and your second one—which you then split into two parts—of financial market settlement and cross-border business. You said that one should think about how to regulate your four areas in a self-standing and discrete way and that each sector might require a different regulatory approach. Could you just say a bit more about that, and in particular what you had in mind on that second area of financial market settlement and commercial cross-border transactions?
Professor Simon Gleeson: Financial market settlement does not seem to me to require regulatory intervention at all as far as what is done with these instruments is concerned. It is very important that if financial market actors are exposed to these instruments, then the credit risks and other risks inherent in them are regulated. Wholesale financial markets is one of these areas where we do not need regulatory intervention at all in terms of what is done. The intervention is all needed on the composition of the asset.
Where commercial cross-border differs from this—especially when you get into SMEs and slightly larger—those users of the payment system engage with and rely on what I call the ecosystem points to some extent. It is an error to divide the world in a binary fashion into consumers and wholesale. It makes more sense in this context to divide into consumers, corporates and financial. As far as corporates are concerned, there probably is some need to regulate things like who is allowed to provide them with custody services and intermediation services so that at least they have some degree of reassurance that they are dealing with service providers that are not going to run away with their coins. It is much easier for a stablecoin custodian to run away with the assets than it is for a bank to run away with the money. There are three different levels of regulation required there.
Lord Hill of Oareford: If you take those three, if one is thinking about how to approach regulation overall, do you think there is any sense in thinking, “Let’s try to fix those three segments that you’ve described from a regulatory point of view”? First, those are clearly the biggest use cases and, if you could crack that, you could deliver quite a lot of savings in cost and probably also in capital. If you are transacting more quickly in an exchange or a clearinghouse, you do not have to have so much capital that could be deployed in the economy.
Professor Simon Gleeson: It would also take massive amounts of risk out of the system as a whole.
Lord Hill of Oareford: If you are saying, which seems to be the case, that on the retail side there are a lot more complicated issues, is there any sense at all in thinking of a sequence to how one regulates and that you go after the big prize of markets first and business, or do you think it all has to be done in one great big piece of regulation that does everything?
Professor Simon Gleeson: If we were introducing this with a clean sheet from nothing, the sequence you described is absolutely what ought to be done. The problem is that the starting point we have at the moment is that the crypto markets are almost entirely retail. There is very little corporate engagement with this at all. What we are talking about is a market that is 90% retail, which means that the service providers in that market are retail-oriented because that is where they make their money. There is a perfectly good argument that part of the reason why corporates and financial institutions have been so extremely unwilling to come into this so far is precisely because it looks like a retail Wild West. So there is an argument that sorting out the retail market as it currently stands is a necessary step for broadening the use of these instruments.
Lord Vaux of Harrowden: A minute ago, you mentioned that the dollar is the global currency. Does that realistically mean that there is not really an opportunity for a sterling-based stablecoin approach and that actually we are wasting our time here?
Professor Simon Gleeson: You may recall when Mark Carney was governor, he had some rather grand plans for a sort of UK crypto-Britcoin that was going to displace the dollar, which by the way is an absolutely terrible idea if you think about it. If sterling were to circulate as a global currency, the amount of sterling would be massively greater than that required by the UK economy, which would give you tidal flows back and forth and would be terrifyingly destabilising.
The real answer to your question is that if stablecoins were to be broadly used in international trade, then a lot of the reason for everybody denominating everything in dollars would disappear. If you are a UK exporter, you do not particularly want to invoice in dollars. The reason you do is that that is what your customer is prepared to pay. In a world where you could manage more or less instantaneous and cost-free currency translation, the logic for there being a single global currency would be a lot weaker than it is now. There is a real role for sterling stablecoins, even if the dollar remains the primary currency of global trade, and the more stablecoins exist, the less likely that dominance is likely to continue.
Q29 Lord Eatwell: I would like to follow up on that because I find your answers puzzling. For example, you said the case for the dollar as a universal currency would disappear if there were instantaneous transfers between currencies—but instantaneous transfer at what rates? The rates are not predictable, which creates a risk in that barrier, so you do not have a universal currency. If you want to have the gold standard, fine. Otherwise, that statement really does not hold water, with all due respect.
I would like to really follow up on the AML dimensions of this because you had some interesting things to say earlier. A striking thing about the stablecoin market at the moment is that it is almost exclusively in dollars: 99 point something percent. An earlier witness said to this committee that the role of the stablecoin is to give access to the US banking system to those people who otherwise would not have access. There are some entirely respectable people who would not otherwise have access in jurisdictions with underdeveloped banking systems, but there are a lot of unrespectable people who do not have access to the US banking system and acquire it via stablecoins. You then made a very interesting statement; you said, “Tracking this stuff is not as hard as you think”. Could you elaborate on that a little?
Professor Simon Gleeson: Yes, of course. First, just on my earlier point, if I am either a buyer or a seller whose base currency is something other than dollars and I invoice in dollars, I am exposed to currency fluctuations between the date of invoice and the date of payment.
Lord Eatwell: Unless you use those dollars for ongoing transactions.
Professor Simon Gleeson: Yes, but my base currency is not dollars. I am not saying it gets rid of the exchange rate risk; I am just saying that you cease to care what currency you have invoiced in.
On the money laundering point, this goes back to the fact that, in real life, crypto assets have to be custodied. In a perfect world, it is theoretically possible for somebody to operate as an entirely independent node in their own right. The problem is that, if you do that, very few people will deal with you.
Lord Eatwell: Dollars under the bed sort of thing.
Professor Simon Gleeson: Yes. We cannot do anything about that. But if access to this market is effectively intermediated through a custodian network, you end up with exactly the same broad pattern as you have with the banking system today.
Lord Eatwell: The issue is one that is often deemed to be encountered with tradespeople, whether you are paid by cheque or by cash, and that is a similar issue.
Professor Simon Gleeson: Yes. As I say, it is technically possible for two people to interact on a digital ledger in such a fashion as for both to be completely independent, freestanding and all the rest of it. But that transaction has many of the same characteristics as handing over a suitcase full of cash.
Lord Eatwell: Yes, exactly. I have just one other, different point, if I may. The basic credit risk with stablecoin is associated with the underlying assets. As we know, the credit risk of underlying assets of government paper depends on the credibility and willingness of the Government to provide liquidity when necessary. The stablecoin is as risky as, let us say, the US Government are today. If the US Government—as they have come very near to doing—stopped paying interest on US treasuries because of issues associated with the overall size of the US deficit, that would be a risk to which you were exposed. Is that correct?
Professor Simon Gleeson: Yes, with one caveat: it is perfectly possible to argue that an obligation of the UK Government to pay in pounds carries no credit risk at all in sterling. The pound may have halved in value, but you are still getting the pound you contracted for. The slightly mysterious thing about the idea of the US Government defaulting is that the last time the US had an actual default, the rating agencies did not downgrade their rating and the market continued to trade US governments at exactly the same prices that it did the previous day. So US defaults are a very odd thing indeed.
You can take a slightly weirder hypothetical. If you imagine that the Greek Government had kept their original currency and there was a stablecoin backed by Greek bonds, where there was a risk of a real default and downgrade, then yes, it is the sovereign debt restructuring risk that the holder carries. But yes, that is quite right.
Lord Lilley: You explained at the beginning that stablecoin is a form of money. It actually has higher reserve backing than a current account in a bank. The difference is it is not issued by banks. Why is it not proposed that banks be allowed to issue it just on the basis that if Kodak had gone into a different camera business, it would have been better protected?
Professor Simon Gleeson: Current regulatory policy is that banks are banned from issuing them and the logic of that—which I understand—is that, if I am a customer of, say, Barclays, I have £100 in my Barclays deposit account and separately have 100 Barclays coins in my custody account, I am going to be completely unable to see the difference between the two. But there is a massive difference in practice because one of them is subject to deposit protection insurance and the other is not.
Lord Lilley: I would be aware of that.
Professor Simon Gleeson: My suspicion is that from certainly a policymaker’s perspective, the risk that retail consumers would effectively demand deposit protection on their bank-issued stablecoins is so great that it is something that should not be allowed to happen.
Lord Lilley: If we protect one, why should we not protect the other?
Professor Simon Gleeson: I suspect the answer to that in turn is: if you are going to protect bank-issued stablecoin, what is your justification for not protecting other stablecoins?
Lord Lilley: I do not know. You tell me.
Professor Simon Gleeson: The point is that, if you extend a deposit protection to stablecoins generally, what you would be doing would be insuring an entire market segment that went far beyond banking. Remember that bank deposit insurance is paid for out of the profits of the banks. It would be possible to create some sort of insurance mechanism that actually extended across all sterling stablecoin issuers, but current regulatory policy is to draw a thick line between bank deposits and stablecoin issuance and say that banks may not issue stablecoins.
Lord Lilley: I had not realised that the banks paid for insurance of bank deposits. I have learned a lot today.
Q30 Lord Smith of Kelvin: We are interested in regulation risk, but I have a straightforward question for you. We have seen stablecoins really take off in the States. Do you think they will actually take off here?
Professor Simon Gleeson: My honest answer is probably not among consumers. They potentially perform some very valuable functions in the financial markets and commercial settlement, and that is where their actual use cases are, but I very much doubt that we will see broad retail use of stablecoins outside crypto trading.
Q31 The Chair: Professor Gleeson, I have one final question. You mentioned earlier that banks have been pushing back at stablecoins and are, of course, developing their own version of tokenised deposits. Do you think there should be a different regulatory response to tokenised deposits compared with stablecoins because they are essentially the same thing?
Professor Simon Gleeson: As I say, the nearest analogue to a bank-tokenised deposit is an old-fashioned banknote, the Bank of Scotland £10 note. If what we get is bank deposits that are settled directly between banks without passing through the Bank of England, then that would unquestionably require a different regulatory approach for the same reason that the old bank clearinghouse was regulated when it was simply operated by the banks as a private business. If what we end up with is private settlement between banks outside the Bank of England-operated central payment system, that will unquestionably require a different regulatory approach. Whether that is how the banks see tokenised deposits developing is something I do not know.
The Chair: You have been very generous with your time and very clear with your answers to our many questions. Thank you very much for coming along this morning. We are grateful to you.
