UK gets off on the right foot with pitch for crypto leadership
Committing to digital Gilts will help cement the UK’s crypto credentials
Just as double entry bookkeeping revolutionised finance in the early Renaissance, placing Italian cities at the centre of European trade, the UK is hoping that its embrace of new financial technology will cement its position at the forefront of the capital markets.
On Monday, economic secretary to the treasury John Glen outlined the UK government’s plans to make the country a global player in the world of cryptoassets.
Buried underneath proposals for the Royal Mint to produce non-fungible tokens (a digital delight for numismatists everywhere) are serious plans "to unleash the potential of crypto-technologies."
The Treasury's appeal to the crypto community includes promises to make stablecoins respectable by bringing them under the scope of regulation, establishing sandboxes to encourage innovation in a responsible manner and re-examining the tax treatment of cryptoassets to ensure competitiveness.
The part of the plan with the most direct relevance to the bond market was a statement of intent to look into the feasibility of issuing sovereign debt using distributed ledger technology (DLT).
The benefits of applying DLT to the capital markets vary in scope depending on who you talk to. At the very least, it is expected eventually to reduce settlement times to near zero. For its more ambitious proponents, it will usher in a quantum leap whose benefits will stretch the imagination.
Examples to follow, or not
Of course, the UK is not the first to explore the technology. Other sovereigns and supranationals are already experimenting, with varying degrees of thoughtfulness.
The World Bank kick-started the revolution in 2018 when it sold the first bond through its Blockchain Offered New Debt Instrument (bond-i) platform, raising A$110m with its inaugural issue.
The deal was created, allocated and settled on the blockchain, although the cash leg was settled using traditional means, the absence of a central bank digital currency (CBDC) holding back this functionality.
A breakthrough came three years later when the European Investment Bank settled a €100m two year note using a digital euro provided by the Banque de France for the cash settlement.
Meanwhile, as a reminder, perhaps, of the immaturity of distributed ledger technology, investors are still awaiting El Salvador’s Bitcoin bond, an outlandish idea the country's president floated last year, saying it would use half of the proceeds to buy the digital currency and the remainder to part fund a Bitcoin city powered by a volcano.
It would probably be best for HM Treasury to keep the market’s expectations in check and start small like the EIB or the World Bank. The potential benefits for the City of London and the UK's capital markets ecosystem are enormous, but only if the government gets it right.
One likely element of such a plan would be the creation of a CBDC. The treasury minister, Glen, did not specify whether digital sterling issued by the Bank of England was on the cards. The Old Lady is set to run a consultation on a possible CBDC later this year, but has not yet decided whether it will issue one. Nevertheless, someone has already come up with the catchy monicker 'Britcoin'.
But it will be important not to get carried away with frivolity when issuing what, after all, will still be sovereign debt. The Debt Management Office and Treasury will need to reassure the market that digital Gilt issuances are serious, repeatable operations if wants to use them to establish its crypto credentials.
As a cautionary example, recall the UK's Islamic finance adventure.
The UK was the first non-Islamic sovereign to issue a sukuk, placing its debut deal in 2014 in an effort to promote itself as a hub for Islamic finance. But despite repeated calls for and pledges of a follow up deal, it took seven years before the DMO returned to the format.
Perhaps the UK's recent success with green Gilts could provide a more promising template — it took the DMO just under a year to progress from a statement of intent by chancellor Rishi Sunak to the final product. A second deal followed only a month after the first, with a segment of the programme explicitly set aside for this year’s visits.
However, the UK was hardly a pioneer in the issuance of green bonds, which have been well-established in the market for years.
Poised to overtake
But while the UK lagged behind other sovereign issuers on sustainable finance, it has a golden opportunity to catch up and overtake its rivals in blockchain bonds.
The Treasury's big announcement on the UK's crypto future was well received by DLT enthusiasts such as John Whelan, the head of the crypto and digital assets unit at Santander, who wrote on LinkedIn: "Appears that the British government will take a much more business friendly approach to crypto and digital assets than the EU's more myopic one. Make no mistake, the prize here is large."
Whelan was referring to the EU's recent decision to extend Transfer of Funds anti-money laundering regulations to non-custodial crypto wallets, which many in the decentralised finance community believe will stunt the development of Web3 in Europe.
If the UK does gain a lead over the EU in the development of blockchain capital markets, it could have a knock-on effect for banks.
Société Générale has emerged as something of a French national champion in digital capital markets, having developed its SG Forge unit to lead the development of blockchain bonds. Unsurprisingly, it played a key role on the EIB's digitally settled bond in 2018 and has since blazed a trail in blockchain covered bonds and decentralised repo.
Could the UK seek to use digital Gilt innovation to encourage and support the development of a national champion of its own?
NatWest Markets would seem like a possible candidate, having recently doubled down on its commitment to technological innovation with the appointment of Chris Agathangelou as its first ever head of digital capital markets.
NatWest also recently worked with Santander on a cross-chain experiment using an "interim" central bank currency created by high tech payment system operator Fnality. Interestingly, the Fnality cash token will be one of the first to be backed by funds deposited in an omnibus account at the Bank of England.
While the prospect of a royally minted non-fungible token might initially raise a few eyebrows, there is — or at least there should be — much more to the Treasury's crypto announcement than mere hype.
Now the government needs to make sure the substance is there to back it up.