Interest-Bearing Stablecoins and the Future of Bank Funding Models

The rise of interest-bearing stablecoins has ignited a seismic shift in financial markets, challenging traditional banking paradigms and prompting urgent regulatory interventions. As of 2025, the U.S. financial system is grappling with the dual forces of innovation and systemic risk, epitomized by the passage of the GENIUS Act in July 2025. This legislation, which prohibits the creation of interest-bearing stablecoins, marks a pivotal moment in the evolution of digital finance. By examining the interplay between regulatory frameworks, systemic risks, and bank funding strategies, this analysis explores how the financial sector is adapting to a world where stablecoins and traditional banking coexist under heightened scrutiny.

The Systemic Risks of Interest-Bearing Stablecoins

Interest-bearing stablecoins pose a unique threat to financial stability by directly competing with banks in the deposit market. By offering yields on digital assets, these instruments risk triggering a "disintermediation" effect, where customers shift funds away from banks, undermining their core role in credit intermediation. The Federal Reserve has warned that such a shift could destabilize the banking system by reducing the volume of bank deposits, increasing liquidity risk, and raising funding costs for institutions. For instance, if stablecoins gain direct access to central bank accounts or rely on non-deposit assets for reserves, banks could face a more volatile and less predictable funding environment.

Moreover, the proliferation of USD-backed stablecoins has introduced asymmetric effects on yield curves. Modest inflows into stablecoins may suppress short-term yields, while outflows could trigger disproportionately larger spikes, amplifying yield volatility. This dynamic is compounded by the risk of unintended dollarization in emerging markets, where local currencies may be displaced by USD-denominated stablecoins, exacerbating financial instability and currency depreciation.

Regulatory Responses: The GENIUS Act and Beyond

The GENIUS Act of 2025 represents a landmark effort to mitigate these risks by imposing strict reserve requirements and prohibiting interest-bearing features on stablecoins. Under the Act, stablecoins must be fully backed by high-quality, liquid assets such as U.S. Treasury bills or demand deposits at insured depository institutions. This 100% reserve requirement aims to prevent stablecoins from replicating the credit creation functions of banks, thereby preserving the integrity of the traditional financial system.

The Federal Deposit Insurance Corporation (FDIC) has further operationalized the Act by proposing rules to govern the issuance of stablecoins by insured depository institutions through subsidiaries. These rules mandate monthly public attestations, annual independent audits, and adherence to anti-money laundering (AML) standards. While the Act has been praised for its clarity, critics argue that it leaves gaps in addressing liquidity concentration risks and the potential for affiliated entities to circumvent interest prohibitions.

Globally, regulatory approaches vary. The UK Bank of England, for example, has proposed a framework allowing stablecoin issuers to hold up to 60% of backing assets in short-term government debt, with 40% in central bank deposits. This hybrid model seeks to balance innovation with financial stability, contrasting with the U.S. approach of stricter reserve allocation.

Bank Funding Strategies in the Post-GENIUS Era

Banks have responded to the regulatory landscape by rethinking their funding strategies. The American Bankers Association has highlighted concerns that stablecoin companies may indirectly offer interest through affiliated entities, potentially undermining traditional banks' role in local lending. To counter this, banks are exploring integration strategies that align with their operational expertise. For example, JPMorgan and Citi are developing deposit token solutions and custody services for digital assets, while regional banks like Cross River Bank are leveraging stablecoins for near-instant settlements via platforms such as Visa.

The Federal Reserve has also noted that stablecoin adoption has altered banks' liability structures, necessitating adjustments in liquidity risk management. Banks are increasingly prioritizing reserve allocation strategies that account for the potential displacement of traditional deposits. For instance, BNY Mellon is leveraging stablecoins to optimize liquidity in global operations, reducing trapped capital and enabling just-in-time treasury management.

Quantifying Systemic Risk and Financial Stability

Empirical data underscores the scale of the challenge. By Q4 2025, the total market capitalization of stablecoins had surpassed $290 billion, driven by institutional interest and regulatory clarity. However, this growth has not been without turbulence. Depegging events, such as the 2023 collapse of USDC and the 2025 depegging of USDe, have exposed vulnerabilities in stablecoin reserves and governance. These episodes highlight the fragility of stablecoin pegs during market stress, particularly when institutional investors fail to support prices.

Systemic risk assessments, such as S&P Global Ratings' Stablecoin Stability Assessment, emphasize the need for robust governance and technological safeguards. The Federal Reserve has also raised concerns about the potential for stablecoin lending through DeFi platforms to amplify leverage and systemic risk. For example, high loan-to-value (LTV) ratios on platforms like Aave enable 10x leverage, increasing the likelihood of cascading defaults during market downturns.

The Path Forward: Balancing Innovation and Stability

The future of bank funding models will hinge on the ability to harmonize innovation with systemic stability. While the GENIUS Act has curtailed direct competition between stablecoins and banks, it has not eliminated all risks. Regulatory frameworks must evolve to address emerging threats, such as the use of uninsured deposits in stablecoin reserves and the potential for stablecoins to disrupt traditional banking models.

Banks, for their part, must continue to innovate within the regulatory perimeter. The integration of stablecoin infrastructure into treasury operations and cross-border payments offers a pathway to enhance efficiency while mitigating risks. At the same time, regulators must remain vigilant in monitoring liquidity concentration, reserve management, and the broader implications of stablecoin adoption for financial stability.

Conclusion

The rise of interest-bearing stablecoins has forced a reckoning in the financial sector, exposing both the opportunities and risks of digital finance. The GENIUS Act and complementary regulatory efforts have laid the groundwork for a more stable coexistence between stablecoins and traditional banks. However, the path forward requires continuous adaptation, as systemic risks evolve alongside technological innovation. For investors, the key takeaway is clear: the future of bank funding models will be shaped not only by regulatory frameworks but also by the resilience of institutions in navigating a rapidly changing financial landscape.