Bank of England's proposed self-custody ban for stablecoins draws fierce industry backlash
Industry experts warn that prohibiting self-hosted wallets for stablecoins would significantly impair critical applications such as cross-border money transfers.
While the United Kingdom explores various strategies to nurture and expand its domestic cryptocurrency sector, the Bank of England (BOE) has introduced multiple regulatory proposals designed to govern stablecoins in ways that address what it perceives as financial stability concerns.
Among these proposals is a prohibition on custodial wallets for holding stablecoins. The cryptocurrency community across the UK, ranging from companies that issue stablecoins to staunch Bitcoin advocates, has uniformly objected to this proposed restriction.
"This would be a serious misstep for the UK, risking long-term damage that is hard to unwind," said Benoit Marzouk, CEO of stablecoin issuer tGBP told Cointelegraph.
Ban could hamper operability and competitiveness
Central to the BOE's regulatory stance on stablecoins, which it has recently examined through multiple inquiries conducted before the House of Lords, is the preservation and protection of the United Kingdom's banking infrastructure.
According to the central bank's position, unrestricted availability of stablecoins, which have the potential to deliver superior returns compared to conventional banking offerings, might trigger a mass withdrawal of deposits, consequently affecting the availability of credit from financial institutions in the UK.
During March testimony, Bank of England Deputy Governor Sarah Breeden informed the House of Lords Financial Services Regulation Committee that BOE is "open to other ways of achieving the objective" of credit availability.
"But I think you would expect us as the financial stability authority to ensure that there isn't a precipitous drop in credit to the businesses and households in the UK," she said.
Among the mechanisms it considers effective for accomplishing this goal is implementing a ban on unhosted wallets. "There is this concept of an unhosted wallet, where you haven't got a wallet provider who is a regulated entity ensuring that AML [Anti-Money Laundering], KYC [Know Your Customer] criteria are complied with. Unhosted wallets will not be permissible in the UK. They are permissible in the US regime," Breeden told the committee.
From the cryptocurrency sector's perspective, such a measure would represent a significant regression. In Marzouk's assessment, implementing this restriction would "wipe out hard-earned network effects."
"If transfers are limited to registered VASPs or custodial wallets, existing GBP stablecoins [...] would become in breach of regulations with holding on self-hosted or issuers would be forced into whitelisting models and re-issuing new tokens."
Joey Garcia, chief strategy, policy, and regulatory affairs officer at Xapo Bank, told Cointelegraph that, rather than serving as an advancement to the existing financial infrastructure, "this ban essentially restricts any attempt to understand and mitigate the perceived risks."
"This would be interpreted as a signal of a hostile regulatory environment, discouraging developers and investment in the UK's fintech sector."
According to Marzouk, the proposal also compromises a critical application for stablecoins, specifically cross-border remittance payments. Within the framework proposed by the BOE, "recipients couldn't access funds unless fully onboarded with a regulated exchange."
"A plane without wings is no longer a plane. Likewise, a stablecoin or blockchain asset that can only be transferred to a predefined list of wallets is not truly blockchain, it is effectively e-money within a closed ecosystem and then you don't need a separate regulation."
Garcia additionally noted that stablecoins would experience a reduction in their practical utility since they "derive much of their value from the ability to be held and transferred on a peer-to-peer basis on open networks."
"This is particularly relevant for the unbanked and underbanked around the globe, for whom self-custodial wallets and regulated on-ramps can be a primary gateway into digital financial services, and access to digital dollars or digital pounds."
Restricting such an essential use case for digital currencies "kills a major strategic opportunity: Positioning the Pound Sterling, one of the strongest and most trusted currencies, as a credible alternative to USD stablecoins," said Marzouk.
Crypto industry questions feasibility of wallet ban
Separate from concerns about competitive positioning is the practical question of whether an unhosted wallet prohibition can actually be implemented and enforced.
Susie Violet Ward, the director and co-founder of Bitcoin Policy UK, said that these rules would do little to address real illicit flows, but would rather "expand data collection, erode privacy, impose costs, and add friction and limit access through banks and intermediaries."
Freddie New, chief policy officer at the Bitcoin Policy UK, said that the proposed policy from BOE was of "such monumental, such overweening, stupidity, that it is hard to formulate a sensible response."
New said, "let everyone in the UK simply continue to use their 'self-hosted wallets' (ie 'wallets') without paying them a second's more attention."
Implementation may prove more complicated than that approach suggests. The central banking authority does possess certain regulatory instruments it can deploy that would have particular relevance for stablecoin operations. However, even with those tools available, "this is extremely challenging to monitor, let alone enforce," said Garcia.
The BOE could direct its enforcement efforts toward Virtual Asset Service Providers (VASPs). According to Marzouk, the central bank has the capability to restrict the creation of new stablecoins to registered VASPs such as cryptocurrency trading platforms. These platforms, in turn, would permit transfers exclusively to other VASPs or custodial service providers "through the validation of existing tools that have been created for the Travel Rule regulation."
Yet even this approach, according to Marzouk, extends the Travel Rule beyond its originally conceived function. "The Travel Rule is designed to enable VASPs to exchange information if there's some complaints from clients of identity theft, for example: It was not intended to restrict or prohibit self-custody."
From Garcia's standpoint, such enforcement is neither "necessary nor feasible." The fundamental technology that powers cryptocurrency wallets enables anyone to generate one. "As long as the internet and public blockchains exist, a direct ban on wallet creation and use is not practically enforceable."
There remains a real possibility that this prohibition will not appear in the final iteration of the Bank of England's regulatory framework. The central bank's most recent Consultation Paper addressing stablecoins, which was released in November, does not explicitly propose such a ban.
Any regulatory modifications would need to proceed through the established legislative process, directed by the Treasury operating within the Financial Conduct Authority's regulatory framework as outlined by the 2023 Financial Services and Markets Act. "This involves formal consultation, industry input, and iterative rulemaking before any measures can be finalised," said Garcia.
The most effective strategy available to the industry for preventing implementation of a ban is sustained engagement with regulatory policymakers, according to Garcia.
"As participants within the sector, we must demonstrate the benefits of this technology clearly to address the concerns and risks that have been identified, to strengthen the case for proportionate regulation."