Stablecoins: Potential for Federal Deposit Insurance Corporation bailouts, concerns over redemption processes, and the risks of mass withdrawals
In the ever-evolving world of digital currency, stablecoins have emerged as a significant player. One of the largest stablecoins, USDC, has been under the spotlight recently, following the collapse of Silicon Valley Bank (SVB) in 2023. At the time, USDC issuer Circle held deposits worth $3.3 billion with the bank.
The incident has sparked discussions and research, with the US National Bureau of Economic Research (NBER) publishing a paper on policy decisions around redemption and timing for stablecoins. Interestingly, during the SVB collapse, all deposit holders, including Circle, were bailed out by the US Treasury. Paul Kupiec from the American Enterprise Institute (AEI) described this move as bailing out Circle and preventing the failure of the second-largest US dollar payment stablecoin.
The collapse of SVB and Signature Bank depleted the FDIC's funds, requiring banks to contribute $16.2 billion. This event underscores the importance of financial stability and the potential risks associated with stablecoins.
To address these concerns, the US Congress introduced the GENIUS Act. This legislation imposes significant regulatory requirements on stablecoin issuers, particularly concerning direct retail redemptions and financial stability risks. Stablecoin issuers are limited to insured depository institutions such as banks and credit unions or entities approved by federal or state regulators.
The Act mandates that stablecoins must be fully backed 1:1 by high-quality, low-risk assets, ensuring that stablecoin holders can redeem their coins for fiat currency at any time. This backing reduces redemption risk and protects consumers.
In terms of financial stability risks, the GENIUS Act requires stablecoin reserves to consist of high-quality assets and subjects issuers to regular audits and strict reporting obligations about reserve composition. This prudential framework is designed to mitigate risks such as runs on stablecoin redemptions, which could otherwise pose systemic risks to the financial system.
The EU, too, has shown concerns about multi-jurisdiction stablecoins. The lack of fees for cashing out in EU stablecoins could make them more prone to redemption pressure in a crisis. On the other hand, the UK is likely to require direct redemption based on a recent consultation for stablecoins, while the US GENIUS Act does not require direct retail redemptions.
Circle's de-pegging event highlighted that both USDC and Tether do not provide direct redemptions to retail stablecoin holders. However, USDC keeps a reasonable level of highly liquid assets at banks compared to Tether, which has negligible amounts. This difference could potentially impact the ease of redemption during a crisis.
Research suggests that gated redemptions are a good idea to reduce runs. The more arbitrageurs, who can be beneficial during normal times, as they help maintain a more stable price for the stablecoin, might also increase the risk of runs due to easier redemption.
In conclusion, the GENIUS Act aims to create a robust federal oversight regime that allows stablecoins to be used safely as payment tools while minimizing risks associated with direct retail redemptions and broader financial stability. It balances federal and state regulatory roles and imposes prudential standards comparable to those applied to traditional banking entities issuing payment instruments.
- In the digital currency landscape, stablecoins like USDC have gained prominence, with their significance further emphasized after the collapse of Silicon Valley Bank in 2023.
- The collapse of SVB sparked debates and research, leading to the publication of a paper by the US National Bureau of Economic Research on policies concerning stablecoins' redemption and timing.
- Stablecoin issuers, such as Circle, were bailed out by the US Treasury during the SVB collapse, raising discussions about the potential risks associated with stablecoins in the industry.
- To mitigate these risks, the US Congress introduced the GENIUS Act, imposing tough regulations on stablecoin issuers, including limiting them to insured depository institutions and mandating 1:1 backing by low-risk assets.
- The GENIUS Act also emphasizes financial stability, requiring stablecoin reserves to consist of high-quality assets and subjecting issuers to regular audits and strict reporting obligations.
- The EU and the UK have shown varying stances on stablecoins, with the former expressing concerns about redemption pressure in a crisis, while the latter might require direct retail redemptions based on recent consultations.
