The GENIUS Act, Reading Between The Lines

All of the crypto-sphere is atwitter with the implications of the final passage of the “Guiding and Establishing National Innovation for U.S. Stablecoins Act’’ or the ‘‘GENIUS Act’’. I went through the text of the act that was signed into law last week. Contrary to what the boosters of the bill believe, the implications for related digital assets and the economy are very mixed at best.

As the first legislation to directly address one form of crypto-assets, the act is seminal. Of course, my own compatriots at the various blockchain companies and organizations are ecstatic over the act. It is best to temper your enthusiasm due to the details in the bill.

First, the act focuses on payment stablecoins, and for other purposes. “For other purposes” could cover an unspecified number of purposes. The constitution of the Stablecoin Review Board and research into non-payment Stablecoins (the bulk of currently issued Stablecoin total value), into interoperability, into novel methods for detecting Anti-Money Laundering violations, and into the effects of foreign issued Stablecoins could be some of these “other purposes.”

Definitions Continued

This act clarifies the definition of a Digital Asset Service Provider. The definition explicitly excludes wallet providers, blockchain protocol vendors, DeFi protocols etc. The removal of confusion that surrounded earlier enforcement actions which made all such activities suspect is a huge relief for such actors. Whew! Exchanges are still in purview.

Payment stablecoins must obey the law. Freezing, burning, seizure and blocking transfer must be enforceable by a “lawful order”. These cannot be implemented by ERC-20 based stablecoins. This is of course anathema to the free souls of the decentralized universe. This is in the act, any non-compliance with a lawful order results in huge daily fines and imprisonment. Also to folks that say, technology does not matter, business use cases over technology seem unaware of the fact that basic capabilities baked into the technical underpinnings are needed BEFORE any business use cases can come to fruition. Look at what the ERC-20 standard and free implementations unleashed on the world.

Payment stablecoin issuers have to be regulated by either a Federal Agency, primarily the OCC or other regulators on the Federal level. There is another tier for State Level Payment Stablecoins which are meant to be regulated by state regulators. The state level issuers limit is $10B and federal issuers are limited to $50B. There are some provisions in the bill for the migration of State Regulated stablecoin issuers to federally regulated issuers.

Other details including breaches of these limits are punted to a Stablecoin Review Board, making for an open-ended set of rules. The act constantly invokes the Review Board and the Treasury Secretary who is the leader of the Stablecoin Review Board giving them tremendous leeway for rule setting.

Neither USDT nor USDC qualify as US payment stablecoins yet according to this act. USDT because Tether is based offshore, USDC does not have a bank charter yet. However, a safe harbor provision may get Circle off the hook while their charter is pending. As soon as USDC is approved by the OCC, they will be instantly not in compliance to the act, as USDC is more than $50 Billion in issuance. As we can see, current stablecoins are not usually used for payments.

Where Are Payment Stablecoins?

Payment stablecoins means a digital asset that is designed to be used as a means of payment or settlement; and the issuer is obligated to convert, redeem, or repurchase for a fixed amount of monetary value. It also represents that the issuer will maintain, or create the reasonable expectation that it will maintain a stable value. In other words, the payment stablecoin has to be used for payment and has to be stable with respect to a currency. Such a stablecoin is NOT a fiat currency, nor a bank deposit, nor a tokenized stablecoin of a bank deposit such as JP Morgan’s Kinexsys.

It is not clear that the current use of USDT and USDC falls within the term “payment stablecoins”. Such payment uses cannot be distinguished from their most frequent use, to hold stable USD instead of volatile home currencies or to use as a stable parking place and an anchor in swap based AMMs and other daily arbitrage trading of volatile crypto-currencies. Stable USD may be a misnomer as USD has fallen in value in the last few months against a basket of currencies.

Stability Of Stablecoins

Any stablecoin whose basic function is stability with respect to a single fiat currency can only be assured by holding liquid reserves denominated in that fiat. For USD based stablecoins the act explicitly enjoins this to be cash, treasuries maturing in 93 days or less and repos as well as reverse repos based on these instruments. The act also warns against concentration risk. Significant portions of these reserves cannot be in one single institution. We have already seen this scenario play out during the collapse of SVB, which custodied more than $3B of Circle’s assets. Only a last minute expansion by the FDIC of the limit to “unlimited” saved Circle and many other startups.

A Stablecoin functions as one of the representations of fiat money that it is based on. In the United States that would be the United Stated Dollar. The other forms available to retail participants are bank deposits and bank notes. Par price, that is the price between the different representations ties all these forms into the singleness of money. Par is 1:1, that is one dollar of bank deposits is equal to one dollar of currency. Stablecoins must follow this. Professor Mehrling has discussed this in a money view of stablecoins. There is no discussion of par in the act.

A Run On Stablecoins

The reserves which are a touch point between stablecoins and traditional markets is where the risk of contagion can start. The restricted redemption of Money Market Funds by BNP Paribas (my previous employer) in 2007 foreshadowed the 2008 financial crisis. A run on a stablecoin issuer could initiate a rapid sell-off in the reserves, including short duration treasury bills. A negative feedback loop on this sort of act can cascade into multiple assets as treasuries are the basis of fixed income and credit markets. We have seen that only bazookas with tremendous firepower through the buying backstop of an institution like the Fed can stem this blood-letting. These are reasonable scenarios to assess the risk of any stablecoin issuer. Additionally stablecoins are not protected by the FDIC, which can cause the panic to spread through retail investors in a very short period of time, maybe even minutes. The Fed will have to ride to the rescue to prevent the larger financial system from collapsing.

How Do Issuers Make Money?

No big issuers of Stablecoins currently pay interest. Most of the money made by the issuers is based on the yield difference between issuing a zero interest stablecoin and the reserves that they hold. This is the classic example of other people’s money making money for your enterprise. In the case of Tether, this payout is in the billions and makes the most money per employee of any enterprise, except for shadowy enterprises such as drug dealing or other illicit activities. If we had negative interest rates on Treasuries or other qualified digital assets, this source of yield farming by the issuers will dry up. Issuers will have to increase their fees, they might also slide into loss-making enterprises.

The 48 pages of the act deals with the seniority of Stablecoin claims, guidelines on custody, commingling of assets and other ideas from traditional finance.

The Genius Of The Act

It is to convince the crypto-universe that it is beneficial to them while advancing traditional institutions for issuing, custodying and exchanging stablecoins. Traditional banking or non-banking institutions who already have bank charters, scale and know-how for customer on-boarding, AML and KYC are the winners. It is to allow a form of private money to come into being and shut out the issuance of CBDCs. It is to remain relatively mum on par price which is only implied. It is to convince the world that the velocity of money unleashed by the near instant settlement at low cost will not have monetary policy implications.