What is a Stablecoin#
A stablecoin is a type of cryptocurrency based on blockchain technology, with the main difference from traditional virtual cryptocurrencies being its 1:1 peg to fiat currency. For example, the largest stablecoin, Tether (USDT), is pegged to the US dollar at a 1:1 ratio. USDT was established by Tether Ltd. in 2014, indicating that stablecoins are not a new concept and did not emerge only after the passage of the "Stablecoin Act." The act essentially brings stablecoins, which have existed for 11 years, into a regulatory framework.
So, what is the role of stablecoins? What are their main use cases?
The birth of stablecoins stemmed from the surge in Bitcoin trading volume in 2014, which created a demand for a stable intermediary currency. At that time, Bitcoin trading was relatively primitive, relying on face-to-face transactions or platform intermediaries, which were inefficient and required high-reputation platforms. This gave rise to stablecoins as an intermediary for Bitcoin transactions.
Thus, stablecoins are essentially "tokens" of the US dollar in the cryptocurrency market. The trading model changes to: users first exchange US dollars for Tether at a 1:1 ratio, then use Tether to purchase Bitcoin; conversely, when selling Bitcoin, they must first exchange it for Tether and then convert it back to US dollars at a 1:1 ratio. In short, stablecoins are blockchain-based US dollar tokens that act as a bridge currency for cryptocurrency transactions. However, the issue is that their value entirely depends on the issuer's promise; how can the reliability of that promise be ensured?
Even though the US broke its promise to peg the dollar to gold in 1971, who can guarantee that the issuing company won't run away with the funds or go bankrupt? All stablecoin issuers (like Tether) do not hold US dollars in third-party accounts but instead use them for investment profits. Before the Federal Reserve's aggressive interest rate hikes in 2022, these companies primarily bought corporate bonds to earn high interest, but corporate bonds carry risks. If a bond defaults, the company may go bankrupt. There have been past cases of stablecoin companies collapsing.
For example, in May 2022, the world's third-largest stablecoin, TerraUSD (UST), collapsed, with its value plummeting from $1 to $0.10 within a week, a drop of over 90%. The related Luna coin's price nearly went to zero. The UST collapse stemmed from a bank run: the South Korean company Terra temporarily withdrew UST liquidity, allowing large funds to exchange for US dollars on a large scale, triggering market panic and a run. The connection between UST and Luna coin led to increased selling pressure on Luna, creating a death spiral. Although the issuing company claimed to hold underlying assets, it could not respond promptly during the run. After 2022, many companies turned to buying high-yield US short-term bonds (with an annual interest rate of about 5%) to obtain stable returns.
Stablecoin issuers essentially engage in banking-like activities, earning interest spreads. Their advantage lies in attracting deposits at low or no interest and then reinvesting in high-yield US bonds. Even if the Federal Reserve lowers interest rates, the annual yield on US one-month short-term bonds still reaches 4.3%, creating a lucrative interest spread. The Federal Reserve's high interest rates have doubled the stablecoin market size, which is now about $200 billion. Therefore, countries supporting cryptocurrencies, including the US, are calling for strengthened regulation, leading to the "GENIUS Act."
What is the Stablecoin Act#
The act stipulates that only three types of entities can issue payment stablecoins:
- First, subsidiaries of banks or credit unions;
- Second, non-bank financial institutions approved by federal regulators (such as institutions regulated by the OCC);
- Third, state-level issuers that obtain state-level licenses and meet federal "substantially equivalent" standards.
Additionally, the act requires all stablecoins to implement 100% reserve backing: issuers must ensure that assets are sufficient for 100% redemption, and the US dollars raised can only be used to purchase highly liquid assets, such as cash, demand deposits, short-term US Treasury bills (≤93 days), short-term repurchase agreements (≤7 days), and central bank reserves. Customer assets must be strictly segregated from operational funds, and re-pledging is prohibited, only allowing temporary pledging for short-term liquidity. Issuers must disclose the composition of reserve assets monthly and undergo audits by registered accounting firms. Issuers with a market capitalization exceeding $50 billion are subject to stricter audits and compliance.
Stablecoin issuers are considered financial institutions under the Bank Secrecy Act and must establish anti-money laundering (AML) and sanctions compliance systems. If large tech companies engage in issuance, they must meet strict financial compliance, user privacy, and fair competition requirements to prevent monopolies and systemic risks.
The core provisions of the act aim to strengthen regulation. Despite the enhanced regulation, Trump strongly supports cryptocurrencies, and the act provides large tech companies with a pathway to issue stablecoins, allowing them and powerful figures like Trump to raise funds through stablecoin issuance and profit from high-yield US bonds. There is widespread expectation that the stablecoin market will grow significantly during Trump's presidency.
A report from Standard Chartered Bank predicts that by the end of 2028, the issuance of stablecoins will reach $2 trillion, leading to an additional $1.6 trillion demand for US short-term bonds, "sufficient to absorb all new short-term bond issuance for the remainder of Trump's second term." This indicates that one of the purposes of US support for stablecoins is to increase the number of short-term bond buyers.
However, can stablecoins solve the $36 trillion debt crisis in the US? The answer is no. The act stipulates that issuers can only purchase short-term bonds with a maturity of 93 days or less and cannot buy long-term bonds, as issuing stablecoins is equivalent to banks attracting short-term deposits, with funds readily available for redemption. If short-term funds are misappropriated to purchase long-term bonds, it will lead to a maturity mismatch problem similar to that of Silicon Valley Bank: Silicon Valley Bank purchased long-term bonds in 2020 and faced severe floating losses after interest rate hikes in 2022, leading to a bank run and bankruptcy in 2023.
The US stablecoin act cannot solve the shortage of long-term bond buyers. Issuers purchase short-term bonds for high-yield profits, which essentially exacerbates the US bond crisis. The market's funding pool is limited, and stablecoins only transfer some funds to purchase short-term bonds; without stablecoins, the market (such as Buffett's $300 billion cash) would have already purchased short-term bonds. Therefore, the act does not address the structural shortage of US bonds.
Trump supports stablecoins because he himself is issuing the USD1 stablecoin. USD1 is set to launch in March 2025 by a DeFi platform controlled by the Trump family, pegged to the US dollar at a 1:1 ratio, supported by US short-term bonds, dollar deposits, and cash equivalents. Trump's son, Eric Trump, is a key figure. Issuing stablecoins to raise funds and then purchasing high-yield short-term bonds is a no-cost profit. The rapid advancement of the act facilitates profit-making for powerful figures like Trump.
On May 19, the US stablecoin act passed procedural legislation in the Senate and still requires voting in both the House and Senate before being signed into law by Trump. Since the act benefits tech giants' financing and allows powerful figures to raise funds, it is relatively easy to pass. On May 21, Hong Kong passed the "Stablecoin Regulation Draft," which is similar to the US act but focuses more on regulation. Hong Kong positions itself as a financial firewall, piloting high-risk new things, while China will not engage until the risks of financial crises are cleared. Even with 100% reserves, stablecoins still carry the risk of bank runs.
Stablecoin Risks#
The Financial Times commented that although stablecoin issuers must operate with 100% reserves, they perform the functions of banks in attracting deposits and redemptions but lack the capital adequacy ratios, liquidity regulations, or deposit insurance constraints of traditional banks, making them more vulnerable during a bank run. Stablecoins are highly correlated with the cryptocurrency market, and if the market crashes (as in 2022), it can easily trigger a bank run collapse (like Luna and UST).
Compared to 2022, current issuers concentrate US dollars to purchase US short-term bonds, making the US bond market highly correlated with stablecoins. Once a bank run occurs, it can easily impact the US bond market. A report from the Bank for International Settlements warns that a stablecoin bank run could lead to $3.5 billion in US bond sales, raising yields by 6 to 8 basis points and triggering financial risks.
Moreover, issuers essentially compete with banks for deposits. A May 27 report from Bank of America Securities pointed out that the efficient payment and DeFi lending services of stablecoins could lead to $6.6 trillion in deposits flowing out of the traditional banking system, weakening their ability to attract deposits and extend credit, impacting small and medium-sized banks and lowering valuations of US banks. The US banking industry has long purchased long-term bonds and has faced severe floating losses due to interest rate hikes over the past three years. Large banks can withstand floating losses (if the Federal Reserve lowers interest rates, the floating losses disappear), but the diversion of depositor funds by stablecoins could increase the risk of floating losses turning into actual losses, repeating the bankruptcy of Silicon Valley Bank.
Before the act was introduced, the international stablecoin market grew wildly, with 100% redemption relying solely on the issuer's promise and a lack of regulation. The 5% high-interest profits still do not satisfy greedy appetites, and the redemption holes are unknown. Although the act's implementation is beneficial for long-term development, it may expose issues with non-compliant issuers in the short term, bringing shock risks to the cryptocurrency and global financial markets.
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