CAI0022

Written evidence submitted by Mastercard

Summary

Mastercard believes that while payment systems will constantly evolve, the requirements for payments as a store of value will not. In other words, for crypto-assets to be a suitable store of value to be used across payment systems they must align with core principles of compliance, strong consumer protections and provide a stable value. Against this background, crypto-assets require an ecosystem that provides the necessary infrastructure, consumer education, security, and regulation to ensure that these assets do not further exacerbate inequities.

With regards to stablecoins, there is a need for standards around the liquidity, composition and safeguarding of the reserves that back these instruments. Risk management standards, including for operational resilience and security, are an important further consideration. We believe that while CBDCs are an exciting new tool in a central bank’s toolbox, careful analysis is needed to determine whether a CBDC is the best way of pursuing a given set of payment policy goals.

Mastercard recognizes that rapid innovation in crypto ecosystems has posed a significant challenge for financial regulators around the world. Regulators may seek to reduce the many risks present in crypto-asset ecosystems, without quashing their potential for innovation. Mastercard welcomes the UK Government’s intention to consult on its regulatory approach to crypto-assets later in 2022 and is committed to supporting policymakers in their ongoing efforts to deliver clarity around crypto-asset regulation - while recognizing that this is an enormously complex task.

1)      To what extent are crypto-assets when used as digital currencies (such as Stablecoin) likely to replace traditional currencies?

As a multi-rail digital payments technology company, Mastercard is exploring ways to support new payment choices and services for consumers, merchants, financial institutions, or anyone in-between - using both new and existing rails. We believe that while payment systems will constantly evolve, the requirements for the store of value of a means of payment will not. In other words, for crypto-assets to be a suitable store of value being used across payment systems, they must align with core principles of compliance, strong consumer protections and provide a stable value. Free-floating crypto-assets that derive their value from demand and offer currently don’t fulfill these requirements and are therefore unlikely to see broad adoption as a means of payment. Stablecoins however have the potential to be broadly adopted as such if they become regulated money-like assets.

Money-like assets play a uniquely important role in any financial system. Traditional currencies issued by central banks (i.e., fiat currencies) act as a common unit for the pricing of other assets within the financial system, provide a ‘safe haven’ as the lowest risk store of value, and – critically – acts as the medium of exchange for payments. For crypto-assets to replace such traditional currencies, they would need to have the same credibility. Free floating crypto-assets however exhibit significant price volatility and have not reached this level of credibility. Thus, they also have not seen broad adoption as a means of payment, even within crypto ecosystems.

Stablecoins however promise a fixed peg to a real-world reference currency. In the words of the Bank for International Settlements they “import the credibility provided by the unit of account issued by the central bank. Their main use case is to overcome the high price volatility and low liquidity of unbacked cryptocurrencies, like Bitcoin.”. The trouble is that not all stablecoins are created equally, and they don’t always work as advertised. Some stablecoins maintain their peg by holding reserves of the underlying reference asset or commodity in the traditional financial system (for example the British Pounds in a commercial bank account) and issue one stablecoin for every unit of the reference asset they hold. Unfortunately, the absence of an established regulatory regime for stablecoins means it isn’t always easy to tell where these reserves are held (e.g., in a domestic bank or offshore) their risk and liquidity (e.g., bank demand deposits vs. risky high-yield bonds), or even if they exist at all (e.g., audited vs. unaudited). To make things even more challenging, not all stablecoins even claim to hold reserves on a 1:1 basis with their current circulation, instead choosing to rely on a system of algorithms to maintain a peg with the reference asset. Unfortunately, as recent experience has shown, these structures are highly susceptible to ‘bank run’ dynamics.

Against this background, there is a clear need for standards around the liquidity, composition and safeguarding of the reserves backing stablecoins, users’ redemption rights and consumer protections, transparency and disclosures made available to users, and risk management standards, including for operational resilience and security. It will also be important to consider resolution arrangements in the event of the failure of a stablecoin. These requirements would ensure that stablecoins can be treated as fungible with money or other money-like mediums of exchange such as commercial bank deposits, thus providing it with credibility as a means of payment.

2) What opportunities and risks would the introduction of a Bank of England Digital Currency bring?

Mastercard is committed to supporting central banks in their chosen path to payment system modernization; including the development of a central bank digital currency (CBDC) where this is relevant. As an operator of safe, scalable global payment networks Mastercard has invested in a range of cutting-edge approaches to payment infrastructure and services, including the use of blockchain technology. We are committed to bringing that expertise to bear in support of the design, testing, and deployment of CBDC networks where central banks choose to pursue their development. For instance, Mastercard is ready to provide its CBDC sandbox as a collaborative testing platform that can be customized to the operating environment of the Bank of England, in order to enable experimentation of CBDC concepts with a variety of partners.

When it comes to potential opportunities of a UK CBDC, we believe that while CBDCs are an exciting new tool in a central bank’s toolbox, careful analysis is important to determine whether a CBDC is the best way of pursuing a given set of payment policy goals. For instance, a CBDC could play a role in payments innovation, increased financial inclusion provided consumers are supported with adequate digital inclusion including digital financial skills, visibility into economic activity, and improved efficiency of national and international payment flows. At the same time, all of these potential benefits can also be achieved through facilitation of a vibrant private sector and competition in payments. For example: real-time payment systems, certain stablecoins, and the development of blockchain based “tokenized deposit” capabilities by commercial banks and fintech companies have great potential to lower costs and improve the speed and efficiency of payment flows. Therefore, while a CBDC is one approach to reducing frictions in payments and could help support a more inclusive financial system, it is not the only means of doing so. Before proceeding with the development of a CBDC, a central bank should therefore closely analyze the case for such an undertaking in comparison with other available approaches to reaching its policy goals.

Apart from the potential benefits, a CBDC also entails new macroeconomic and financial stability risks, new operational and cyber security risks, and business incentive and consumer adoption risks:

• Most notably, a CBDC has the potential to shift consumer demand for central bank money relative to commercial bank money. Large-scale or volatile deposit substitution caused by this could have several implications for financial stability. For instance, the introduction of a CBDC could lead to a reduction in commercial bank deposits, as bank customers would be able to choose to move some of their deposits to the CBDC. Since deposits constitute an important source of low-cost funding for banks’ lending operations, the outflow of deposits at a significant scale could have adverse consequences for the cost and availability of credit in the broader economy. Further, a CBDC could potentially reduce the effectiveness of traditional monetary policy operations executed via changes to interest rates due to an overall reduction in the stock of commercial bank money. Finally, a CBDC could trigger a “rush to safety” that could undermine the stability of otherwise solvent banks if consumers see a CBDC as less risky than traditional deposits during a period of financial stress. The introduction of a CBDC may therefore significantly increase the volatility of deposit substitution during times of crisis—placing pressure on commercial banks’ liquidity and solvency positions Another key area of risk associated with a CBDC is the enormous complexity of mitigating fraud and cyber-risk across a retail CBDC ecosystem. The cost to the global economy of cybercrime is expected to grow by 15 percent per year over the next five years, reaching $10.5 trillion USD annually by 2025. A retail CBDC will inevitably face sophisticated fraud and cyberattacks from both private and state-sponsored actors. CBDC users must trust that the system will be accessible and operational where and when it is needed; that their funds, accounts, identity, and other data are secure; and that they will be protected in the event of fraud.

Effectively deploying the strategies and techniques needed to secure a retail payment system will require the Bank of England to consider a number of new dimensions. Firstly, retail payment systems have significantly more endpoints than the wholesale payments system, with each opening offering a potential point of vulnerability. Effectively securing these endpoints requires the development of tools that work across the payment ecosystem proactively monitoring, detecting, and acting on security and cyber risks across their digital supply chain.

• Secondly, while supervised intermediaries in a two-tier retail CBDC ecosystem will likely be responsible for conducting their own Know Your Customer (KYC) and Anti-Money Laundering (AML) activities, their inability to track transactions beyond their perimeter leaves them vulnerable to financial criminals—who have developed tools that exploit such limitations. To avoid inadvertently facilitating financial crime, central banks that issue CBDCs may need to do more than set stringent KYC and AML standards for supervised intermediaries; they may also need to curate a network-level view that empowers all intermediaries to more effectively identify and trace financial crime as it moves across the ecosystem.
• Finally, it will be important to consider that modern cybercriminals exploit both organizational silos and national borders to undermine the safety and security of critical systems. The result is a world where no organization pursuing a strategy of cybersecurity ‘self-reliance,’ regardless of their sophistication, can be confident that their systems are secure. The safest organizations will be those that ‘travel together’— sharing critical insights in real-time from a network that is global in scope. To effectively secure a retail CBDC from both foreign and domestic threats, central banks will need to deploy ecosystem-level monitoring tools that are global in scope; relying on partners to provide critical intelligence from beyond their own borders.
• Apart from macroeconomic/financial stability risks and cyber-risk, the introduction of a CBDC carries the risk of the private sector not building the necessary products and services on top of the infrastructure. Building new wallet solutions, integrating with new payment infrastructure, and enabling the various links in the payment value chain are all costly activities. Sustainable payment ecosystems are therefore dependent on a delicate balancing of incentives between those stakeholders who bear the costs of enabling payments and those who benefit from payment services. In order for a central bank’s CBDC infrastructure to sustain a vibrant and competitive ecosystem of payments innovators, incentives will need to exist that allow payment service providers to generate an appropriate return on their investments. Further, the success of a CBDC will depend on the adoption rate which, in turn, will depend on many factors such as security and convenience. Consumer education and awareness on the characteristics and capabilities of the CBDC will be key for broad adoption

Even if the aforementioned risks are addressed, Mastercard believes that to fully reap the benefits of a CBDC, there are a few key principles to follow. First, it is critical to ensure that a CBDC would be fully interoperable with other payment systems. Interoperability between payment systems avoids closed loops that reduce the fungibility of money, fragment liquidity, and limit competition. Further, a “two-tier” model – where the private sector is involved in the distribution of the CBDC – will provide a secure, fast, and resilient technology environment that avoids the unnecessary expense of parallel infrastructure and ensures that compliance requirements remain primarily with industry. Ultimately, consumers will be more likely to adopt a CBDC if it can be used on existing acceptance infrastructure and is supported by known and identifiable payment form factors (physical and digital) that are linked to the user’s existing devices and accounts. Therefore, adopting an ‘open acceptance’ framework, using existing acceptance technologies and networks to facilitate payments by CBDC, can maximize the day-one ubiquity of the system and minimize complexity of adoption for users and merchants alike.

3)      What impact could the use of crypto-assets have on social inclusion?

Mastercard views the potential for digital assets to act as an enabler and accelerator of financial inclusion with a mix of enthusiasm and caution. On one hand new technologies can play a critical role in unleashing people’s full economic potential and helping to drive equitable and sustainable economic growth. On the other hand, technology alone is never a silver bullet to addressing the complex social, economic, and historical forces contributing to financial exclusion. Against this background, we believe that a mix of technology and policy measures is needed to reap the full benefits of digital assets to improve digital and financial inclusion in the UK.

The Covid-19 pandemic has both further exacerbated digital and financial exclusion and highlighted the link between digital and financial inclusion, and importance of digital financial skills, particularly for vulnerable consumers and young people, including those living in poverty. Those with no, or limited, digital skills have not been able to adapt to the changing environment and crisis as effectively, including being able to gain other employment or benefit from online support services, as quickly as those with better digital skills, connectivity and know how. As such when considering the potential impact of crypto-assets on social inclusion, governments and industry must work together to ensure consumers, particularly those most vulnerable and currently excluded or underbanked, are adequately equipped with the digital financial skills to enable them to both understand and use crypto-assets products most suitable to their needs. It should not be assumed that digital currencies or other crypto-assets are automatically a means to improving financial inclusion, when many people across the UK remain digitally excluded, with 11.9m people (22% of the population) still do not have the digital skills needed for everyday life in the UK[1].      

Furthermore, one of the cornerstones of financial inclusion is trust and consumer protection. Individuals must have confidence that they are getting what they pay for and that they are protected in the event of fraud, disputes, refunds, or data misuse. Unfortunately, many of today’s ~2,600 digital currencies fail to offer the stability, regulatory compliance and consumer protections needed to earn this trust. At the same time, theft, fraud, and manipulation of crypto-asset markets remain troublingly common, with some specifically targeting minority and financially excluded communities who may be less resilient to volatility and losses.

Against this background, crypto-assets require an ecosystem that provides the necessary infrastructure, consumer education, security, and regulation to ensure that these assets do not further exacerbate inequities. When designing such an ecosystem, it will be critical to have regulatory frameworks for digital assets in place that include requirements for adequate and intelligible disclosure of information to customers, rights of recourse, and standards on protection of customer information, including how a customer’s data can be used. This should be done in tandem with efforts to continuously improve digital financial inclusion across the UK.

Once trust and consumer protection are in place, digital assets innovations have the potential to support a range of inclusionary use cases – such as providing digital wallets to individuals who are excluded from, or choose not to use, traditional banks and providing alternate mechanisms for establishing the financial history needed to access credit. Ultimately, the selection of these use cases should be informed by research, design, and piloting that takes a human-centered approach and leads with understanding the specific needs and challenges of traditionally excluded segments to solve for them.

4)      Are the Government and regulators suitably equipped to grasp the opportunities presented by crypto-assets, whilst at the same time mitigating against the risks?

Mastercard recognizes that rapid innovation in crypto ecosystems has posed a significant challenge for financial regulators around the world who seek to walk a fine line between reigning in the many risks present in crypto-assets ecosystems without quashing their potential for innovation. We applaud the UK Government’s recent efforts in advancing the Financial Services and Markets Bill (FSMB) which would take significant steps to include crypto-assets into the regulatory perimeter and provides the basis for further necessary measures. We believe that efforts like the FSMB will help to crowd out bad actors while encourage responsible innovation and we particularly support the proposed approach of bringing stablecoins used as a means of payment within the scope of existing UK regulations for payment services and electronic money issuance.

It is Mastercard’s view that the overall regulatory efforts in this space should be focused on three key issues:

1. Clarifying and enforcing consistent compliance expectations across different types of payment rails
2. Establishing clear regulatory frameworks for stable payment tokens
3. Resolving key uncertainties around the regulation of floating crypto-assets

Regarding the first priority, we firmly believe that crypto-assets ecosystems - and indeed any financial ecosystem - should succeed or fail based on their own inherent merits (e.g., speed, efficiency, or a capacity for innovation), not on the basis of regulatory arbitrage or an unlevel playing field. As such, a given jurisdiction’s regulatory obligations for crypto-assets - particularly around payments - should set compliance requirements, enforcement measures and regulatory outcomes that are in line with those of other payment technologies.

Regarding the second priority, we believe that clear and consistent compliance regimes can do little to ensure the safety and stability of payments if the medium of exchange used cannot be trusted. That’s why establishing clear guidelines and gating requirements for ‘stable payment tokens’ are a crucial measure that would ensure the parity and fungibility of money (and money-like assets) in the digital asset space, providing stakeholders with confidence that any such tokens being used for payment met the highest standards. We therefore encourage regulators to prioritize the creation of robust frameworks for payment instruments within crypto-asset ecosystems.

With regard to the regulation of crypto-assets for payments, we believe that particular focus should be given to stablecoins which require the development of a novel regulatory framework. More specifically, clear regulatory standards are required to ensure the safety and stability of stablecoin arrangements, particularly regarding liquidity, quality, and custody of reserves. Additionally, there is a need for clearer guidance around users’ redemption rights, consumer protections, transparency and disclosure requirements, and risk management standards – especially involving operational resilience, settlement finality, and cybersecurity. It will also be important to consider resolution arrangements in the event of the failure of a stablecoin. Where stablecoins aim to operate with functional equivalence to deposits, it makes sense that the issuers of such stablecoins be subject to the existing regulation for deposit-taking activities, such as being required to be licensed as a bank. Otherwise, all issuers of stablecoins should at least be subject to supervisory oversight and reporting requirements as are applied to licensed banks, including regulatory examination and reporting requirements. Careful consideration should be given to the application of deposit insurance for these assets, which could increase the appeal of regulated stablecoins.

Finally, with respect to the third priority, we believe that the lack of regulatory clarity concerning floating crypto-assets has been unhelpful to consumers, investors and businesses seeking to navigate this space. To-date crypto-assets have suffered from a lack of regulatory clarity on issues ranging from tax treatment and disclosure requirements to fundamental questions about which regulatory authority has oversight over a given crypto-asset product or service. Navigating this kind of uncertainty imposes serious risks, both for the sellers of digital assets, who may struggle to determine whether they are complying with regulatory expectations, and for the buyers, who may lack clarity on the protections they enjoy.

Against this background, Mastercard welcomes the UK Government’s intention to consult on its regulatory approach to crypto-assets later in 2022 and is committed to supporting policymakers in their ongoing efforts to deliver clarity around crypto-asset regulation while recognizing that this enormously complex task will not be accomplished overnight. Given that, we urge legislators and regulators to focus their attentions on the following questions as a foundational starting point in this effort:

• Which crypto-assets will be considered securities or commodities and subject to the corresponding regulatory regimes?
• How will crypto-assets, particularly those used to facilitate payments, be treated for tax purposes?
• Which activities involving crypto-assets and blockchain technology will require licensing, for example, as a money transmitter or payment institution or equivalent type of entity?
• Which activities involving digital assets and blockchain technology will cause a non-bank to be treated as a service provider to a bank?
• What type of standards will regulators apply to reduce operational risks and ensure the resiliency and reliability of blockchain transactions, such as management of cyber risk and protection of consumer data?
• Which consumer protections will apply to payments transactions using digital assets, such as limitations on consumer liability for unauthorized transactions?

5)      What opportunities and risks could the use of crypto-assets—including Non-Fungible Tokens—pose for individuals, the economy, and the workings of both the public and private sectors?

Mastercard supports the view that crypto-assets and their networks can provide many novel opportunities for innovators that enable the development of interesting new use-cases, e.g. in the area of financial services such as payments. Firstly, they can provide a basis for open innovation due to the ease with which new blockchains can be created. Secondly, the technical capabilities of the blockchain technology can enable types of transactions that weren’t previously possible (most notably the execution ‘atomic swaps’ and the ability to enable rich programmability around asset transfers). Third, within a given blockchain, new innovations are ‘composable’, meaning they can be combined with other innovations on that same chain to create offerings that are greater than the sum of their parts. However, unlocking the full potential of these innovative capabilities depends on clear and consistent regulatory standards. For a more detailed overview of concrete use cases of crypto-assets and their underlying technology, please refer to our response to Question 6.

Apart from the abovementioned opportunities of crypto-assets, the rapid innovation taking place across this ecosystem also involves serious risks both for the market in general and users in particular. Key risks that should be closely studied by policymakers include:

• Compliance and counterparty risk: Crypto-assets present significant security risks due to their ability to transact in a near instantaneous and global manner, potentially heightening money laundering, terrorist financing, and fraud risks. Transactions within public and permissionless digital asset ecosystems are frequently referred to as ‘trustless,’ which is true in the sense that parties to a transaction are not required to rely on a trusted central party to execute a transaction faithfully. However, by design many of these ecosystems are pseudonymous, making it challenging for parties in a transaction to ensure that their counterparties are compliant with all relevant AML, CFT, KYC, and sanctions related obligations.

To manage these risks, we believe that the policymakers should collaborate closely with crypto-asset stakeholders that specialize in anti-money laundering, sanctions, fraud detection, and blockchain analytics to support the overall security and compliance of this emerging industry. Identifying virtual asset service providers that present high levels of money laundering, dark market, and other criminal activities is also critical to improving security in the ecosystem. Finally, the FATF travel rule should be stringently applied to transfers of value associated with cryptocurrencies and tokens to mitigate money laundering, sanctions evasion, fraud schemes, and other illicit activity

• Cybersecurity and interoperability risks: Crypto-assets present significant risks to both retail and institutional users as a result of a highly sophisticated hack, theft, and fraud attacks that are prevalent to these ecosystems. In many cases, a lack of education among both retail and wholesale users further compounds these security concerns. In addition to the significance of these attacks on a given counterparty, they can also represent a risk to national security, particularly in the face of growing evidence that sanction entities in certain, foreign jurisdictions are employing coordinated attacks as a means of financing their activities.

As in the case of the compliance risks mentioned above, we believe that the policymakers and regulators should collaborate closely with crypto-asset stakeholders that specialize in monitoring and mitigating security risks across these ecosystems. Many of these same companies have developed training to educate users in these spaces to mitigate security concerns that may occur due to lack of consumers, investors, and businesses’ understanding in the digital asset ecosystem.

Additionally, we believe particular attention should be given to the security risks associated with decentralized ‘cross-chain bridges’ which seek to enable interoperability between the underlying blockchains of different digital asset ecosystems. We believe that interoperability between different digital asset networks is critical to capitalizing on the long-term potential of these systems. The absence of systems for interoperability traps liquidity in closed loops; reducing the fungibility of money, fragmenting liquidity, and limiting competition. However, there is growing evidence that decentralized ‘cross-chain bridges’ introduce a wide range of security concerns, as demonstrated by a number of recent high-profile breaches

The demonstrable vulnerability of these cross-chain bridges’ highlights the need for trusted intermediaries that facilitate interoperability between blockchains, with the ability to establish/enforce clear guidelines for the finality of transactions, set standards for programable transactions, and operate transparent dispute resolution processes. Regulatory authorities can play a valuable role in encouraging the emergence of such operators by establishing baselines for consumer protection, security, data protection, privacy etc.

• Risks from the absence of a regulated ‘money-like’ asset: In most digital-asset ecosystems stablecoins, which proport to maintain a stable peg to a reference asset like the US dollar, function as the primary source of liquidity, store of value/collateral, and ‘risk-off’ asset. In this way, stablecoins have effectively become a substitute for fiat currency, acting as the “stable” leg in trading transactions involving more volatile crypto-assets or as the “collateral” for lending and borrowing. Unfortunately, these assets are not all maintained to the same standards, with some stablecoins holding illiquid reserve assets or employing partially collateralized algorithmic structures that are highly susceptible to ‘bank run’ dynamics. The result is that, while some stablecoins live up to their name, others can see their value fall effectively to zero over the course of a few days of market volatility – an issue that can be particularly difficult for consumers to navigate in the absence of a robust regulatory regime that set standards for what can be considered a stablecoin
• Risks from the lack of clear governance processes: Traditional finance has strong governance procedures in place for unwinding mistakes, assigning responsibility for losses (for example in the event of fraud), and managing disputes between parties. Unfortunately, the same is not always true for crypto-assets ecosystems, where the ‘rules of the road’ are often being determined along the way. As a result, ecosystem members often lack certainty about how issues - ranging in seriousness from a mis-directed transaction to a failed stablecoin - will impact them. We believe that the establishment of robust governance procedures and dispute practices for managing the consequences of user-error, fraud, and cyber-attacks will be essential to the broader adoption of digital assets. Moreover, while the details of these governance practices should be defined by private sector stakeholders at the level of a given digital asset ecosystem, the public sector can play a valuable role in providing clear regulatory frameworks that serve as a foundation for robust governance

6)      How can distributed ledger technology be applied in the financial services sector?

Blockchain is best known as the underlying technology that powers crypto-assets, but it has many other potential applications. Mastercard is actively investing in blockchain research across a range of areas and has identified the following applications:

• Trade Finance: Digitizing trade finance processes could enable greater transparency and help reduce fraud across the value chain (e.g., Letters of Credit)
• Supply Chain/Provenance: Blockchain has the potential to converge physical and digital supply chains, enabling an end-to-end automated flow that removes paper and establishes trust across the ecosystem

• Programmable payments: Programmability means the ability for users to build simple conditional obligations (colloquially, “smart contracts”) into a payment. This could theoretically support a wide variety of use cases, including escrow services, automated insurance claims, and the provision of installment loans at the point of sale
• Cross-border payments: Crypto-assets have significant potential concerning cross-border payment use-cases, such as trade finance and remittances. However, as has been clearly identified by the G20 Cross Border Payments Roadmap, existing barriers to the speed, efficiency, transparency, and accessibility of payments are not exclusively – or even primarily – technological. A range of issues, including fragmented regulatory requirements, unharmonized messaging standards, and barriers to the cross-border flow of data would need to be resolved alongside the deployment of new technologies in order to deliver transformational improvement in the cost/speed of remittances and/or cross-border B2B flows

7)      What work has the Government (and its associated bodies) done to understand, prepare for and, where relevant, encourage changes that may be brought about by increased adoption of crypto-assets?

Mastercard applauds the efforts of the UK Government and its associated bodies toward clarifying the regulation of crypto-assets, In particular, clarifying the application of AML/CFT and consumer protection rules and extending the Money Laundering Regulations (MLR) to firms that engage in crypto-asset activity will strengthen the safety and security of crypto-asset related transactions while supporting innovation. Moreover, we believe that already established processes, such as the FCA’s quarterly perimeter report, provide a strong basis upon which to propose specific legislation in response to new market developments, and to incorporate crypto-assets more broadly into the regulatory perimeter.

Nonetheless, and as we set out in our responses to questions 4 and 12, the rapidly evolving nature of this space will demand continuous engagement from regulators and policymakers to ensure clear, risk-based rules for firms engaging in activities involving crypto-assets. Most notably, we broadly support the proposed approach of bringing stablecoins “used as a means of payment” within the scope of existing UK regulations for payment services and electronic money issuance. However, and as we further explain in our response to question 10, it will be important for the FCA to work with the HMT, the BOE and the PSR to bring more clarity into the definition of these types of stablecoins and to the question of what regulatory framework applies to stablecoins with non-payment characteristics or that are used for purposes other than as means of payment.

8)      How might the Government’s processes – for instance the tax system - adapt should crypto-assets be adopted more widely?

The rapidly evolving structure of crypto-asset ecosystems pose novel and challenging questions with respect to their legal characterization and therefore, appropriate taxation. Uncertainty with respect to the tax status of these assets can present a meaningful barrier to their adoption, particularly with respect to their use as a payment instrument. For an asset to enjoy broad adoption as a medium of payment we believe it must have a stable value, and counterparties to an exchange must have confidence that the transfer of the asset does not constitute a taxable event. With this in mind, we believe that the use of regulated stablecoins for payment of goods and services or to facilitate peer-to-peer, account-to-account or peer-to-merchant payment transactions should not per se constitute a taxable event, just as such payment transactions using the British pound do not constitute a taxable event. While we recognize that some stablecoins, particularly those that are partially collateralized, used to facilitate investments in other crypto-assets or provide their holders with some form of yield, may be subject to more complex tax considerations, we believe this presents a case for clearly delineating between payment and non-payment stablecoins.

Additionally, and more generally, Mastercard supports the view that tax policy should treat digital goods and services consistently with other, physical goods and services. If digital goods and services are sold for non-speculative purposes, their tax treatment should strive to establish equivalence with the treatment of other goods and services. Ultimately, tax policy should not just differentiate based on the type of good or service, but also take into account the underlying purpose of a sale/transaction of that good or service.

9)      How effective have the regulatory measures introduced by the Government - for instance around advertising and money laundering - been in increasing consumer protection around crypto-assets?

N/A

10)  Is the Government striking the right balance between regulating crypto-assets to provide adequate protection for consumers and businesses and not stifling innovation?

Overall, and as stated in our response to question 7, we believe that important groundwork has already been undertaken by the UK Government and its associated bodies when it comes to regulating crypto-assets. Nonetheless, Mastercard believes that a few points deserve further regulatory action.

We agree with the proposed approach in the context of the Financial Services and Markets Bill (FSMB) of bringing “stablecoins used as a means of payment” within the scope of existing UK regulations for payment services and electronic money issuance. This includes the intention that these stablecoins should be “subject to the same requirements and protections as other similar payment methods” as this should help to ensure a level playing field and reduce the risk of regulatory arbitrage.

However, we see the need for clarifications as the FSMB does not contain any definition of what constitutes a “stablecoin used as a means of payment”. Therefore, we believe clear guidance will be required as to what crypto tokens fall within this definition to provide industry with necessary clarity. Regulators could for instance set out defining characteristics such as whether a particular stablecoin is backed by a single fiat-currency or a basket of currencies and/or define different sub-categories of such stablecoins.

Another aspect that needs clarification is the distinction made in the FSMB between “stablecoins used as a means of payment” and “digital settlement asset” (DSA). For example, the proposed definition of a “digital settlement asset” in the FSMB refers to assets that “can” be used to settle payment obligations. As any digital asset could potentially be used in this way if two parties agree to treat it as a means of payment, we think further clarification will be needed here. This will be particularly important in order to prevent overlapping regulation and potentially contradicting obligations, all of which may hinder innovation.

Apart from stablecoins used as means of payment, it is also critical to clarify the regulatory treatment of “other” stablecoins. As explained in more detail in our response to question 4, we believe that clear regulatory standards are required to ensure the safety and stability of stablecoin arrangements in general and particularly regarding their liquidity, quality, and custody of reserves. Overall, we encourage the development of regulatory frameworks for stablecoins that ensures a level playing field by applying equivalent rules to similar activities and risks. Consequently, we believe that operating a payment system that supports the authorization, clearing, and settlement of stablecoin payment transactions among participants that are regulated financial institutions should be regulated equivalently as they are today.

Finally, we would like to caution that it would be very problematic for the payments sector and its end users if the above-mentioned, planned extension of the regulatory perimeter were to capture also the mere tokenization of a legal liability – e.g. the tokenized representation of commercial bank liabilities. If this were the case, it would likely result in duplicative requirements which could stifle innovation and create significant barriers to market entry for certain technical service providers.

11)  Could regulation benefit crypto-asset start-ups by improving consumer trust and resilience?

Yes, crypto-asset businesses would generally benefit from regulation, as their growth and safety depend on clear regulatory standards. The rapid innovation taking place across the crypto-asset ecosystem is creating exciting opportunities, but it also involves serious risks. For some of these risks, regulators and international standards setters like the FATF, have provided welcome guidance with respect to the compliance expectations of activities involving crypto-assets by both incumbent financial institutions and newer virtual asset service providers (VASPs). However, the rapidly evolving nature of this space will demand continuous engagement from regulators and policymakers to ensure a well-founded and clear set of rules for participants in emerging digital currency ecosystems.

Whereas clear regulatory standards are an important prerequisite for crypto-asset businesses’ competitiveness and the ability of large players to get involved, regulations without enforcement are not effective. While establishing clear rules is necessary, it unfortunately is insufficient to induce compliance with them. Absent realistic threat of enforcement, smaller and less risk averse firms may find themselves with few incentives to invest in appropriate compliance solutions. For example, the FATF’s Travel Rule is not consistently enforced across jurisdictions, despite a range of readily available compliance solutions. Enforcement, or the threat thereof, would dramatically increase the adoption of Travel Rule, providing financial intermediaries with the ability to better detect and report on illicit crypto transactions.

Further, preventing regulatory arbitrage is essential to encouraging responsible innovation in the digital asset space. Although crypto-assets embody new technology, the function of these assets and services they enable (trading, money transmission, settlement, lending) are often highly analogous to those that exist today. As such, they often present similar risks that regulatory frameworks already have been designed to address. Where regulatory and compliance requirements are not uniformly deployed across activity types, strong incentives will exist for innovators to engage in regulatory arbitrage, perversely harming those organizations and products/services that are most in-line with policy objectives of the public sector.

Ultimately, clear, consistent, and high regulatory standards for crypto-assets and related activities will help accelerate the best kinds of crypto innovation while mitigating the most concerning risks. This will not only increase the resilience of this sector but also increase consumer trust, e.g., through adequate and intelligible disclosure of information to customers, rights of recourse, and standards on protection of customer information.

12)  How are Governments and regulators in other countries approaching crypto-assets, and what lessons can the UK learn from overseas?

Regulators around the world have started to respond to the explosive growth of crypto-assets and related risks by drafting new rules and/or extending the regulatory perimeter of existing regulations. These efforts are often focused on clarifying the applicable rules for crypto-assets including licensing requirements and tightening compliance with AML/CFT rules but sometimes going beyond that by setting out entirely new rules like e.g. for stablecoin arrangements.

Mastercard believes that clear and consistent regulatory standards are critical for the growth and safety of the crypto-asset ecosystem. In the same vein, these standards should be internationally coordinated as much as possible to avoid regulatory fragmentation across jurisdictions. Some important examples of jurisdictions and international standard setters proposing such regulations include the following:

• On international level, the Financial Action Task Force (FATF) has been very active with regard to crypto-assets by extending its AML and CFT measures to virtual assets VASPs to prevent criminal and terrorist misuse of the sector. Most notably, it has developed guidance for VASPs on how to apply the FATF’s Travel Rule which requires them to share relevant originator and beneficiary information alongside virtual asset transactions, to help preventing criminal and terrorist misuse of cryptos. As mentioned in our responses to Questions 5 and 11, we believe that the consistent, international application and enforcement of this rule is critical to enable safe growth and responsible innovation in the crypto-asset sector.
• On regional level, the EU has been at the forefront of regulatory developments concerning crypto-assets, as legislators recently struck a political compromise on the Markets in Crypto-Assets (MiCA) regulation. Pending the final legal text, these new rules will provide for a unified licensing and supervisory regime for Crypto-Asset Service Providers (CASPs) and set out a basic taxonomy of different tokens. Further, the EU’s Transfer of Funds Regulation (implementation of the FATF’s Travel rule) was extended to include CASPs. MiCA notably also introduces regulatory requirements for stablecoin issuers (e.g., mandatory liquidity reserves and right of redemption for stablecoin holders).

Mastercard believes that these examples provide for a strong basis for the regulation of crypto-assets in other jurisdictions, as they are addressing some of the most important and urgent issues in this space to date. High, clear and consistent regulatory standards will ultimately also attract the best innovators contributing to safe and responsible growth of the crypto ecosystem in the respective countries. Against this background, we support the view that the FSMB represents an exciting opportunity for the UK to remain competitive in the crypto space by timely and successfully delivering on the regulatory measures foreseen in the bill.

13)  The environmental and resource intensity of using crypto-asset technology

Organizations around the world are facing pressure to limit the consumption of non-renewable energy sources and the emission of carbon into the atmosphere. As such, it is unsurprising that certain crypto-assets have faced significant scrutiny regarding their ‘mining’ process, which can be quite energy intensive. However, it is important to remember that crypto-assets and blockchain networks vary significantly in terms of their energy intensiveness and that carbon emissions associated with a given mining process may vary significantly depending on a range of factors including the source of electricity and type of equipment being used by a given miner.

In spite of these complexities, critically assessing the question of how much energy consumption is too much, is a worthy question that’s closely intertwined with debates around our priorities as a society. As the digital assets space continues to evolve, we believe discussions on the climate impacts of cryptos can and should be a continued area of focus. To facilitate productive discussions on this topic, there is a broader need to focus on obtaining good data to assess the true contribution of digital assets to climate risks, as well as potential technological and policy responses that could mitigate these risks – such as the adoption of less energy-intensive blockchains and the use of renewable energy sources.

September 2022

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