In their research, Budish and Sundam focus on an “ideal” data structure for stablecoins that is backed not only by “truly secure claims to maintain stability (i.e. central bank reserves and short-term government bonds)” but also by the rule of law. In this case, we found that blockchain technology has the potential to reduce the cost of existing transactions and enable new ones. An ideal blockchain also has the potential to significantly reduce back-office costs in the financial industry by automating and speeding up transaction settlement. And creating more competition could reduce costs.
“One interpretation of our analysis, which seems intuitively appealing, is that technologies like blockchain could be valuable for finance, just as other computational technologies have proven valuable in finance. Small efficiencies are likely to be created in the short term, but any large efficiencies, if any, will develop slowly over time,” the researchers wrote. But to reap these benefits, Budish says, the fundamental issue of trust must first be overcome.
The role of regulation
As Budish points out, there are existing structures in which we all place our trust: legal and financial systems that have developed over centuries. There is a growing movement linking it to cryptocurrencies. Booth’s Zingales says that despite the original liberal crypto vision of a government-free utopia, the death of the intermediary has been exaggerated. According to him, the cryptocurrency industry not only needs regulation to survive, but also to grow. Stablecoins are also subject to the most aggressive regulation because they are growing faster than cryptocurrencies in general in a traditional environment.
In January, President Trump issued an executive order creating a working group at the Treasury Department to propose a framework for managing digital assets. In July, he signed the bipartisan bill, the Guiding and Establishing National Innovation for U.S. Stablecoins Act, which establishes a federal framework to regulate stablecoins for use in payment systems and improve reserve transparency. The GENIUS Act includes reserve requirements aimed at ensuring that stablecoins pegged to the dollar do not lose their one-to-one relationship.
Of course, details are very important. For example, consider the idea of an interest-bearing stablecoin. Stablecoins have so far operated with little securities or banking regulation, and in guidance published in April of this year, the SEC defined “covered stablecoins” and deemed them not to be securities when offered or sold.
However, covered stablecoins cannot pay interest, according to the SEC. If a stablecoin did this, it would not meet the definition of an exempt stablecoin and would be regulated as a security. In fact, there is a relatively new yield stablecoin that trades as YLDS.
But Zingales points out that there are surprisingly similar types of financial products already on the market. “We already have a stablecoin that pays interest. It’s called a bank deposit,” he says. “Actually, there is nothing new. Stablecoins are basically a type of deposit.”
Should high-yield stablecoins be regulated like securities or bank deposits? Amanda Fisher of the advocacy group Better Markets argued for the latter, tweeting, “The fact that Congress is even debating the legislative structure of what is clearly not allowed under 21(a)(2) Glass-Steagall (formally the Banking Act of 1933, which separated commercial and investment banking) is evidence of the power of the crypto lobby.” When Robert Armstrong of the Financial Times contacted her for an article on cryptocurrencies, she pointed to research by Gary B. Gorton of Yale University and Jeffrey Y. Chan of the University of Michigan. Gorton and Chan write, “Depositors are creditors, but holders of money market fund shares are owners. Investors in money market funds experience capital gains and losses, and an investor’s ability to ‘redeem’ is merely a means by which the investor transfers ownership.”
Furthermore, if the stablecoin is something like a banking product, why not consider having it issued by a central bank? “Imagine you had a central bank digital currency, essentially a Fed-backed stablecoin, and it earned interest,” Budish said.
“Perhaps there is a version that allows for a consumer payments system that is cheaper and less frictional than the current consumer payments system,” he continues. “Cryptocurrency could be a source of competition for the traditional financial system. And if it makes the traditional financial system more efficient, less costly, and more user-friendly, that would be great.” Cryptocurrency Use Cases and Blockchains Although he expresses concerns about the sustainability of banks, he believes central bank digital currencies have the potential to have high economic value, saying they are “backed by the traditional trust of the rule of law and the reputation of central banks, and therefore do not face the challenges of scaling up the Nakamoto Trust.”
That’s exactly what the European Central Bank is doing. ECB Governing Council member Piero Cipollone told the European Parliament in April that the introduction of a digital euro could strengthen Europe’s strategic autonomy.
But U.S. regulations are moving in the opposite direction. President Trump’s executive order specifically prohibits the Fed from creating, issuing, or distributing central bank digital currencies because such CBDCs “threaten the stability of the financial system, individual privacy, and the sovereignty of the United States.” Meanwhile, despite YLDS’ registration with the SEC, the GENIUS Act prohibits stablecoin issuers from paying any form of interest or yield to stablecoin holders.
So what about systemic risk?
Regulation may help usher stablecoins out of the Wild West and onto Wall Street, but many people still have deep concerns.
The 2024 Annual Report of the Financial Stability Oversight Council, created under the Dodd-Frank Act of 2010, states that “stablecoins continue to represent a potential risk to financial stability because they are highly vulnerable in the absence of appropriate risk management standards.”
The U.S. Treasury’s Treasury Borrowing Advisory Committee is comprised of bond market leaders from BlackRock, Bridgewater, Citigroup, Goldman Sachs, Millennium, PIMCO, and other financial giants. A presentation TBAC made to Treasury officials in April highlighted issues of interest and concern, including the potential impact on bank deposits. According to the presentation, if stablecoins pay interest or provide other features that compete with banking products, “banks may need to increase interest rates to maintain funding or find alternative funding sources (i.e., to expand large-scale funding activities).”
The growth of stablecoins could also impact the market for Treasury securities. The reserve requirements set forth in the GENIUS Act may provide an additional source of increased demand for U.S. Treasuries, particularly short-term demand. The law requires stablecoin issuers to hold reserves, preferably comprised of risk-free and low-risk government assets, which is expected to increase demand for short-term government bonds and shift the yield curve.
TBAC also raised the question of whether stablecoin issuers should be able to access emergency funds in times of stress or volatility through a window where banks borrow directly from the Fed.
Barry Eichengreen of the University of California, Berkeley, wrote in the New York Times that hundreds or even thousands of companies and banks could issue their own stablecoins based on the rules set out in the GENIUS bill. “The Trump administration claims the Genius Act will lead our country into a modern future, but what they forget is that America had a similar banking system more than 150 years ago that caused chaos and financial ruin,” he wrote in June.
Zingales studies regulatory capture, crony capitalism, and the potential for competitive destruction by special interest groups such as the cryptocurrency lobby. He predicts that as regulation becomes a reality, some stablecoin issuers will eventually take on tacit government support, which could create moral hazard.
“These institutions want some form of regulation, some form of integration with traditional finance and government, because that gives them legitimacy and the ability to seek redress if necessary,” he says.
Let’s say Tether, which had a market cap of about $150 billion in July, grows 5x to 10x. People take comfort in its size and can use it to conduct all kinds of transactions, from buying groceries to business investments. But if something goes wrong, such as a depegging or ledger hack, the U.S. government may feel it has to bail out Tether, regardless of the coin’s regulatory status. As such, it provides tacit support to El Salvador-based companies that have a mixed track record of regulatory compliance and state and federal law enforcement.
“Depositors now know that these issuers are too big to fail,” Zingales said. “It is inconceivable that the Trump administration would allow stablecoins to fail and have a weakening effect on the system,” he continued. “They’re trying to save it. Systemic risk hasn’t gone away yet.”
As the industry evolves, regulators will need to create some separation between cryptocurrencies and the traditional financial system, Zingales said. “If one of the two fails, the other one will help us. What we don’t want is for the two to mix and both to go down.”
