Bitcoin-Backed Stablecoins Top List of GENIUS Act Loopholes
As focus now turns to the details of the act’s implementation, that watershed could threaten to spring a few leaks. For all its strengths as a statutory framework, the law is less a finished architecture than a foundation.
Federal Reserve Governor and former Vice Chair of Supervision Michael Barr said in a Thursday (Oct. 16) speech that the ways federal and state regulators interpret, coordinate and enforce the GENIUS Act’s provisions will determine whether the United States stablecoin ecosystem becomes a trustworthy component of the modern financial system or a source of systemic fragility reminiscent of past crises.
“[T]here is a lot of work to do on the part of the government to fill in the specifics during the rule-writing process,” Barr said, adding that digital assets like Bitcoin could serve as a stablecoin reserve asset under the GENIUS Act as it is currently written.
The act permits repos backed by “any medium of exchange authorized or adopted by a foreign government,” Barr said. That definition, however, could encompass volatile assets such as Bitcoin, given El Salvador’s continuing recognition of Bitcoin as legal tender. A clever issuer might argue that a Bitcoin-backed repo qualifies as an eligible reserve asset.
“[S]tablecoin issuers traditionally retain profits from investing reserve assets and therefore have a high incentive to maximize the return on their reserve assets by extending the risk spectrum as far out as possible,” Barr said in the speech.
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Bitcoin-backed stablecoins would, naturally, be less stable than their name might imply. Caveat emptor.
Read also:Keeping Stablecoins Stable is Complicated: Why CFOs Need to Pay Attention
The Fragile Foundations of ‘Stable’ Reserves
Among the most immediate task for regulators lies in defining the prudential standards governing reserve assets. On paper, the act lists permissible reserves such as treasuries, repos and deposits, but even within these categories lurk vulnerabilities.
One provision permits uninsured deposits as part of the reserve mix, a detail that evokes uneasy memories of March 2023, when uninsured deposits catalyzed the failures of Silicon Valley Bank and Signature Bank, Barr said in the speech.
“The historical examples point out that issuing liquid liabilities redeemable at par but backed by assets, even high-quality ones, about which creditors might have questions, makes private money vulnerable to run risk,” Barr said. “…Three key features—redemption on demand, at par and backed by noncash assets—render stablecoins susceptible to runs similar to fragile banks or money market funds.”
Even if reserve standards are tightened, the GENIUS Act introduces another risk: regulatory fragmentation. It empowers four federal agencies, along with each state and territorial regulator, to serve as primary supervisors of stablecoin issuers. While the law seeks to ensure “substantially similar” oversight, in practice, this diversity of authorities could foster inconsistent rulebooks, Barr said in the speech.
The U.S. has long wrestled with the consequences of regulatory pluralism. The dual banking system, federal and state charters operating side by side, has spurred innovation and arbitrage. A patchwork of standards could incentivize issuers to seek the most permissive charter, creating a race to the bottom in oversight.
This risk is magnified by the law’s broad definition of permissible activities. Stablecoin issuers may engage in a range of “digital asset service provider” and “incidental” activities beyond issuance, including exchange and brokerage functions. Without tight coordination, one regulator’s “incidental” activity could be another’s prohibited line of business, Barr said.
The nightmare scenario is a future in which a state-chartered issuer, operating under a lenient interpretation, takes on the risk profile of FTX while maintaining only the capital buffers of a payments intermediary. Unless agencies harmonize interpretations, the GENIUS Act could inadvertently enable the very intermediation risks it was designed to contain.
At the same time, not all instruments marketed as stablecoins fall under the act’s definition. That means certain dollar-denominated tokens can still circulate entirely outside the new regulatory perimeter, creating confusion among users who may assume they enjoy statutory safeguards.
See also:Stablecoins Aren’t Created Equal: Mapping the Issuer Marketplace for CFOs
Building the Guardrails for the Path Forward
Stablecoins promise efficiency, particularly in cross-border payments, where traditional systems remain slow and costly. But efficiency without trust is self-defeating.
Against this backdrop of uncertainty, tokenized deposits emerge as an alternative. Technologically, they mirror stablecoins, as they are digital representations of value that can move seamlessly across blockchains. But unlike stablecoins, tokenized deposits exist within the traditional banking framework.
Each tokenized deposit represents a claim on an insured deposit at a regulated bank. This structure inherits the prudential advantages of banking, like deposit insurance, established supervisory regimes, capital and liquidity requirements, and orderly resolution procedures. Moreover, banks can access the Federal Reserve’s discount window, ensuring liquidity under stress, which is an assurance no stablecoin issuer can yet match.
While tokenized deposits are not immune to risk, their regulatory pedigree is stronger. They offer a path to innovation without compromising systemic safeguards. As stablecoin regulation evolves, policymakers may find that tokenized deposits, rather than privately issued stablecoins, could offer the most durable foundation for digital payments innovation.
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