As Washington lawmakers seek to hash out a legal framework for stablecoins, financial policy experts question whether the technology will harm or benefit the biggest bond market in the world.
It is broadly agreed that Treasury notes, bills and bonds will — and should — play a central role as reserve assets for stablecoins that seek to peg themselves to the value of the U.S. dollar. But whether the benefits of a broader pool of U.S. debt investors outweigh the risks of opening a new front for vulnerabilities is up for debate.
Sen. Bill Hagerty, R-Tenn., the lead sponsor of the Guiding and Establishing National Innovation for U.S. Stablecoins Act, or GENIUS Act, has said the
“The United States can and should be a leader in payment stablecoins,” Hagerty said during a Senate Banking subcommittee hearing last week. “They improve transaction efficiency, expand financial inclusion and strengthen the dollar status as a world reserve currency, all while driving demand for U.S. Treasuries.”
But others say that while an increase in demand for Treasuries is welcome in normal times, as it drives down U.S. borrowing costs and adds liquidity to the market, it could be problematic during periods of stress.
In a
“The creation of major new demands for Treasury bills and Treasury-backed repos and reverse repos by stablecoin issuers could cause dangerous shortages of available Treasury bills, particularly during periods of financial stress,” Wilmarth wrote. “Those shortages could trigger serious disruptions and liquidity crises such as the repo market crisis in September 2019 and the ‘dash for cash’ that occurred in global financial markets in March 2020, following the outbreak of the COVID-19 pandemic.”
The risks and rewards for the Treasury market may not be mutually exclusive, but how lawmakers weigh the two and craft legislation accordingly could have profound impacts for stablecoins and the financial system more broadly, said Jess Cheng, a partner for the law firm Wilson Sonsini and a former Federal Reserve lawyer.
“The guardrails, the rules, the boundaries around the reserve assets will be critical,” Cheng said. “It’s going to be critical to the market acceptance and uptake of stablecoins, but also, more broadly, it would have sweeping impacts on the financial sector, including potentially on the Treasury market.”
Along with Hagerty’s bill, Reps. French Hill, R-Ark., and Brian Stiel, R-Wis., introduced similar legislation in the House last month, dubbed the Stablecoin Transparency and Accountability for a Better Ledger Economy, or STABLE, Act. Both bills would require that stablecoins be matched at least one-to-one with a limited variety of high-quality assets, including Treasuries and related short-term repurchase agreements.
Both bills would allow for other holdings, such as physical currency, deposits at insured depositories or — if the issuer is a Federal Reserve member bank — reserves at the Fed. But the understanding is that most reserves would be Treasuries or related instruments. Recognizing this reality and its potential for creating new risks throughout the financial system, the bills broadly prohibit stablecoin issuers from using their reserve Treasury holdings as collateral for other borrowings — a practice known as rehypothecation.
Bill Nelson, executive vice president and chief economist at the Bank Policy Institute, said these types of strict limitations around reserve assets are critical for mitigating risks in the burgeoning stablecoin market. This is especially important, he said, given the fact that nonbank issuers will lack the backstops available to banks.
“When someone tells you they’re going to be creating money-like assets for you to hold and then backing it with stuff you can’t really see transparently and, moreover, they’re not going to be holding capital or have access to deposit insurance or a lender of last resort, that’s a financial stability risk almost always,” Nelson said.
The renewed push for
Meanwhile, prominent financial authorities — including Fed Chair Jerome Powell and former Vice Chair for Supervision Michael Barr — have flagged
Stablecoin skeptics, however, question how well suited the technology is for addressing the issues in the Treasury market. Nelson said stablecoins l will only benefit Treasuries to the extent that they generate net new demand for government debt instruments, rather than simply shifting existing demand from established holders to these new entrants.
“It depends upon what all those other participants in the financial system do with those stablecoins,” Nelson said. “If they are replacing their holdings of Treasuries, that’s not going to help. If they are replacing their holdings of currency, that’s not going to help. If it’s replacing their holdings of government-only money market mutual funds, that’s not going to help. You need to look at least one step — and preferably, a couple steps — deeper than, ‘There will be stablecoins backed by Treasuries, so the demand for Treasuries will be higher.'”
Nelson, a former deputy director of monetary affairs at the Federal Reserve Board, added that to the extent that stablecoin use drives down bank deposits and cash — both of which show up as liabilities on the Fed’s balance sheet — it could cause the central bank to hold fewer Treasuries, thus shrinking its annual remittance payments to the federal government.
But stablecoin proponents believe the assets will generate new pockets of demand. Jennifer Schulp, director of financial regulations studies at the Cato Institute, sees opportunities for the technology to enhance peer-to-peer payments and filter into other financial products in non-consumer-facing ways. The biggest growth, she said, will likely come from outside the U.S. to facilitate cross-border payments or simply provide a stable store of value not available in some domestic banking markets.
“The Hagerty view that this will lead to increased demand in the market, is one that makes sense, but not necessarily because domestic demand will shift,” Schulp said. “We’ll see some changes in terms of the way people are using money, but there’s more of an opening internationally for increased Treasury demand as this opens more doors for access to the dollar across the world.”
Fed Gov. Christopher Waller, who oversees payments activity for the Board of Governors, has similarly said that the advent of stablecoins could reaffirm the dollar’s global primacy.
“One of the things I’ve always argued with stablecoins is to say that they will broaden the reach of the dollar across the globe,” Waller said during a speaking engagement last month. “They’re going to make it even more of a reserve currency than it is now.”
Some policymakers see those close ties between the dollar and stablecoins as an additional imperative to get the regulatory framework right. In
“They basically borrow the trust that you all have in the central bank,” Barr said at an event at Yale University. “And because of that, it’s really important to us, as the central bank, that they be regulated appropriately, they have strong prudential regulation … over the structure of the market, over the issuers, over the wallets, over the way in which the stablecoin purports to be pegged to the dollar — what collateral is actually backing that?”
Barr did not endorse any specific policies or proposals, but echoed other Fed officials in supporting the advancement of any federal regulatory framework for stablecoins.
Schulp noted that both the GENIUS Act and the STABLE Act would give the Fed less authority over stablecoin activity than the leading stablecoin bill from the last Congress, which was sponsored by then-Rep. Patrick McHenry, R-N.C., and Rep. Maxine Waters, D-Calif. Schulp said the new bills still give the Fed more control over the market than she would like, but they are a step in a better direction.
Contrary to some policy analysts who see stablecoins as a bank-like activity that should be subject to banking oversight, Schulp argues that stablecoins are fundamentally less risky than traditional banking activities and should therefore not be weighed down by heavy government oversight.
“What we’re looking at here are fully-backed tokens,” she said. “We’re not looking at fractional reserve banking, so we shouldn’t be designing regulation that looks like fractional reserve banking regulation over fully-backed tokens. We’re just dealing with different issues here.”
Other academics and policy experts have less trust in the stability of stablecoin. In his paper, Wilmarth notes that more than 20 stablecoins failed between 2016 and 2022, and all the top stablecoins lost the peg to their target currency at some point between 2019 and 2023.
In light of these risks, some have urged lawmakers to give stablecoin regulators sharper tools.
Massad also criticized the proposals for being too vague, particularly with respect to capital requirements, which, according to the legislation, “may not exceed what is sufficient to ensure the … [issuer’s] ongoing operations.” In the wake of last year’s Supreme Court ruling on Loper Bright v. Raimondo — which determined that courts, not agencies, get to interpret unclear statutes — Massad said such language would make it easy for regulated issuers to successfully challenge their capital requirements.
“Instead of explicitly constraining authority, and providing language that enhances the ability of rejected applicants or disgruntled issuers to challenge regulators, the legislation should explicitly provide sufficient authority and discretion for regulators to respond to whatever risks and circumstances arise,” he said. “To be clear, the Loper Bright decision invites Congress to delegate authority; it does not prohibit it. If ever there were a case where that is needed, where we do not want courts making judgments about complex, technical issues — such as whether capital and liquidity requirements are ‘in excess’ — it is here.”
Cheng said the de-emphasis of safety and soundness is a product of the current environment. Where the McHenry-Waters bill was, in part, a response to emerging risks and volatilities in the stablecoin sector, the STABLE and GENIUS proposals have arisen in a pro-growth moment.
But, Cheng said, such proactive regulatory legislation is not without tradeoffs for some market participants.
“When we’re thinking about legislation that serves to enable something new and be a driver for innovation in the financial sector, that’s a bit of a different calculus from legislation that’s passed in response to a failure, like the global financial crisis,” she said. “This type of legislation can open up new markets and enable new offerings, but at the same time, we are not working off a blank slate here. There will be winners and losers across the payments and banking industries.”