Today’s essay was written by my bank nerd friend, Todd Phillips. Todd is an Assistant Professor at Georgia State University’s Robinson College of Business and a former attorney for the Federal Deposit Insurance Corporation.
As debate continues about whether stablecoins are deposits (they aren’t) and whether stablecoin issuers are banks (more debatable), it is worth asking whether other facets of the bank regulatory regime that are excluded from the Senate’s GENIUS Act are nonetheless necessary to ensure the protection of stablecoin holders and the financial system.
One aspect that has not received nearly enough attention is the bankruptcy process. I want to highlight two significant problems.
The first problem is that, despite efforts to ensure that stablecoin holders are made as whole as possible, the ambiguity of the legal structure of stablecoins means that some token holders cannot receive anything in bankruptcy.
Legally, bank deposits are debts. When I deposit $100 in my bank, I have lent that money to the bank, which may do whatever it wants with those funds (subject to prudential regulatory requirements that ensure the safety and soundness of the institution). And, under the normal bankruptcy rules, I would become an unsecured creditor of my bank if it failed, last in line for repayment in bankruptcy (this has been changed by the Federal Deposit Insurance Act for insured depository institutions and national banks, discussed further below).
But stablecoins are not deposits. Indeed, the definition of the term “payment stablecoin” in the GENIUS Act explicitly provides that a stablecoin “is not a deposit (as defined in section 3 of the FDI Act), including a deposit recorded using distributed ledger technology.”
What are stablecoins, then?
The GENIUS Act doesn’t say. But they are very likely to be any of three different frameworks: Demand notes, receipts for money held for the benefit of stablecoin holders in bailment or trust, and commodities that issuers have pledged to repurchase.
If stablecoins are notes or receipts, holders will have a legal right to the reserve assets backing their tokens. Receipt holders would be the legal owners of the reserve assets, meaning those assets would be exempt from the bankrupt estate. Note holders would be unsecured creditors last in the priority waterfall, though the GENIUS Act contains a provision providing that a “claim of a person holding a payment stablecoin issued by the debtor shall have first priority over any other claim.”
But if stablecoins are issued as commodities to be repurchased, then they are simply products, and some holders are not necessarily owed anything in bankruptcy. Today, some of the largest stablecoin issuers — like Paxos and Tether — allow their coins to be redeemed for fiat currency only by specific individuals or in sufficiently large volumes. While individuals meeting an issuer’s redemption requirements have what is effectively repurchase agreement with token issuers, others have no legal claim on the reserve assets and will not be protected by the GENIUS Act’s insolvency provisions. These users can sell their tokens to those who can have legal claims, of course, but this would likely happen only with haircuts as private-sector actors arbitrage the language of the legislation.
In short, the GENIUS Act allows the creation of stablecoins for which it is practically impossible for some token holders to receive repayment at par in bankruptcy, even if there are sufficient reserve assets available.
The second and more pernicious problem with the GENIUS Act is that it does nothing to encourage stablecoin issuers to be placed into bankruptcy before they become insolvent.
One principal role of bank regulators is to place banks into receivership before they become insolvent. Beginning the process before insolvency allows all depositors — both insured and uninsured — to be made fully whole. That said, if regulators do not act quickly enough and a failing bank’s liabilities exceed its assets, the FDIC’s pre-funded Deposit Insurance Fund allows the FDIC to conduct the receivership process, and the FDI Act allows the FDIC to recover administrative costs before creditors.
Although the GENIUS Act provides that stablecoin issuers are not banks (the bill allows banks to issue stablecoins through wholly owned subsidiaries), the logic of the banking laws applies — regulators must be able to place issuers into receivership and begin the bankruptcy process before that capital is depleted, or otherwise pre-fund the bankruptcy process.
Unfortunately, the bill lacks any such provisions. For stablecoin issuers that are bank subsidiaries, federal banking regulators may place entire banks into conservatorship in order to begin the bankruptcy process for the stablecoin-issuing subsidiaries, but this is certainly overkill. For nonbank stablecoin issuers, that responsibility is left to state regulators, and only to the extent permissible under each state’s individual laws. Not even the Office of the Comptroller of the Currency has this authority for the nonbank stablecoin issuers it regulates.
To be clear, the GENIUS Act does not allow federal stablecoin regulators to engage in one of the most fundamental regulatory activities necessary to protect stablecoin holders and the financial system.
This lack of authority is even more problematic given that, as Adam Levitin has explained, the GENIUS Act is written in such a way that no trustee in their right mind would sign on to facilitate an insolvent stablecoin issuer’s bankruptcy. The provision requiring stablecoin holders’ claims “shall have priority over … any other creditor” means that, if a stablecoin issuer is insolvent, there will be no funds available for the trustees who perform the bankruptcies. Compare this with the FDI Act’s provision giving the FDIC’s expenses first priority claims, with depositors coming in second. Effectively, the GENIUS Act presupposes that stablecoin issuers will place themselves into bankruptcy before they become insolvent. Like that’s going to happen.
One way to get around this problem is to impose bonding requirements on stablecoin issuers, which is a common requirement in state money transmitter laws and which the FDIC may impose on foreign banks. These funds would be set to pay for trustees that will see bankruptcies through to the end. The GENIUS Act doesn’t include such a provision, but it does allow regulators to impose capital requirements on issuers. Will this provision allow regulators to require issuers to post bond? Maybe, but I’m not hopeful.
The GENIUS Act attempts to impose a regulatory structure on stablecoin issuers that ensures, to the greatest extent possible, that stablecoin holders will be protected before bankruptcy and after. Unfortunately, its permissiveness on what is a stablecoin and its insolvency provisions undermine its efforts.
