by William C. Dudley, Chair, Bretton Woods Committee; Former President, Federal Reserve Bank of New York

Stablecoins are a digital asset—the vast majority are denominated in U.S. dollars—designed to facilitate payments. To ensure a stable value in dollars, stablecoins need to be fully backed by high quality reserves such as cash, short-term Treasuries, and other high-quality liquid assets. In recent years, stablecoins such as Tether and USDC have primarily served as on- and off-ramps from sovereign fiat currencies, such as the U.S. dollar, into cryptocurrencies and other crypto assets and as a faster and cheaper way of conducting cross-border payments. While USDC has been subject to regulation in several jurisdictions within the United States and abroad, Tether and other stablecoins have been largely unregulated. All stablecoins have operated outside of traditional payment rails, such as checks, credit cards, fast payment networks, and wire transfers.

The GENIUS Act dramatically upends this regime by requiring that all stablecoin issuers in the United States be regulated by the Office of the Comptroller of the Currency (OCC) or state bank regulators.

What Is the Motivation for the GENIUS Act?    

Stablecoin usage has increased markedly in recent years and the use cases for stablecoins—such as to facilitate cross-border payments—are compelling. Yet, no uniform regulatory regime had been put in place in the United States at the federal level. Instead, the goal was to limit usage, with bank regulators discouraging banks from providing clearing and custody services to stablecoin issuers. 

Also, as stablecoin usage proliferated, it became apparent that more needed to be done to ensure that stablecoins would always be fully backed by safe assets. The failure of Silicon Valley Bank provoked a run on Circle’s USDC in the secondary markets because a significant portion of the USDC reserves were held in SVB uninsured deposits. In addition, the use of stablecoins to circumvent anti-money laundering rules needed to be addressed. 

Finally, the Trump administration anticipated that a well-constructed USD stablecoin regime could support the use of the dollar as a reserve currency and bolster the demand for Treasury securities as reserve assets.  

How Does the Genius Act Attempt to Do This?

The Genius Act establishes rules for stablecoin issuers that operate in the United States:

• Stablecoins must be fully backed by cash, short-dated U.S. Treasury securities, other high-quality liquid assets, or deposits at insured banks. 
• Such reserves must be segregated from the issuer’s other assets. In bankruptcy, stablecoin holders have priority over other claimants.
• Issuers cannot pay interest on stablecoins. This is to support stablecoins as a medium of exchange (e.g., a substitute for cash) rather than as an investment asset (e.g., an alternative to bank certificates of deposit or money market mutual funds).
• Stablecoin issuers will be subject to capital and liquidity rules implemented by federal and state regulators and must be compliant with the anti-money laundering and Bank Secrecy Act requirements applied to banks. If a stablecoin issuer is regulated at the state level (an option largely available only if the issuer has less than $10 billion of outstanding stablecoins), the state rules must be consistent with national regulations. 

Will the GENIUS Act Achieve Its Objectives?

While the GENIUS Act is an important milestone in establishing guardrails for stablecoin use and issuance, how well it will achieve its objectives depends on how it is implemented.

There are three important open questions. First, will the requirements for stablecoin reserves be sufficient to ensure that stablecoins always trade at their par value? The GENIUS Act allows stablecoins to be backed by non-insured deposits at insured institutions and, although they are deemed as high quality liquid assets, money market instruments including repurchase agreements which carry liquidity and settlement risk. If a stablecoin issuer’s viability were threatened and redemptions soared, this could create a risk that the stablecoins price could “break the buck”—at least in secondary trading markets. The capital and liquidity regulations that will be implemented by federal and state banking regulators will be important in influencing the incentives for stablecoin issuers to hold the highest quality assets—i.e., central bank reserves and Treasury bills. At the same time, the fact that a foreign stablecoin issuer, such as Tether, may continue to issue their USD stablecoins outside the United States without complying with the reserve, capital, and liquidity requirements of the GENIUS Act could exacerbate run risks in what is a truly global market.     

Second, does the prohibition on payment of interest go far enough? While issuers cannot pay interest on stablecoins, this prohibition does not extend to affiliates and third parties. If stablecoin holders were able to earn interest, then stablecoins would become more attractive as investment assets. The concern is that this could lead to an outflow of bank deposits into stablecoins and potentially could constrain the ability of banks to lend to households and small businesses. In times of banking stress, it could also provide greater incentives to run out of uninsured bank deposits into stablecoins.

Third, the Genius Act provisions will not rein in stablecoin issuers that operate abroad and do not conduct business in the United States. Such extraterritorial issuers will be able to evade the regulatory and prudential standards needed to ensure that their stablecoins are safe.

What Are the Next Steps?

The national bank regulators will need to enact liquidity and capital regulations for stablecoin issuers over the next two years. The choices made during this process will have important consequences for the safety of stablecoins and their utility for payments. Although stablecoin issuers may prefer to operate with fewer constraints, banks will want to see more safeguards, in part, to protect their legacy payment activities and deposits. 

What About the Role of the Fed?    

The Federal Reserve is considering opening up its master accounts used to clear payment transactions to non-traditional payment providers. These accounts enable banks to settle payment transactions directly on the central bank’s books—minimizing settlement, liquidity, and interest rate risk. 

Governor Christopher Waller has proposed that the Fed offer “skinny” accounts to non-traditional fintech firms that have a bank charter. These accounts would allow payments to be settled at the Fed, but they would not earn interest on their balances, nor would daylight overdrafts or access to the discount window be permitted; services that are available to traditional banks. 

If enacted, Governor Waller’s proposal could be an important step in bringing stablecoin issuers into the Fed’s orbit and improving the safety and resilience of the payment services that they offer. However, the initial impact would likely be limited for two reasons. First, to participate fintech firms would have to obtain limited banking charters from the OCC. These would likely only be available to firms that confined their activities to payments and financial services: the long-standing prohibition on mixing commerce and banking would be respected as the GENIUS Act makes it difficult for non-financial companies to issue stablecoin. Second, the prohibition on payment of interest would incent such firms to minimize the size of their reserve accounts at the Fed. This would undercut the safety of the stablecoins compared to 100% Fed reserve backing.

Over time, as stablecoin regulations are promulgated and stablecoin usage increases and becomes more mainstream, the Fed could open up its access to stablecoin issuers more broadly.  This could have several benefits including making stablecoin usage safer. In other words, the “skinny” account proposal might ultimately just be the first step in providing greater access to Fed master accounts and settlement.

Featured Author:

William C. Dudley, Chair, Bretton Woods Committee; Former President, Federal Reserve Bank of New York