What is a Stablecoin#
Stablecoins are a type of cryptocurrency built on blockchain technology. The core difference between stablecoins and traditional virtual cryptocurrencies is that stablecoins maintain a 1:1 peg to fiat currencies. For example, the largest stablecoin globally, Tether (USDT), is pegged to the US dollar at a 1:1 ratio. USDT was established 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 are the main functions and application scenarios of stablecoins? Their emergence was driven by the surge in Bitcoin trading volume in 2014, which created a demand for a stable intermediary currency. This is because Bitcoin transactions occur directly between "wallets" and cannot be traded directly with US dollars. The trading model at that time was relatively primitive, requiring face-to-face operations: buyers transferred Bitcoin, and sellers delivered goods; or relied on platform intermediaries, where buyers transferred Bitcoin into sellers' wallets, and sellers then deposited US dollars into buyers' accounts. This model relied on trusted platforms and was inefficient, leading to the creation of stablecoins as an intermediary for Bitcoin transactions.
Thus, stablecoins essentially act as a "token" for the US dollar in the cryptocurrency market. With stablecoins, the Bitcoin transaction process becomes: buyers first exchange US dollars for Tether at a 1:1 ratio with Tether Limited, and then use Tether to purchase Bitcoin. Tether Limited promises a 1:1 exchange, so after sellers convert Bitcoin to Tether, they can exchange Tether for US dollars with Tether Limited. In short, stablecoins are blockchain-based US dollar tokens used for cryptocurrency transactions, serving as a bridge currency, akin to "casino 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 the reliability of these promises?
Even the United States tore up its promise in 1971, decoupling the dollar from gold; who can ensure that issuing companies won't abscond with funds or go bankrupt? Furthermore, all stablecoin issuing companies (like Tether) do not hold large amounts of US dollars in third-party accounts after acquiring them, but instead invest them to earn returns. Before the Federal Reserve's aggressive interest rate hikes in 2022, these companies invested US dollars in corporate bonds for high yields. However, corporate bonds carry risks, and if bonds default, the issuing companies could be dragged down. There have been past cases of stablecoin companies facing defaults.
For example, in May 2022, the world's third-largest stablecoin, TerraUSD (UST), collapsed, with its value plummeting from a 1:1 peg to the US dollar to a decoupling, dropping from $1 to $0.10 within a week, a decline of over 90%. The price of Luna, which traded using UST, nearly went to zero. This was the largest collapse in stablecoin history, triggered by a bank run: when the Korean company Terra adjusted the UST liquidity pool, it withdrew some liquidity, leading to a decrease in UST liquidity, prompting large funds to exchange UST for US dollars on a large scale, causing market panic. Many holders joined the bank run, and since UST was linked to Luna, purchasing Luna required exchanging UST for US dollars. During the bank run, holders sold Luna for US dollars, causing Luna to crash and creating a death spiral. Although the issuing company claimed to have asset reserves, no one could quickly liquidate assets during the bank run. After the Federal Reserve raised interest rates in 2022, many companies switched to purchasing high-yield US short-term bonds with US dollars, earning 5% interest annually, but this was built on the burden of US fiscal policy.
Therefore, stablecoin issuing companies essentially engage in banking activities, earning interest spreads. Compared to banks, their advantage lies in attracting deposits at low or no interest and reinvesting in high-yield US bonds. Even if the Federal Reserve lowers interest rates, the current annual yield on US one-month short-term bonds still reaches 4.3%, providing substantial profit margins. The high interest rates set by the Federal Reserve have allowed stablecoin companies to thrive in recent years, rapidly expanding the market size to about $200 billion, doubling from a year ago. This has prompted countries supporting cryptocurrency trading, including the United States, to call for regulation of stablecoins, leading to the introduction of the "GENIUS Act" in the US.
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 "substantive equivalence" standards.
Additionally, the act requires all stablecoins to have 100% reserve backing, meaning issuers must ensure that assets are fully redeemable, 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 bills (≤93 days), short-term repurchase agreements (≤7 days), and central bank reserves. Customer assets must be segregated from operational funds, prohibited from being re-pledged, and can only be temporarily pledged for short-term liquidity. 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 face stricter audit and compliance requirements.
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 of the act is to strengthen regulation, but against the backdrop of Trump supporting cryptocurrency, it provides large tech companies and powerful figures (like Trump) with opportunities to issue stablecoins for profit and gain exorbitant profits through high-yield US bonds.
There is widespread expectation that the stablecoin market will expand 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, creating an additional $1.6 trillion demand for US short-term bonds, "sufficient to absorb all new short-term bond issuance during Trump's second term." This indicates that one of the purposes of the US supporting stablecoins is to increase the number of buyers for short-term bonds.
But can stablecoin issuance solve the US $36 trillion debt crisis? The answer is no. The act stipulates that issuers can only purchase short-term bonds with maturities of 93 days or less and cannot buy long-term bonds. This is because issuing stablecoins is similar to banks attracting short-term deposits, where funds can be redeemed at any time; if used to purchase long-term bonds, it would lead to a mismatch in maturities similar to that of Silicon Valley Bank. Silicon Valley Bank purchased long-term bonds with customer deposits in 2020, and after the Federal Reserve raised interest rates in 2022, it faced severe losses on long-term bonds, being forced to sell during a bank run, turning unrealized losses into realized losses, and ultimately going bankrupt in 2023. Therefore, the act cannot solve the shortage of long-term bond buyers for US debt.
Stablecoin issuers purchase US short-term bonds for high yields, which actually exacerbates the fiscal burden on the US and worsens the debt crisis. At the same time, the market's liquidity pool is limited; stablecoin issuance merely shifts funds to buy short-term bonds; even without stablecoins, the market (such as Buffett's $300 billion cash) already has plenty of short-term bond buyers. Trump strongly supports stablecoins because he is also involved in issuing them: in addition to personal cryptocurrencies, he has launched the USD1 stablecoin. USD1 is set to be launched in March 2025 by a DeFi platform controlled by the Trump family, pegged 1:1 to the US dollar and supported by US short-term bonds, US dollar deposits, and more. Trump's son, Eric Trump, is a key figure. By issuing stablecoins to raise funds and then buying high-yield short-term bonds, it is almost a risk-free profit. The act is being expedited to facilitate profit-making for Trump and other powerful figures.
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 its benefits for tech giants and powerful figures, the passage is likely to be smooth. 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 ventures to pilot, but China will not participate in this round of financial crisis cleanup, as stablecoins, even with 100% reserves, still carry the risk of bank runs.
Risks of Stablecoins#
The Financial Times commented that although stablecoin issuers are required to operate with 100% reserves, they essentially perform the functions of banks in absorbing 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 once the market crashes (as in 2022), stablecoins can easily face bank runs due to the collapse of associated coins (like Luna and UST).
Compared to 2022, current issuers have concentrated large amounts of US dollars to buy US short-term bonds, tightly binding the US bond market to stablecoins. Once a bank run occurs, it could impact the US bond market. A report from the Bank for International Settlements warns that a bank run on stablecoins could directly drive up US bond yields: a $3.5 billion sell-off could lead to a yield increase of 6 to 8 basis points, triggering financial stability risks.
Moreover, issuers essentially compete with banks for deposits. A May 27 research report from Bank of America 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 valuations of US banks. Over the past decade, US banks have purchased large amounts of long-term bonds, and the Federal Reserve's aggressive interest rate hikes have led to severe unrealized losses. Large banks can still withstand these losses (unrealized losses do not become realized unless there is a bank run, and interest rate cuts can eliminate them), but the diversion of depositor funds by stablecoins could increase the risk of unrealized losses turning 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, lacking regulation, and the 100% redemption was solely based on the promises of issuers. It is questionable how many existing issuers meet the standards. The 5% high-yield profits are still insufficient to satisfy greed, and the actual holes in 100% redemption are unknown. Although the implementation of the act is beneficial for long-term development, it may expose non-compliant issuers in the short term, bringing unknown shocks to the cryptocurrency and global financial markets.
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