The GENIUS act does not adequately address the discrepancy between highly regulated regular lenders such as banks and crypto vendors aiming to mimic credit markets without adequate safety regulations. I recently argued for closing the stablecoin loophole in the GENIUS Act to protect Main Street communities that may switch from safer community banks with strict safety regulations to crypto stable coins where it is not. Credit competition should occur with an equal level playing field, not where incumbents are regulated while new competition is not.
As expected, crypto vendors are pushing back on efforts to close the loophole. However, the arguments I’ve heard in favor of the loophole do not recognize how the banking system works in practice.
First, some of these crypto executives are simply fearmongering, conjuring up claims that the financial system as we know it is unstable and lending practices which have been in existence dating back to at least the 1600s are, oddly, nefarious. But the current fractional reserve banking mode, although not flawless, has generated more wealth and capital creation than in any lending scheme devised by current crypto currency leaders.
Banks adhere to an extensive system of regulations and rules that have been developed over generations to ensure market stability, while cryptocurrency as a collateralized instrument, does not. In fact, though I would argue that banks are often over-regulated, nearly all economists agree that some level of regulation is necessary for a secure credit market. Banks have capital, liquidity, and reserve requirements designed to ensure both adequate access to capital in the marketplace and demand for deposits from depositors. Unlike banks, stablecoin issuers provide no FDIC insurance protections, are not subjected to stress testing or rigorous supervision examination, and cannot rehypothecate those assets into lendable securities.
Some have countered that FDIC has a coverage cap, but the vast majority of small business and individual deposits are well under this limit. In addition, while some may like to claim current stablecoin issuers and exchanges are more secure because of a 1:1 ratio pegged to stable assets, it by no means indicates a riskless financial innovation. Popular stablecoins like USDT and USDC have experienced depegging and price fluctuation, and more importantly over 20 stablecoins have collapsed in recent years.
It’s economic ignorance to suggest that the financial model which has built our current wealth and prosperity over hundreds of years is excessively risky. We won't be better off allowing what was envisioned to be a payment instrument to serve as short- or long-term lending collateral without the regulatory parity that has safeguarded the U.S. credit markets.
Second, crypto vendors have downplayed the importance of community banks in the U.S. economy and the negative impact on them from unregulated lending by stablecoins. Coinbase CEO Brian Armstrong even went so far to claim that the risks to community banks is a “red herring.” This is despite ample empirical evidence that community financial institutions and those who disproportionately depend on them as a source of capital (i.e. small businesses and agricultural customers, will be greatly negatively affected.
Just ask the actual community banks themselves whether the risk is real. The Independent Community Bankers of America found that "community bank lending capacity is most negatively impacted if payment stablecoin holdings are permitted to earn yield, interest, or ‘rewards.” They are projecting $1.3 trillion in displaced deposits and $850 billion in reduced lending capacity unless Congress acts to close the loophole. In addition, the American Bankers Association's Community Bankers Council, representing community banks across all 50 states and territories, opposes allowing stablecoin issuers to pay interest.
Of course, any incumbent industry typically argues against the damage caused by new competition, so one should be skeptical of the banks warning signs. But the key difference here is that the incumbent is tightly regulated and the new competition is not. This is exactly why Congress needs to put into place a level playing field by closing the GENIUS Act loophole. Either that or almost completely deregulate banks to par with crypto lending, something that seems extremely unlikely of course. For better or worse, fractional reserve banking is currently how capital is created and accessed in this country. It’s safe and well-regulated while the current regime for stablecoins is not. Congress can’t lose sight of these key facts when considering the CLARITY Act.
