Stablecoins get their rulebook

The GENIUS Act became law with the president's signature on 18 July, giving payment stablecoins a federal rulebook. Its operating rules borrow directly from the Securities and Exchange Commission's Rule 2a-7, which governs institutional prime money market funds.

How the law got here

Stablecoins have been waiting for a statute since TerraUSD, an algorithmic token backed by little more than its sister coin, collapsed in May 2022 and took tens of billions of dollars of paper wealth with it. A year later USDC, one of the more conservative tokens, briefly lost its peg when its issuer, Circle, disclosed that part of its cash reserves were stuck at Silicon Valley Bank. Those two episodes supplied the case for reserve rules. Bipartisan majorities in both chambers this summer supplied the votes, and Circle's listing on the New York Stock Exchange in June showed how much investor appetite there is for a regulated issuer.

Money-fund rules for tokens

Under the act, issuers may not hold commercial paper, corporate debt or illiquid alternative assets in their reserves. The reserves must sit in FDIC-insured cash deposits and US Treasury obligations maturing within 93 days, and nothing else. The law also requires daily liquidity stress tests and real-time cryptographic proof of reserves, and it sets heavy capital penalties for mismatched durations.

The borrowing from Rule 2a-7 is deliberate. That rule was tightened after the Reserve Primary Fund broke the buck in September 2008, when losses on Lehman Brothers paper pushed its share price below a dollar and set off a run on prime money funds. The lesson drawn then was that a product promising par redemption must hold assets that can be sold at par in a hurry. Applying the same logic to tokens means a stablecoin holder should, in principle, be as safe as an investor in a government money fund.

The act also bars issuers from paying interest to holders. That is a concession to the banks, which feared that a yield-bearing token would pull deposits out of their balance sheets. It means issuers keep the income on their Treasury bills, which at current short-term rates is a very profitable business.

Narrow banks by another name

Reserve standards of money-market quality should remove the risk of a broken peg that sank the early algorithmic tokens. Compliant issuers become, in effect, federally chartered synthetic narrow banks, which should speed their use in institutional payments and corporate cash management.

The narrow-bank idea has a long history. Economists at the University of Chicago proposed full-reserve banking in the 1930s, arguing that money backed one-for-one by safe assets could not suffer a run. More recently a firm called The Narrow Bank sought a Federal Reserve master account to offer exactly that service and was refused, a dispute that went to court. The Fed's worry was that a riskless deposit alternative would drain funds from ordinary banks in a crisis. A stablecoin backed by bills and insured deposits now does much of what that firm proposed, without needing the Fed's permission.

Following the dollar

The plumbing is worth tracing. A corporate treasurer who buys tokens sends dollars from a bank account to the issuer. The issuer keeps some of that money as an insured deposit and uses the rest to buy Treasury bills maturing within 93 days, either at auction or from dealers. The treasurer's bank has lost a deposit, the Treasury has gained a lender, and the token can now move between wallets around the clock without touching the banking system until someone redeems it. Scale that up and a slice of the economy's transaction balances ends up financing the government rather than bank loans.

Who gains and who loses

The Treasury is the clearest winner. The market for dollar stablecoins is already worth more than $200 billion, and every new token issued under the act must be backed largely by short-dated government paper. Treasury Secretary Scott Bessent has argued that stablecoin growth will add to demand for bills, and the arithmetic supports him: reserves have nowhere else to go.

Banks are the likeliest losers, even with the ban on interest. Corporate treasurers who move operating cash into tokens for faster settlement are taking it out of bank deposits, which fund loans. Offshore issuers face a choice between meeting American reserve standards and losing access to American customers, which favours large domestic players such as Circle. Payment networks and card firms face a new rival for cross-border business, where settlement delays and fees are highest.

The case against

The strongest objection is that safe assets do not make a structure run-proof. In March 2020 the Treasury market itself seized up for several days as investors dumped even government bonds for cash, and the Fed had to buy on a vast scale to restore order. A stablecoin issuer facing mass redemptions in such a week would have to sell bills into a disorderly market with no deposit insurance on the tokens and no automatic access to the discount window. The rules shrink the risk of a broken peg; they do not abolish it.

There is also a question of timing. The act's main provisions take effect only after regulators write detailed rules, which will take many months, and the House has passed a separate bill on the structure of crypto markets that the Senate has yet to take up. Until both are settled, some issuers will wait before committing to the federal regime.

What to watch

The indicators are simple. The total value of dollar stablecoins shows whether the law is drawing money in. The share of Treasury bills held by issuers, disclosed in their monthly reserve reports, shows how large a buyer they are becoming. And the draft rules from the banking regulators will show how strict the stress tests and capital charges turn out in practice.

The act brings stablecoins inside the federal financial system, and as issuers grow they will probably become steady buyers of short-dated Treasuries, handing the government a new and largely automatic source of funding. Expect that demand to show up first at weekly bill auctions over the next year or two, and expect the banks to lobby hard, and soon, for a way to issue tokens of their own.