Senate stablecoin bill is deeply flawed

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Last month, Sens. Bill Hagerty, R-Tenn.; Tim Scott, R-S.C.; Cynthia Lummis, R-Wyo.; and Kirsten Gillibrand, D-N.Y., introduced a bill called the "GENIUS Act," which would establish a new regulatory framework for stablecoins. Contrary to its lofty title, the legislation, known as the Hagerty bill, would create a dangerously weak regulatory regime for stablecoins. That deeply flawed regime would pose grave and unacceptable dangers to consumers, investors, our financial system and our economy.

The Hagerty bill would allow stablecoins, which are volatile deposit-like instruments, to be offered to the public without the essential protections provided by federal deposit insurance and other regulatory safeguards governing banks that are insured by the Federal Deposit Insurance Corp. By placing the federal government's imprimatur on poorly regulated and unstable stablecoins, the Hagerty bill would greatly increase the probability that future runs on stablecoins would trigger systemic crises requiring costly federal bailouts to avoid devastating injuries to our financial system and economy.

A stablecoin is a crypto asset whose issuer represents that the stablecoin will maintain parity with a designated fiat currency or another referenced asset or group of assets. Most global stablecoins are linked to the U.S. dollar. Dollar-linked stablecoins, such as Circle's USD Coin, or USDC, are functionally equivalent to bank deposits. The issuers of dollar-linked stablecoins promise to redeem their coins or transfer them to third parties, on a dollar-for-dollar basis, upon the holder's demand or within a specified time period.

Despite the promises made by stablecoin issuers, stablecoins have proven to be anything but stable. More than 20 stablecoins collapsed between 2016 and 2022. Every one of the world's leading stablecoins lost its "peg" to the U.S. dollar (or other designated reference asset) on multiple occasions between 2019 and 2023.

Recent stablecoin runs resemble the runs that have occurred on uninsured deposits, money market mutual funds and other uninsured short-term financial claims during U.S. financial crises stretching from the nineteenth century through 2023. The federal government incurred huge costs in rescuing uninsured depositors during financial crises that occurred in 1980-92, 2007-09 and 2023. The federal government also provided blanket guarantees and emergency loans to protect investors in money market mutual funds and other uninsured short-term financial instruments during 2008 and 2020.

Those financial crises demonstrate that uninsured deposits and other uninsured short-term financial claims are highly vulnerable to systemic runs whenever there are serious doubts about the obligors' ability to repay those claims in a timely manner. The Hagerty bill ignores the painful lessons of those crises because it fails to establish a strong and effective regulatory regime for stablecoins, and it also fails to provide a credible federally supervised fund to ensure their timely repayment.

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In addition, the Hagerty bill would allow nonbank issuers of stablecoins to pay interest on their stablecoins and compete for short-term funding with FDIC-insured banks. The Hagerty bill's severely deficient regulatory regime would permit nonbank stablecoin issuers to offer short-term financial instruments that mimic deposits with substantially lower compliance costs, compared to FDIC-insured banks. Consequently, nonbank stablecoin issuers could offer substantially higher interest rates on their stablecoins and would probably attract large amounts of deposits currently held by FDIC-insured banks.

Siphoning deposits from FDIC-insured banks into nonbank stablecoin issuers would significantly impair the ability of those banks to provide loans to consumers and Main Street businesses that cannot obtain credit from the capital markets on reasonable terms. Congress should reject the Hagerty bill because it would undermine our banking system and severely weaken the performance of our economy by disrupting the flow of much-needed credit from FDIC-insured banks to consumers and Main Street businesses.

Moreover, the Hagerty bill would enable Big Tech firms and other commercial enterprises to acquire nonbank stablecoin issuers and use stablecoins as "shadow deposits" to enter the banking business and build dominant financial empires. Big Tech firms would then have access to detailed information about their customers' financial assets and transactions. That access would greatly increase the ability of Big Tech firms to leverage and monetize their customers' private personal information.

Congress should reject the Hagerty bill. Congress should instead pass legislation requiring all issuers and distributors of stablecoins to be FDIC-insured banks. That legislation would keep Big Tech firms out of banking and would maintain our nation's wise and longstanding policy of separating banking and commerce.

Requiring all stablecoin issuers and distributors to be FDIC-insured banks would also ensure that stablecoins, like other banking services, are provided in a safe, well-regulated manner that protects the welfare of consumers and investors, the stability of our financial system and the successful performance of our economy. To modernize our payments system, Congress should encourage tokenization (digital representation) of deposits by FDIC-insured banks, and Congress should support full implementation of FedNow's instant payment and settlement services for FDIC-insured banks and their customers.

The Hagerty bill has many other glaring defects, which are described in my recently published policy brief. Those shortcomings provide additional compelling reasons for Congress to reject it and approve legislation requiring all stablecoin providers to be FDIC-insured banks.