In May 2021, the Luna stablecoin lost its algorithmic peg to the Dollar, which led to the erosion of $45 billion for cryptocurrencies and various other assets in the hours immediately following this event. Even financial institutions with no obvious exposure to cryptocurrency felt the impact of the collapse. While many U.S. regulators may wish the asset class didn’t exist, it has become impossible to ignore it and pretending that doing so will insulate the rest of financial markets from its impact will no longer work.
The passage of the Genius Act earlier this year created a pathway for the widespread adoption of stablecoins, which are a type of cryptocurrency tied to some other stable asset like a fiat currency. Some entities market stablecoins as being a safe and potentially profitable way for people to get in on the cryptocurrency mania, and insinuate that stablecoins are akin to “digital dollars”: That is, perfectly safe and without any downside.
Their stable value leads some adherents to suggest that people can purchase stablecoins and simply hold them, much like a savings account. While the Genius Act prohibits stablecoins from paying interest, many evade this restriction by offering their holders “rewards” that might equal a few percent of the total amount of stablecoins they hold--in other words, something that looks very much like an interest payment but with another name.
However, stablecoins do not offer anything remotely close to the safety and security of holding actual dollars in a bank. For starters, stablecoins are not regulated like bank deposits, which have deposit insurance and are maintained in institutions that undergo scrupulous oversight and auditing from various government entities. And while the most well-known stablecoins are backed by an equivalent amount of dollar reserves, others are based on algorithms that may not always function as intended--as was the case with the Luna stablecoin. What’s more, while blockchain technology is proving increasingly resilient to cyber threats, insiders compromising the asset remain a threat to stablecoins.
The regulatory differences between stablecoins and ordinary dollar holdings create an uneven playing field where crypto firms compete with banks but without the same rules, reserves, or federal deposit insurance. Holders of Luna Stablecoins lost everything when it failed while people with deposits in Silicon Valley Bank lost nothing.
Allowing stablecoins to function as bank accounts without well-structured rules and oversight does not constitute competition: It is a loophole doomed to end in tears for any number of unwary investors.
Crypto lobbyists claim this is about “competition” and liken stablecoin rewards--which are essentially a way to get around prohibitions against paying interest--as being similar to credit card rewards. But this too is a false equivalence: The government heavily regulates credit card companies, the Federal Trade Commission sets--and administers--their rules, and there is a lengthy legal record protecting consumers’ rights to their rewards. Stablecoin issuers are not subject to any such rules governing their rewards, meaning consumers are left unprotected if things go wrong. And the first rule of any nascent technology is that things will inevitably go wrong.
The U.S. Treasury has warned that improperly marketed stablecoins could drain $6.6 trillion in bank deposits from the financial system by inducing consumers to store savings in unregulated accounts that could evaporate overnight in a crisis. Such a development would destabilize traditional banking by siphoning deposits away from insured banks while concomitantly creating systemic risks if stablecoin issuers fail, similar to the 2008 financial crisis but turbocharged by digital speed with which stablecoin depositors can move their assets.
In the event of a widespread failure of stablecoins, families and communities--and not hedge funds--will be left holding the bag.
Young people today who use Web3 technologies and digital assets for such things as gaming or peer payments may have never heard of Lehman Brothers and have never experienced a financial upheaval like the 2008 financial crisis engendered, and this lacuna makes them easy targets of the marketing campaigns designed to obfuscate these risks. Closing the stablecoin loophole is common-sense reform that will protect consumers while allowing crypto innovation to continue responsibly.
As someone who continues to benefit from crypto and the evolution of digital assets, I know that innovation is not incompatible with safeguards. Just as no one buys a car without brakes, basic consumer protections, capital requirements, and oversight are essential if stablecoins are to play a role in the financial system going forward.
The U.S. can’t afford to repeat the mistakes of the past by allowing risky, unregulated products to masquerade as safe. Lawmakers should close the stablecoin loophole before families, communities, and the economy pay the price.
