US Senate Moves to Regulate Stablecoins Amid Banking Risks

The US Senate is preparing to pass the GENIUS Act, a bill aimed at establishing legal frameworks for the issuance and backing of stablecoins. This legislation would permit companies issuing these dollar-backed tokens to store reserves in banks, purchase Treasuries, or lend money to banks in a manner similar to money-market funds. The primary objective is to regulate the rapidly expanding segment of the crypto market that is increasingly impacting the traditional banking system.

The core issue is not whether stablecoins are removing money from banks, as they are not. Instead, the concern lies in the type of money that remains and who bears the associated risk. When a stablecoin is minted using real US dollars, the issuer must place those dollars into reserves. This money is not lost; it is transferred into a bank account, government debt, or short-term lending agreements known as repurchase agreements. However, this money no longer resides in a low-risk, government-insured account under $250,000. Instead, it accumulates in large, uninsured accounts that can disappear during a panic, transforming stable retail cash into volatile corporate cash. This cash is less likely to remain stable during adverse conditions.

Analysts from JPMorgan Chase have described stablecoins as a digital form of money-market funds, stating that "bank deposits are not ‘destroyed’ by such a change, but are simply transferred to other economic agents." The real problem is the increased risk exposure for banks. Researchers from the European Central Bank have highlighted that "collecting deposits from stablecoin issuers transforms retail deposits that can serve as a stable source of funding for banks into volatile deposits that cannot." This transformation is concerning for regulators, as it can lead to fragile funding structures for banks if too many insured deposits are moved into stablecoins. This scenario has already occurred in the past.

In March 2023, Circle Internet Group, the company behind USDC, attempted to transfer more than $3 billion out of Silicon Valley Bank as it was collapsing. However, the transfer did not settle before the FDIC took over, and USDC dropped below $1 on multiple exchanges, losing its dollar peg. Circle confirmed in its public filing that the dislocation only ended after regulators guaranteed all deposits at SVB. The largest banks are likely to weather this storm, but smaller institutions will bear the brunt of the impact.

Circle also mentioned in its filing that it has changed its reserve management strategy, holding the "significant majority" of its cash with global systemically important banks, including Bank of America, JPMorgan, Citigroup, and Wells Fargo. These giants are well-equipped to handle liquidity, as they are required to hold sufficient high-quality assets to withstand significant fluctuations, giving them an advantage when stablecoin issuers move billions of dollars. However, smaller banks are not built for such volatility. If everyday savers start using stablecoins for regular spending and short-term savings, small banks will be the first to feel the impact. Their primary strength, government-insured retail deposits, will be eroded, turning their main advantage into a weakness.

Additionally, some large banks are exploring the possibility of issuing their own stablecoins. If these banks, which already dominate global finance, start minting their own crypto-backed dollars, they will not only host reserves but also control the entire pipeline. Meanwhile, the ecosystem around stablecoins is expanding. People are beginning to earn yield simply by holding these tokens, and there is now a market for tokenized Treasuries, allowing individuals to earn returns on government debt without interacting with a bank. This puts further pressure on banks to raise their interest rates, which erodes their profits.