The GENIUS Act outlines a national regulatory framework for stablecoins, a form of digital currency backed by a pool of short-term dollar assets, which are likely to become more prominent in business and consumer payments.
The act leaves one important question unanswered: Who provides the liquidity backstop in the event of a run? Any institution that holds someone’s money in another form with guaranteed conversion back into dollars one for one is always at risk of a run in times of financial stress.
Money market funds experienced runs during the Global Financial Crisis, and in 2023 an exit of depositors contributed to three regional bank failures. Circle Internet Group Inc.’s USDC stablecoin briefly depegged from its one for one exchange price during the banking turmoil of 2023 because it had billions of dollars in bank deposit reserve assets stuck in Silicon Valley Bank which failed.
How did that resolve? The government declared a systemic risk exception, and effectively insured all deposits of SVB, including those above $250,000. USDC was made whole, along with other large depositors thanks to a federal backstop.
The act leaves one important question unanswered: Who provides the liquidity backstop in the event of a run? Any institution that holds someone’s money in another form with guaranteed conversion back into dollars one for one is always at risk of a run in times of financial stress.
Money market funds experienced runs during the Global Financial Crisis, and in 2023 an exit of depositors contributed to three regional bank failures. Circle Internet Group Inc.’s USDC stablecoin briefly depegged from its one for one exchange price during the banking turmoil of 2023 because it had billions of dollars in bank deposit reserve assets stuck in Silicon Valley Bank which failed.
How did that resolve? The government declared a systemic risk exception, and effectively insured all deposits of SVB, including those above $250,000. USDC was made whole, along with other large depositors thanks to a federal backstop.
Why Use Stablecoins?
Stablecoins offer payment advantages. First, transactions settle almost instantly on a distributed digital ledger rather than passing through intermediary banks and credit card companies. Second, if a retailer accepts stablecoin as a form of payment, that cuts out credit card fees. U.S. businesses paid $172 billion in credit card fees in 2023, according to the National Retail Federation.
Having access to a stable, dollar-backed asset is also a valuable tool to underbanked populations that want to hold dollar earnings in a safer form than cash or even transfer them with less cost to family members in another country.
The Citi Institute estimates that the supply of stablecoins could grow to $1.6 trillion by 2030 in their baseline scenario, or to $3.7 trillion in their most optimistic case. DeFi Llama estimates the market’s size at about $266 billion.
Having access to a stable, dollar-backed asset is also a valuable tool to underbanked populations that want to hold dollar earnings in a safer form than cash or even transfer them with less cost to family members in another country.
The Citi Institute estimates that the supply of stablecoins could grow to $1.6 trillion by 2030 in their baseline scenario, or to $3.7 trillion in their most optimistic case. DeFi Llama estimates the market’s size at about $266 billion.
The Genius Act Provides Protections
The legislation does provide a framework for oversight and managing risk. Here are some of the highlights:
There are gatekeepers. The law says stablecoin issuers must be “permitted’’ by a state or a federal regulator.
There are watchdogs. The bill designates regulators. Bank issuers fall under their bank regulator, while nonbank
issuers could fall under the Office of the Comptroller of the Currency (OCC) or a state regulator.
Importantly, there are specific criteria for what the reserves backing the coins can be. Here is a partial list: coins and currency, commercial bank deposits, repurchase agreements, Treasury securities maturing in 93 days or less, and, for banks, money on deposit with a Federal Reserve bank
There are gatekeepers. The law says stablecoin issuers must be “permitted’’ by a state or a federal regulator.
There are watchdogs. The bill designates regulators. Bank issuers fall under their bank regulator, while nonbank
issuers could fall under the Office of the Comptroller of the Currency (OCC) or a state regulator.
Importantly, there are specific criteria for what the reserves backing the coins can be. Here is a partial list: coins and currency, commercial bank deposits, repurchase agreements, Treasury securities maturing in 93 days or less, and, for banks, money on deposit with a Federal Reserve bank
What’s the Risk?
Sudden surges in withdrawals or redemptions may overwhelm an issuer’s ability to provide large amounts of instant liquidity. If a stablecoin issuer can’t meet all the requests to redeem back into dollars because of sudden market illiquidity, investors are going to have to wait for the event to unwind or possibly exit at less than one for one.
A series of bank failures in 2023 showed that even banks with deposit insurance and access to the Federal Reserve’s lending backstop aren’t immune to run risk.
“When stablecoins get bigger, they are going to have larger deposit accounts and large concentrations of Treasury portfolios,’’ says Andersen Institute economist Rashad Ahmed. “This can cause large redemptions in Treasury markets and large demand for bank deposits.”
Imagine that one stablecoin issuer is having trouble liquidating a large amount of Treasury bills. The bill market gets roiled, word gets out, and now investors start to wonder if other stablecoins face liquidity problems and herd effects start to overwhelm markets. Everyone wants out.
A rapidly spreading financial wildfire “is when you pull out all the stops’’ as a backstop lender like the Fed, said Jim Clouse, a fellow at the Andersen Institute and a former deputy director at the Fed’s Board of Governors. “Do you need a special liquidity backstop for stablecoin issuers? That is the $100 million question.’’
A series of bank failures in 2023 showed that even banks with deposit insurance and access to the Federal Reserve’s lending backstop aren’t immune to run risk.
“When stablecoins get bigger, they are going to have larger deposit accounts and large concentrations of Treasury portfolios,’’ says Andersen Institute economist Rashad Ahmed. “This can cause large redemptions in Treasury markets and large demand for bank deposits.”
Imagine that one stablecoin issuer is having trouble liquidating a large amount of Treasury bills. The bill market gets roiled, word gets out, and now investors start to wonder if other stablecoins face liquidity problems and herd effects start to overwhelm markets. Everyone wants out.
A rapidly spreading financial wildfire “is when you pull out all the stops’’ as a backstop lender like the Fed, said Jim Clouse, a fellow at the Andersen Institute and a former deputy director at the Fed’s Board of Governors. “Do you need a special liquidity backstop for stablecoin issuers? That is the $100 million question.’’
Safety Nets are Costly
Explicit safety nets bring high regulatory costs on banks which today undergo stress testing and are subject to a variety of capital and liquidity requirements to strengthen them against failure.
An implicit safety net has costs for the public because it can result in excessive risk-taking that may require a federal bailout. Economists call this moral hazard. Investors expect the Fed or some federal agency will bail an institution out, while they don’t bear the cost of regulation.
Public costs from implicit safety nets come in several forms, such as mispriced risk and market dysfunction when things blow up. There is always a question of whether a federal agency will recover its loans after a bailout.
An implicit safety net has costs for the public because it can result in excessive risk-taking that may require a federal bailout. Economists call this moral hazard. Investors expect the Fed or some federal agency will bail an institution out, while they don’t bear the cost of regulation.
Public costs from implicit safety nets come in several forms, such as mispriced risk and market dysfunction when things blow up. There is always a question of whether a federal agency will recover its loans after a bailout.
Stablecoin Banks
Circle has applied to the OCC to establish a national trust bank, which it calls First National Digital Currency Bank NA. Other coin issuers have also applied for banking licenses.
Circle said the trust would “oversee management’’ of USDC’s reserve assets and would offer digital asset custody services to institutions. Importantly, having a standing trust bank would further integrate Circle into electronic dollar payment systems, run by the Fed and private banks.
National trust bank status, however, doesn’t automatically confer access to the Fed’s discount window or deposit insurance, said Max Bonici, who advises banks and fintechs on banking regulations at Davis Wright Tremaine LLP in Washington.
“The minute a national trust bank accepts deposits it becomes a bank’’ and the holding company is subject to Fed oversight and restrictions, Bonici said. Staying away from transactional deposit taking also makes it easier to affiliate with other non-bank companies, he said. It is an open question whether institutions will have access to the discount window if they stay away from transactional insured deposit taking.”
Circle said the trust would “oversee management’’ of USDC’s reserve assets and would offer digital asset custody services to institutions. Importantly, having a standing trust bank would further integrate Circle into electronic dollar payment systems, run by the Fed and private banks.
National trust bank status, however, doesn’t automatically confer access to the Fed’s discount window or deposit insurance, said Max Bonici, who advises banks and fintechs on banking regulations at Davis Wright Tremaine LLP in Washington.
“The minute a national trust bank accepts deposits it becomes a bank’’ and the holding company is subject to Fed oversight and restrictions, Bonici said. Staying away from transactional deposit taking also makes it easier to affiliate with other non-bank companies, he said. It is an open question whether institutions will have access to the discount window if they stay away from transactional insured deposit taking.”
The Bottom Line
The GENIUS Act didn’t specify whether there is an emergency federal backstop for an instrument that is convertible back into dollars one for one at any time. But the law specifies that reserves must be kept in high-quality liquid assets, so in calm times there should be no problem raising cash for redemptions.
Stablecoins aren’t bank deposits and as of now don’t have the protection of the Fed’s bank liquidity backstop known as the discount window. This could change if stablecoin issuers sign up to become full-fledged banks.
Stablecoins aren’t bank deposits and as of now don’t have the protection of the Fed’s bank liquidity backstop known as the discount window. This could change if stablecoin issuers sign up to become full-fledged banks.
