The Genius move that could blow up in America’s face

Last week the US Senate passed the Genius Act legislation which would bring stablecoins into the mainstream of the US financial system. This week the Bank for International Settlements (BIS) warned that stablecoins perform badly on the main tests for any form of money.

Stablecoins are a form of digital currency backed by a fiat currency, like the US dollar, or other safe assets that always match the value of the stablecoin. To date, they’ve been used almost exclusively within the speculative crypto world. The bill would enable them to become a medium for exchange within the traditional finance world.

Donald Trump wants to make the US the crypto capital of the world. Credit: AP

They are touted as being a more efficient, lower cost and more timely form of payment than traditional bank-centred payment systems, with settlement of transactions clearing almost instantly. Until now, they have been largely, or at least very lightly, unregulated.

The US is about to change that by regulating them, but also by conferring the credibility of Congress, the White House and US law on their issuance and use.

Given that the crypto sector donated at least $US250 million ($385 million) to the election campaign of Donald Trump and other crypto supporters in Congress, it wasn’t surprising that Trump has authorised the creation of a national digital currency reserve and declared that he wants to make the US the crypto capital of the world. Providing a legal framework for stablecoins would make them the centrepiece for bringing crypto into the mainstream of finance.

The Trump family, of course, now has a significant exposure to cryptocurrencies, with at least half a dozen crypto-related businesses, including the USD1 stablecoin issued by their World Liberty Financial group. The token has a market capitalisation of $US2.2 billion.

Under the bill that passed through the Senate, issuers of stablecoins would be required to hold at least one dollar of high-quality and liquid reserves – US Treasury bills, bank deposits, government money market funds and the like – for each $US1 of stablecoins. Issuers would have to post monthly statements of their assets and larger issuers would be audited annually.

There would new “know your customer” requirements,” although how well that would work and be regulated in the crypto world of anonymous transactions is an open question.

There are already about $US250 billion of stablecoins on issue but, assuming the House endorses the bill (it has previously passed a slightly different version, named the STABLE Act) the legislation is likely to encourage a flood of new issuers.

Amazon and Walmart and other retailers, large and small, are said to be preparing to issue their own tokens, along with other participants in payment chains. The major US banks have talked about creating one, the big tech companies would inevitably become involved and, as with the Trumps, there’d be a host of entrepreneurial types entering the sector.

The Trump family, of course, now has a significant exposure to cryptocurrencies.Credit: Bloomberg

A report by Citigroup earlier this year said there could be $US3.7 trillion of stablecoins on issue by 2030, while a US Treasury analysis estimated there’d be $US2 trillion on issue by 2028.

The potential benefits of wide use of stablecoins are obvious. They’d cut out the middlemen of finance – the crypto universe is a peer-to-peer one – making merchant fees, interchange fees and wire transfer fees increasingly redundant, along with the waiting for funds to be cleared.

That explains retailers’ interest in them, and the threat they pose to the major credit and debit card operators.

US Treasury Secretary, Scott Bessent, is also enthusiastic about what they might mean for the US dollar and US Treasury market.

The dollar and US Treasury securities are already the most common assets used to back stablecoins and could be expected to be the assets of choice for tokens issued within the framework established by the Genius Act.

That would provide a massive new source of demand for the dollar and Treasury securities, buttressing the dollar’s global dominance and lowering the US government’s cost of funds, or at least that’s Bessent’s theory.

In practice, most of the funds to provide the dollar-for-dollar backing for the stablecoins would probably come from traditional finance sources – banks and money market funds being the most obvious. The flows of US dollar assets would be redirected, rather than new sources tapped.

That’s an important point, because it means deposits could be withdrawn from highly-regulated and, for deposits of less than $US250,000 in the US, insured environments into one that is far less onerously regulated and where the funds would not be insured.

Unlike bank deposits, where the Federal Reserve Board backstops the system, there would be no lender of last resort (one of the BIS criticisms), fewer protections against the use of the tokens for illicit activities (another) and they don’t have the capacity that banks have to create money (yet another weakness identified by the BIS).

Unlike a US dollar, which is trusted and accepted almost universally, there is no guarantee that a $US1 dollar stablecoin will actually be worth a dollar, or be accepted by everyone as a medium of exchange.

If the forecasts of the extent to which the stablecoin issuance could grow are correct, they could have an impact on the stability of the US and potentially other banking systems.

They would convert largely retail deposits, which are generally stable and are covered by federal insurance, into more volatile and uninsured wholesale deposits. The regional banking crisis in the US in 2023 was triggered by a run on Silicon Valley Bank’s wholesale deposits.

Under the Genius Act, stablecoin issuers would be required to hold $US1 of easily cashable assets for each $US1 of stablecoins.

It’s relatively easy for the issuers to acquire US Treasury bills, or repurchase agreements backed by Treasury securities or cash to match new deposits.

If there were, however, a sudden flood of redemption requests and a need to cash out the underlying assets urgently – if the issuer had to dump assets to raise cash in the face of what, in a bank, would be a “run” – there would be a likelihood of losses on the face value of the Treasury bills and other assets in a forced sale.

Some existing stablecoins have traded well below par. With no guarantor or lender of last resort, any liquidity event in a stablecoin would spark a frenetic scramble for the exit by investors, exacerbating the losses and raising the spectre of contagion for the rest of the sector.

While the Genius Act makes it explicit that the stablecoins wouldn’t be guaranteed by the government or have access to the Fed’s facilities, if there were a sector-wide implosion and trillions of dollars of Treasury securities and bank deposits were being dumped into the markets, the pressure for the White House to intervene would be extreme.

It would be even more extreme if the president at that moment had a multi-billion exposure to the stablecoin market. The act prohibits members of Congress or the US executive branch from owning or issuing stablecoins, but an attempt by the Democrats to include the president and vice president in that prohibition failed.

US Treasury Secretary, Scott Bessent, is also enthusiastic about what stablecoins might mean for the US dollar and US Treasury market.Credit: AP

The other major criticism of the act is that it could create a “back to the future” moment, a return to a 19th century America where almost anyone could open a bank and issue their own currency as long as they had a dollar of collateral for each dollar they issued.

Unlike a US dollar, which is trusted and accepted almost universally, there is no guarantee that a $US1 dollar stablecoin will actually be worth a dollar, or be accepted by everyone as a medium of exchange.

Fiat currencies are fungible, crypto assets are not. Each stablecoin could be backed by a different mix of assets and therefore their vulnerability to an external event, or ability to respond to a run, will differ between issuers.

Short of real time continuous auditing of every stablecoin issuer, there can’t be the same level of trust that there is in the traditional banking and payment systems.

By endorsing and providing credibility for stablecoins, however, the US lawmakers are bringing crypto into the mainstream of the US banking and payments systems, fragmenting them to at least some degree and introducing a potential new source of instability.

Only hindsight will tell whether that is such a good idea.

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