A vulnerability has made stablecoins the focal point of a trillion-dollar battle.

Written by: Adam Willems, Wired Magazine

Compiled by: Saoirse, Foresight News

U.S. President Donald Trump showcases the signed bill during the signing ceremony of the "GENIUS Act" at the White House. Photo: Francis Chung; Image source: Getty Images

On July 18, after more than a decade of regulatory uncertainty in the U.S. cryptocurrency industry, American lawmakers finally brought some areas of the industry under a regulatory framework. The newly signed "U.S. Stablecoin Innovation and Establishment Act" (referred to as the "GENIUS Act") sets forth a series of requirements for stablecoin issuers: stablecoins are cryptocurrencies that claim to be tied to the value of a more stable asset, and their issuers must provide 100% full reserves for the tokens in cash or short-term government bonds, accept audits, and comply with anti-money laundering rules, among other stipulations. Furthermore, to position stablecoins as "digital cash" rather than "funds storage tools," the Act also prohibits stablecoin issuers from paying interest.

But the key point is that the bill does not prohibit cryptocurrency exchanges from providing rewards for users' stablecoin holdings — this means that stablecoin holders can still receive economic incentives that are very similar to "interest." Nowadays, if Coinbase users hold a stablecoin called USDC on the platform, they can achieve an annual yield of up to 4.1%, which is comparable to the expected returns of high-yield savings accounts.

U.S. banking groups believe that this regulation constitutes a significant regulatory loophole that could encourage the public to withdraw funds from banks and deposit them into cryptocurrency exchanges with much looser regulations. The rewards offered by some exchanges even exceed those of high-yield savings accounts (which generally have an annual yield of around 4.25%, with specific rates varying by institution). For example, the exchange Kraken advertises its "USDC holding reward annual rate of up to 5.5%."

Even without considering the reward mechanism, stablecoins still pose potential risks to consumers compared to bank deposits and cash. Unlike checking or savings accounts, cryptocurrencies are not protected by the Federal Deposit Insurance Corporation (FDIC) insurance — this means that if the issuer of the stablecoin goes bankrupt, the U.S. government will not directly intervene to compensate consumers for their financial losses.

Some regulatory agencies and cryptocurrency supporters believe that the strict reserve requirements and bankruptcy protection clauses in the "GENIUS Act" are sufficient to replace FDIC insurance. However, stablecoins have previously experienced collapse events, and a research report by the Bank for International Settlements (BIS) indicates that even for stablecoins classified as "minimum volatility" under the "GENIUS Act", their trading prices "rarely maintain the claimed pegged value level". BIS researchers point out that this phenomenon raises doubts about the "ability of stablecoins to serve as reliable payment tools."

Research from the Federal Reserve Bank of Kansas City indicates that the rising demand for stablecoins could have a ripple effect on the economy. The bank's Assistant Vice President Stefan Jacewitz stated, "If users purchase stablecoins with bank deposits, the funds available for the bank to lend will inevitably decrease." He further pointed out that incentives such as rewards "could lead to an acceleration in the velocity of funds and an expansion in scale, exceeding normal market levels."

In April of this year, a report released by the U.S. Treasury Department indicated that, influenced by the GENIUS Act, consumers could transfer up to $6.6 trillion from bank deposits to stablecoins. Research from the American Bankers Association (ABA) pointed out that if this situation occurs, the amount of funds banks can lend will decrease, and in the long term, borrowing costs for consumers and businesses may rise.

The game behind the compromise

The advancement of the "GENIUS Act" took four years to finally come into effect, during which most members of the U.S. Congress agreed on the principle that "stablecoin issuers should not pay interest." "The drafters of the bill are clear that stablecoins are a special tool - they are digital cash, digital dollars, and not a security instrument that can generate returns," said Corey Then, Global Policy Deputy General Counsel at Circle.

In March this year, Coinbase CEO Brian Armstrong spoke out on this issue. He stated on the X platform (formerly Twitter) that users should be allowed to earn interest through stablecoins, comparing this model to "regular savings accounts, without the cumbersome disclosure obligations and tax implications required by securities regulations."

Ron Hammond, who previously served as a senior lobbyist for the prominent cryptocurrency industry group Blockchain Association, revealed details of the subsequent negotiations: ultimately, the banking groups agreed to reach a deal that included their long-standing demand to "prohibit stablecoin issuers from paying interest"; however, this provision still left room for cryptocurrency exchanges—allowing them to provide monetary incentives for users' stablecoin holdings. Hammond stated that some cryptocurrency companies initially hoped the bill would explicitly allow "interest", but the mainstream cryptocurrency groups ultimately were willing to accept this compromise.

"At least the cryptocurrency industry has successfully pushed for the inclusion of relevant statements in the bill, opening the door for 'returns' or 'similar returns' rewards," said former House Financial Services Committee Chairman McHenry. He now serves as the Vice Chairman of the blockchain project Ondo.

Some experts in the cryptocurrency industry are dissatisfied with the current "alarmist attitude" of banking groups. Cody Carbone, CEO of the cryptocurrency advocacy and lobbying group Digital Chamber, stated: "Raising concerns about the stablecoin reward mechanism at this stage is neither sincere nor does it acknowledge the multi-round in-depth discussions that shaped the GENIUS Act. Banking representatives were involved throughout the legislative process, negotiating alongside stakeholders in the cryptocurrency space, and the final language of the bill that allows exchanges and affiliated platforms to offer rewards related to stablecoins is a direct result of these discussions."

Second chance of the game

The cryptocurrency industry is willing to compromise in part because it does not want to expend too much political capital on this "experimental bill" — the industry sees the "GENIUS Act" as a "touchstone" for broader regulatory legislation in the cryptocurrency space. Hammond explained: "The concern of the cryptocurrency industry at that time was: 'If even a relatively simple bill like the stablecoin bill encounters obstacles, then our chances of passing it will be greatly reduced, and the likelihood of passing a market structure bill within the next two years is almost zero.'"

The "Market Structure Act" referred to by Hammond is the "CLARITY Act". This act aims to establish a regulatory framework for products and financial platforms on blockchain, similar to the regulatory rules currently applicable to traditional financial entities such as stock markets, banks, and institutional investors. The "CLARITY Act" has passed the House of Representatives, and the Senate version is expected to be released in September this year. A few days after the signing of the "GENIUS Act", the drafters of the Senate "CLARITY Act" released a consultation letter raising a key question: should legislative measures be taken to restrict or prohibit mechanisms such as stablecoin rewards?

The "CLARITY Act" provides a second chance for the cryptocurrency industry and the banking sector, allowing both sides to push for the implementation of provisions not included in the "GENIUS Act." Paul Merski, Executive Vice President of Congressional Relations at the Independent Community Bankers of America (ICBA), a major lobbying and advocacy group for community banks in the U.S., stated that the association will oppose any provisions that "violate the core principle of 'prohibiting interest payments.'" He called this principle a key element established by the "GENIUS Act." "We have addressed this issue in legislation related to stablecoins and will also ensure that relevant provisions are included in the market structure legislation to avoid regulatory loopholes."

"The issue is that the progress of the two pieces of legislation is different: the losing side in the last round of negotiations will make a comeback, while the winning side needs to defend the provisions they have already fought for." McHenry pointed out, "Now we have entered the second round of negotiations, and all the topics from the last round have to be discussed again, which significantly increases the difficulty of the second round of negotiations."

During the advancement of the CLARITY Act, the U.S. banking industry is also publicly laying out plans in the stablecoin space. Citigroup and Bank of America have hinted at the potential issuance of their own stablecoins; meanwhile, PNC Bank and JPMorgan have established partnerships with Coinbase. Taking JPMorgan as an example, its collaboration plan will allow customers to link their bank accounts directly to cryptocurrency wallets as early as next year.

JPMorgan is also piloting a "deposit token" system: this system uses technology similar to stablecoins but does not require assets to be reserved at a 1:1 ratio as mandated by the GENIUS Act to support the value of the tokens. Ultimately, if the CLARITY Act leads to the prohibition of the stablecoin "reward" mechanism, the banking industry may regain an advantage in this game of deposits and interest rates involving trillions of dollars.

"The banking groups clearly miscalculated in the game of the GENIUS Act, such mistakes are extremely rare for them." McHenry stated, "They have now made a comeback and are taking a hard stance - the risks in this game are extremely high."