What is a Stablecoin#
A stablecoin is a type of cryptocurrency that is also based on blockchain technology. The main difference between stablecoins and traditional virtual cryptocurrencies is that stablecoins are pegged to fiat currencies at a 1:1 ratio. For example, the largest stablecoin in the world, Tether (USDT), is pegged to the US dollar at a 1:1 ratio. USDT was created by Tether Limited in 2014, so stablecoins are not a new phenomenon and did not emerge only after the passage of the "Stablecoin Act." The act actually brings stablecoins, which have existed for 11 years, into a regulatory framework.
So what is the role of stablecoins? What are their main application scenarios?
The birth of stablecoins stemmed from the surge in Bitcoin trading volume in 2014, which created a demand for a stable intermediary currency in the market. This is because Bitcoin transactions are conducted directly between "wallets" and cannot be traded directly with US dollars. The trading model at that time was relatively backward, for example, requiring face-to-face transactions: the buyer would transfer Bitcoin, and only then would the seller deliver the goods; or relying on platform intermediaries: the buyer would transfer Bitcoin to the seller's wallet, and the seller would then deposit US dollars into the buyer's account. This model relied on reputable platforms and was inefficient, leading to the emergence of stablecoins as an intermediary for Bitcoin transactions.
Therefore, stablecoins are essentially "tokens" of the US dollar in the cryptocurrency market. After the introduction of stablecoins, the Bitcoin trading process became: the buyer first exchanges US dollars for Tether at a 1:1 ratio, and then uses Tether to purchase Bitcoin. Tether Limited promises a 1:1 exchange, so the seller must first exchange Bitcoin for Tether before converting it back to US dollars with Tether Limited. In short, stablecoins are blockchain-based US dollar tokens that act as a bridge currency for cryptocurrency transactions, similar to "tokens" in the cryptocurrency market. However, the problem is that the value of stablecoins entirely depends on the promises of the issuing company. Who can guarantee that these promises are reliable?
Even the United States once broke its promise in 1971 by decoupling the dollar from gold; who can ensure that issuing companies won't run away with the funds or go bankrupt? Additionally, all stablecoin issuing companies (like Tether) do not deposit the large amounts of US dollars they receive into third-party custodial accounts but instead invest them to earn returns. Before the Federal Reserve's aggressive interest rate hikes in 2022, these companies typically purchased corporate bonds to obtain high interest. However, corporate bonds carry risks, and if the bonds purchased default, stablecoin companies may be dragged down and go bankrupt. In recent years, there have been cases of stablecoin companies collapsing.
For example, in May 2022, the world's third-largest stablecoin, TerraUSD (UST), collapsed, with its value plummeting and decoupling from the US dollar, dropping from $1 to $0.10 within a week, a decline of over 90%. The price of Luna, which was traded using UST, also nearly went to zero within a week. This was the largest collapse of a stablecoin, stemming from a bank run: the Korean company Terra temporarily adjusted the liquidity of the UST pool, leading to a decrease in UST liquidity, prompting large funds to exchange UST for US dollars en masse, triggering market panic. UST was linked to Luna, and users needed to use UST to purchase Luna. During the bank run, UST holders sold Luna for US dollars, causing Luna to crash, which in turn triggered UST sell-offs, creating a death spiral. Although the issuing company claimed to hold underlying assets, no one could quickly liquidate those assets during a bank run. However, after the Federal Reserve raised interest rates in 2022, many issuing companies invested US dollars into high-yield short-term US Treasury bonds, achieving annualized returns of 5%, enjoying stable high interest (though this is based on the US fiscal predicament).
Stablecoin issuing companies essentially engage in banking activities, earning interest spreads. Compared to banks, their advantage lies in being able to attract deposits at low or no interest and then reinvest in high-yield US Treasury bonds. Even if the Federal Reserve cuts interest rates, the current annual yield on US one-month short-term bonds is still 4.3%, providing substantial interest spread profits. The high interest rates set by the Federal Reserve have allowed stablecoin companies to thrive in recent years, rapidly expanding the market size. The current market size of stablecoins is approximately $200 billion, doubling from a year ago. Therefore, countries supporting cryptocurrencies, including the United States, are calling for regulation of stablecoins, which has driven the introduction of the US "GENIUS Act."
What is the Stablecoin Act#
The act stipulates that only three types of entities are allowed to 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 have obtained state-level licenses and meet federal "substantive equivalence" standards.
In addition, the act requires all stablecoins to implement 100% reserve backing: issuers must ensure that assets are sufficient for full redemption, and the US dollars obtained from issuance can only be used to purchase highly liquid assets, such as cash, demand deposits, short-term US Treasury bonds (≤93 days), short-term repurchase agreements (≤7 days), and central bank reserves. Customer assets must be strictly segregated from operating funds, prohibited from being re-pledged, and can only be temporarily pledged for short-term liquidity purposes. Issuers must disclose the composition of reserve assets monthly and are subject to audits by registered accounting firms. Issuers with a market capitalization exceeding $50 billion must comply with stricter auditing and compliance requirements.
Stablecoin issuers are regarded as financial institutions under the "Bank Secrecy Act" and must establish anti-money laundering (AML) and sanctions compliance systems. If large technology companies engage in issuance, they must meet financial compliance, user privacy, and fair competition requirements to prevent monopolies and systemic risks. The core of the act is to strengthen regulation, but Trump strongly supports cryptocurrencies, and the act provides an entry point for large technology companies, facilitating their and Trump's powerful figures to profit through the issuance of stablecoins and earn huge profits from high-yield US Treasury bonds.
There is widespread expectation that the stablecoin market will grow dramatically during Trump's presidency. A report from Standard Chartered 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 Treasury bonds, "sufficient to absorb all new short-term Treasury bond issuance during Trump's second term." This indicates that one of the purposes of US support for stablecoins is to increase buyers of short-term bonds.
But can the issuance of stablecoins solve the $36 trillion debt crisis in the US? Analysis shows it cannot. The act stipulates that issuers can only purchase short-term Treasury bonds with maturities of 93 days or less and cannot buy long-term Treasury bonds. The reason is that issuing stablecoins is equivalent to banks attracting short-term deposits, with funds that can be redeemed at any time; if used to purchase long-term US Treasury bonds, it would lead to a mismatch of maturities similar to that of Silicon Valley Bank. Silicon Valley Bank invested customer deposits into long-term US Treasury bonds in 2020, and after the Federal Reserve raised interest rates in 2022, it faced severe unrealized losses and went bankrupt in 2023 due to a bank run. Therefore, the act cannot solve the shortage of long-term bond buyers in the US. The purchase of short-term bonds by stablecoin issuers is for high-yield returns, which actually exacerbates the US Treasury crisis. Furthermore, the issuance of stablecoins only shifts market funds to short-term bonds rather than creating new buyers (for example, Buffett's $300 billion cash is also invested in short-term bonds); the market does not lack buyers for short-term bonds, only for long-term bonds.
Trump strongly supports stablecoins because he himself has issued the USD1 stablecoin. USD1 is set to be launched 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 Treasury bonds, dollar deposits, and cash equivalents. Trump's son, Eric Trump, is a key figure. By issuing stablecoins to raise funds and reinvest in high-yield short-term bonds, it is almost a risk-free profit. The rapid advancement of the act is related to facilitating profits for powerful figures like Trump.
On May 19, the US stablecoin act passed procedural legislation in the Senate and still requires votes from both the House and Senate before being signed into law by Trump. Given that the act is favorable for financing technology giants and powerful classes, it is likely to pass easily. On May 21, Hong Kong passed the "Stablecoin Regulation Draft," which is similar to the US act but focuses more on regulation. Hong Kong often serves as a financial firewall, allowing high-risk new things to pilot, but China will not get involved until the risks of this round of financial crisis are cleared. This is because during a financial crisis, even stablecoins operating with 100% reserves still face the risk of bank runs.
Risks of Stablecoins#
The Financial Times commented that although stablecoin issuers must operate with 100% reserves, they essentially perform the functions of banks in absorbing public liquidity and promising redemption, yet lack the capital adequacy ratios, liquidity regulations, or deposit insurance constraints of traditional banks, making them more vulnerable during bank runs. Stablecoins are highly correlated with the cryptocurrency market, and if the market crashes (as in 2022), it can easily trigger bank runs due to associated coins (like Luna and UST).
Compared to 2022, current issuers have invested large amounts of US dollars into short-term US Treasury bonds, tightly linking the US Treasury market with stablecoins. Once a bank run occurs, it can easily impact the US Treasury market. A report from the Bank for International Settlements warns that a bank run on stablecoins could lead to rising US Treasury bond yields: a $3.5 billion sell-off could cause yields to rise by 6 to 8 basis points, triggering financial stability risks.
Additionally, stablecoin issuers compete with banks for deposits. A research report from Bank of America on May 27 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, particularly impacting small and medium-sized banks and lowering the overall valuation of US banks. The US banking industry has purchased a large amount of long-term bonds over the past decade and is now facing severe unrealized losses due to the Federal Reserve's interest rate hikes in recent years. Large banks can still sustain themselves (unrealized losses can disappear in a rate-cutting cycle), but if stablecoins divert depositors' funds, it could turn unrealized losses into realized losses, potentially leading to a repeat of the Silicon Valley Bank bankruptcy case.
Another issue is that before the act was introduced, the international stablecoin market grew wildly without regulation, with 100% redemption relying solely on the promises of issuers. It is questionable how many issuers currently meet regulatory requirements. The 5% high-yield profits still do not satisfy the greedy, and the actual redemption holes are unknown. While the implementation of the act is beneficial for long-term development, it may expose non-compliant issuers in the short term, bringing short-term shocks and risks to the cryptocurrency and global financial markets.
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