Press Room
Will PayPal’s stablecoin succeed where Facebook’s failed? – Ben Lee and Dion Seymour
Crypto Tax Partner, Ben Lee, and Crypto & Digital Assets Technical Director, Dion Seymour, discuss PayPal’s announcement of their own stablecoin and its UK tax implications, in Law360.
Ben and Dion’s article was published in Law360, 31 August 2023.
Cryptoassets, much like New York, never sleep. They are constantly changing and, sometimes, that change is rapid. Not too long ago, Facebook (now Meta) tried to release Libra (renamed to Diem and eventually abandoned), a token that could be used as a means of payment in the Facebook ecosystem. Facebook did not count on the strong reactions from governments and regulators, and the Libra project was eventually wound down. However, the Libra project may well have spurred the development of Central Bank Digital Currencies (CBDCs), as well as regulations such as the EU Markets in Crypto Assets (MiCA).
In this article we will consider how the recent announcement from PayPal on the release of a US Dollar pegged stablecoin could be perceived by policy makers and if it represents a groundbreaking innovation or will fail as other stablecoins have before it.
Advent of PayPal USD
On 7 August 2023, PayPal announced that it would release a dollar-pegged stablecoin based on the Ethereum network called PayPal USD, or PYUSD.[1] This marks the first time a major financial company has released its own stablecoin. Unlike with the release of Libra, there has been little excitement from the regulators. This, however, could be due to the fact that there are now regulations that apply to stablecoins, and PYUSD, according to PayPal, has the necessary regulatory permissions, at least in the US as PYUSD is currently only available for US customers.
To date neither the UK nor the EU have had a stablecoin launch that could have the same level of impact. Therefore, undoubtedly, policymakers in the UK and the EU will be watching the impact of PYUSD with a keen eye.
In the EU MiCA will regulate the issuance and provision of stablecoins either backed by currency or by real world assets. The UK’s regulation for stablecoins, the Financial Services and Markets Bill (FSMB), recently received Royal Assent meaning it has passed the final stages to become legislation.[2] The EU and UK have taken divergent approaches to the implementation of the regulations, with the EU favouring standalone regulation whilst the UK seeking to amend existing regulations to include cryptoasset. However, the regulations are broadly comparable as are the timelines.
Stablecoins
As a reminder, ‘stablecoin’ is a term that is used to describe cryptoassets that maintain a stable value. There is a risk of ‘depegging’, which is where the token stops tracking the value it should, with notable failures such as Terra USD, which collapsed in May 2022, resulting in an estimated US$50bn being wiped off the crypto market.[3] Furthermore, the question of how a stablecoin is backed is more complex than one might realise at first glance. TerraUSD was backed by an algorithm meant to increase and decrease supply to maintain value. In contrast, some stablecoins such as USDC and USDT are backed by capital reserves that are intended to support and maintain the value of the tokens. Where they are backed by an algorithm, there are no assets being held in reserve in the case of a “bank run”. But even when there is a reserve, there is no guarantee that a token can be immune to “bank runs” and maintain its value – even USDC briefly depegged in March 2023.
Libra was intended to be backed by a basket of currencies, but being from such a large company, it led governments to worry about possible currency runs and losing influence over monetary policy. PYUSD is reported to be fully backed by US dollar deposits, short term treasuries and other similar reserves, making it not dissimilar from Libra. PYUSD will operate in a different way compared to other stablecoins, with its use being initially controllable by only certain “wallets”, but use will become less limited in the near future. This approach appears to be focused on consumer protection, and PYUSD could be more accurately called a Centralised Collateral Digital Currency (CCDC), due to the high level of centralised control.
Reaction in Europe and the UK
This begs the question: why has PYUSD not been seized upon in the same way that Libra was by governments and regulators? It may be that the Libra announcement in 2019 was just too soon and governments and regulators did not understand crypto as they do now. In 2023, there are a number of global approaches to regulate cryptoassets and a more accepting stance is being taken by governments. Following the announcement of PYUSD, there has not been the the same negative comments from politicians reported in the news as as saw from the French finance minister in 2019, when he said “we cannot authorise the development of Libra in Europe” (a statement made, ironically, at the OECD’s blockchain conference aimed at promoting these technologies).[4] Since the announcement of Libra, the political landscape has changed and even the UK Government has announced it wants the UK to become a crypto hub.
The launch of PYUSD will undoubtedly create ripples in the US, as there is still a lot of debate on stablecoin regulation, with a federal bill for regulation of stablecoins that recently failed to reach a deal. Across the pond in Europe, the situation couldn’t be more different. The EU has published MiCA, which covers the issuing of stablecoins, and HM Treasury has also set out the upcoming regulatory framework for stablecoins in the UK. Elsewhere, the Monetary Authority of Singapore (MAS) has announced a regulatory framework for stablecoins, and other jurisdictions are also expected to develop their regulations.
The apparent increased acceptance for the creation of stablecoins, or, at least, the increasing regulations around the development of stablecoins, have not reduced the interest of central banks in creating digital versions of their own currency. In the UK, the Bank of England has been undertaking research to design a digital version of the pound (often called “Britcoin”) although, to date, there appear to be few cases for it to be used. Globally, many jurisdictions have central bank digital currency projects underway and some have been launched, such as the Sand Dollar in the Bahamas. In the US, there is less appetite for a CBDC, but there has been discussion of how the Federal Reserve’s new instant payment service “FedNow”, may put pressure on non-bank systems such as PayPal. FedNow enables near-instantaneous banking payments, potentially offering cheaper alternatives to PayPal, perhaps causing the third-party payment provider to reconsider its business model.
Despite the move by banks to enter the digital space, the move by PayPal, a FinTech company, could be soon joined by technology firms that are increasing their focus on providing finance, also known as TechFin companies, are becoming more prominent in the financial services markets. For example, Apple has a number of financial services available and it is likely that X (formerly known as Twitter) could move to create more financial services although this has only been hinted at by X’s CEO Elon Musk. Nevertheless, the separation between banking, commerce, and technology is becoming increasingly blurred. Apple, and other technology firms, are not financial companies. Furthermore, how far these firms will be able to continue to blur the distinction between financial and technology companies is becoming a pressing policy question.
For PayPal’s PYUSD, there is ever more competition within the payment intermediaries space. This ranges from the boom in “buy now pay later” from firms such as Klana Bank AB, to central banks developing their own versions of digital currency – such as “Britcoin”. The question inevitably arises: what does this offering from PayPal provide users?
The Reality of Stablecoins
The advantages of stablecoins as an alternative for remittances are widely debated. In theory, they can offer a fast, safe, real-time transfer of value with lower costs involved. PayPal states that “PayPal USD is designed to reduce friction for in-experience payments in virtual environments [and] facilitate fast transfers of value”.
In reality, stablecoin users have seen volatile transaction costs of sending stablecoins as a result of the supporting network (e.g. gas fees on Ethereum pre-merge), and the double-hop problem (exchange fees on acquisition and disposal of stablecoins into fiat). With over 430 million active accounts at the end of 2022, PayPal is well placed to drive adoption of their stablecoin, but it remains unclear what benefits users may attain from using the centralised stablecoin. It has been said that CBDCs are a solution looking for a problem; with PayPal’s stock in steady decline over the last 12 months as a result of increased competition in the digital payments landscape, perhaps the launch of PYUSD is less solution based, but rather designed to keep PayPal competitive within modern markets, providing new sources of revenue, from Web3 markets rather than benefits to traditional users.[5]
U.K. Tax Implications
Despite PYUSD being available only to US PayPal customers initially, it is worth noting the potential tax implications should a disposal of PYUSD be made by a UK taxpayer. Stablecoins are typically pegged to a fiat currency, and the tax implications of disposing of stablecoins are often overlooked or misunderstood.
Currency is often thought of as being tax free in the UK, however this only applies to sterling. Some limited exemptions apply, for example, the use of foreign currency abroad for personal use or where there is a debt (in any currency). However, it is unclear if PYUSD could be considered a currency or if the amounts held are a debt with PayPal. If it is a debt with PayPal, and PYUSD does have a distinctive feature compared to other stablecoins, (in that the tokens are capable of being converted back to fiat on the PayPal platform) then the tax treatment could be the same as for other debts (and bank accounts). If the exceptions do not apply, then PYUSD cannot benefit from the exemptions for currency and, as in the UK, stablecoins are treated as assets, similar to other cryptoassets, the disposal of stablecoins could potentially give rise to a capital gain or allowable loss.
There are often questions regarding how a stablecoin can give rise to a capital gain, as the value is meant to be stable. To date, the majority of stablecoins are pegged to the US Dollar and not the pound Sterling. Therefore, the value of a stablecoin is affected by foreign exchange fluctuations. For example, when the value of the British Pound against the dollar reached a historic low on 26th September 2022, investors could have taken advantage of this by selling any USD denominated stablecoin (USDC, USDT etc) to make a return in pound Sterling. In this event they will have, likely, created a gain.
This is particularly relevant for contractors within the Web3 industry. Web3 is considered by some to be the next iteration of the internet and is a shorthand for projects that utilise blockchain technology to share, store and use data. Contractors working on Web3 projects may receive USD pegged stablecoin as remuneration for their services. Receipt of stablecoin tokens for services is taxable as income at the time they are received. If these are not immediately converted to GBP upon receipt but retained indefinitely, there is an increased risk of further taxable gains linked to foreign exchange movements.
For the 23/24 tax year, individuals must report their capital gains to HMRC which cumulatively exceed the annual exempt amount of £6,000 (22/23 £12,300) or received proceeds from the sale of assets exceeding £50,000 throughout the tax year (22/23 £49,200).
Conclusion
The move by PayPal will prove interesting to watch for EU and UK policy makers. If the release is considered to be a success for PayPal it would seem logical for them to release PYUSD in other markets although perhaps it will be PYEUD/PYGBP. Perhaps the question will be if we should expect other firms such as X or Apple to follow suit as they are already increasingly moving into the financial services space. Any such moves for such large firms to issue in the EU or UK will be a test for their as yet untested regulatory regimes to be able to stand the test of time.
[1] https://newsroom.paypal-corp.com/2023-08-07-PayPal-Launches-U-S-Dollar-Stablecoin.
[2] https://bills.parliament.uk/bills/3326
[3] https://www.federalreserve.gov/econres/feds/files/2023044pap.pdf.
[4] https://www.politico.eu/article/french-finance-minister-wants-to-block-facebooks-libra-digital-currency.
[5] https://committees.parliament.uk/committee/175/economic-affairs-committee/news/160221/central-bank-digital-currencies-a-solution-in-search-of-a-problem-report-published.
Photo by Stanislaw Zarychta on Unsplash.
Email: Dion Seymour