Genius Act Legalizes Stablecoins, Aims to Prevent Bank Disruption

The Genius Act, which is expected to be signed into law soon, introduces a new form of money into the US banking system: stablecoins. These digital assets are designed to maintain a stable value, often pegged to a reserve asset like the US dollar. The act legalizes stablecoins as non-bank money, a move that echoes the introduction of money market funds in the 1970s.

Historically, money market funds posed a significant threat to traditional banks. When interest rates surged beyond what banks were legally allowed to pay on deposits, money market funds, which faced no such restrictions, offered higher returns and attracted a substantial portion of retail savers' funds. This regulatory arbitrage weakened the banking system, as banks struggled to compete and were forced to make increasingly risky loans to maintain profitability.

The Genius Act aims to prevent a similar scenario by prohibiting issuers from paying interest on stablecoins. This measure is intended to protect the banking system from a potential "rate war" that could drain demand deposits and impair banks' ability to lend. However, the effectiveness of this prohibition remains uncertain.

Stablecoin issuers may find innovative ways to reward users without directly paying interest, much like banks once offered toaster ovens and televisions to attract deposits. Additionally, decentralized finance (DeFi) protocols are already providing high yields on stablecoins through smart contracts, offering users an alternative to traditional banking products.

The introduction of stablecoins could mark the beginning of a shift in the US financial system, similar to the transition from bank loans to capital markets that followed the deregulation of money market funds. If stablecoins gain widespread adoption, they could become a significant component of the shadow banking system, offering users higher yields and greater accessibility.

However, the long-term impact of stablecoins on the banking system remains to be seen. While the Genius Act aims to mitigate the risks associated with interest-bearing stablecoins, the innovative nature of the crypto industry may render such regulations ineffective. As stablecoins continue to evolve, regulators will need to adapt their approach to ensure the stability and integrity of the financial system.