Stablecoins: Potential for FDIC-backed rescues, withdrawal issues, and the possibility of financial panics
In the ever-evolving world of digital currencies, the role of stablecoins has become increasingly significant. These digital assets, designed to maintain a stable value, are subject to rigorous regulation in the United States, thanks to the recently enacted GENIUS Act.
The GENIUS Act, which stands for the "Stablecoin Transparency Act of 2021," mandates that stablecoin issuers in the United States maintain strict reserve backing and redemption policies. This means that stablecoins must be backed 1:1 by U.S. dollars or short-term Treasuries, and issuers must demonstrate operational soundness, including the ability to redeem coins at par for U.S. dollars.
The Act introduces clear redemption and operational requirements to enhance investor confidence and reduce run risks by ensuring transparent reserves and monthly disclosures. Additionally, issuers must retain technical capacity to freeze or burn coins if legally required, allowing authorities to intervene during extreme market distress to limit systemic risks.
The Act primarily governs fiat-backed stablecoins, aiming to lower run risks during crises by ensuring direct, reliable redemptions at par and maintaining full reserve transparency. Algorithmic and crypto-collateralized stablecoins, however, remain unregulated under this law and inherently face greater instability and redemption uncertainty.
The implications of stablecoin design on run risks are intricate. Fiat-backed stablecoins, being fully collateralized and redeemable directly at par for dollars, are considered to have the lowest run risk. In contrast, algorithmic and crypto-collateralized stablecoins, which rely on volatile assets, make redemption at stable value uncertain during stress.
The collapse of SVB and Signature Bank depleted the FDIC's funds, resulting in banks having to contribute $16.2 billion. This incident underscores the importance of stablecoin regulation, as easier redemption options increase the risk of runs, as shown in the case of EU stablecoins with no fees for cashing out.
The GENIUS Act aims to align stablecoins more closely with traditional payment and settlement mechanisms to enhance financial system stability. However, the debate surrounding stablecoins continues, with concerns about what happens if something goes wrong with a stablecoin.
In Europe, there is controversy regarding stablecoins issued in both the EU and elsewhere, as retail holders could not directly redeem in the United States but could in Europe, potentially depleting more of the European reserves than those in the US.
The findings from a May research paper by the US National Bureau of Economic Research (NBER) explored policy decisions around redemption and timing for stablecoins, highlighting a key trade-off between price stability and financial stability. Gated redemptions, as proposed in the UK, are suggested to reduce runs.
As the world of stablecoins continues to evolve, so too does the need for comprehensive regulation. The GENIUS Act is a significant step towards ensuring the stability and reliability of this growing sector, providing a framework that aligns stablecoins more closely with traditional financial systems.
[1] Source: Congressional Research Service [2] Source: Federal Reserve Bank of St. Louis [3] Source: CoinDesk
- In the world of digital currencies, the role of stablecoins, designed to maintain stability, has grown increasingly significant, particularly in light of the GENIUS Act.
- The GENIUS Act, or the "Stablecoin Transparency Act of 2021," mandates that stablecoin issuers in the United States maintain a 1:1 reserve backing and clear redemption policies.
- The Act aims to enhance investor confidence and reduce run risks by ensuring transparent reserves and monthly disclosures, while requiring issuers to retain the technical capacity to freeze or burn coins if necessary.
- Algorithmic and crypto-collateralized stablecoins, however, remain unregulated under the GENIUS Act, and their inherent instability and redemption uncertainty contrast with the lower run risk associated with fiat-backed stablecoins.
- The implications of stablecoin design on run risks are complex, as the collapse of SVB and Signature Bank demonstrated in the case of EU stablecoins with no fees for cashing out.
- As the stablecoin industry evolves, comprehensive regulation, such as the GENIUS Act, becomes crucial to ensure the stability and reliability of this growing sector, aligning it more closely with traditional financial systems.
