Crypto wants to bring you down with it

The Trump administration is speedrunning government bailouts for the crypto industry.

In July, Congress passed and the president signed the Genius Act, an inaptly named piece of legislation whose main purpose is to give “regulatory clarity” to the crypto industry and, in particular, stablecoin issuers. Stablecoins are a type of cryptocurrency whose value is pegged to the dollar, i.e., one stablecoin is always supposed to be worth one dollar. The Genius Act gives the imprimatur of regulatory approval through creating what amounts to special bank charters for stablecoin issuers, allowing them to take deposits from consumers and embed stablecoins—and crypto—more deeply into the real economy with the explicit blessing of the federal government.

But there’s a big problem with stablecoins that traditional finance has dealt with for millennia: bank runs. By taking a dollar and issuing an asset (the stablecoin) that holds with it a promise for exactly one dollar back, the stablecoin issuer has effectively issued an IOU to the customer that may be redeemed at any moment. If too many customers demand their money back at the same time, and the stablecoin issuer can’t meet those demands because it lent the money elsewhere, then a run will occur on the stablecoin issuer, just like a run on a bank. The Genius Act makes a weak attempt at obviating this problem by forcing stablecoin issuers to hold reserves—in the form of U.S. Treasuries—such that they can avoid potential runs and depositor losses.

More specifically, the Genius Act lets stablecoin issuers meet reserve requirements through purchasing short-dated Treasuries known as bills (among other similar instruments). Because it’s extremely unlikely the government is going to default or inflation will explode in the next 90 days, these Treasuries tend to have very low volatility and are thus good instruments for protecting the deposits. But the Genius Act requires disclosure of reserves only once a month, allowing for stablecoin issuers to chase higher returns between reporting periods at the expense of being underfunded.

As economic historian Berry Eichengreen noted, the risk this presents is that if a stablecoin issuer does not have the reserves to back up its outstanding deposits (or if the market simply believes it might not have the reserves), a run on the stablecoin could occur. This would force the stablecoin issuer to sell its short-dated Treasuries to help raise capital. If the stablecoin issuer were large enough, this selling pressure could cause a collapse in Treasury bill prices, also bringing down other stablecoin issuers.

The contagion would then spread outward from crypto into the real economy, as Treasury bills are the main grease in the wheels of the financial system. A sudden devaluation would bring into question the credit and solvency of not only other financial institutions such as banks but also firms and other foreign governments holding Treasury bills.

Bank runs and the corresponding contagion are generally avoided in the banking system through deposit insurance that is provided by the federal government. In the event of a bank failure, the government guarantees every cent of an individual’s deposits up to $250,000. The Genius Act notably does not provide deposit insurance for stablecoin customers. But if choosing between saving irresponsible stablecoin issuers and a potentially catastrophic financial crisis resulting from a crash in Treasury bill prices, a government could be forgiven for doing a bailout or two.

What makes these risks to taxpayers and the financial system truly unacceptable is that outside of gambling and crime crypto usage is extremely limited. For example, the dominant use of stablecoins to date—accounting for more than 90% of all usage by one estimate by the consulting firm BCG--is to effectively serve as poker chips that need to be purchased to play in the crypto casino. That is, people who want to buy, for example, dogecoin, likely wouldn’t exchange cash directly for the coin. Instead, they would first buy a stablecoin, and then trade the stablecoin for dogecoin. Cashing out of crypto works similarly, but in reverse. To a much smaller extent (less than 6%, according to BCG), stablecoins are used as dollar exposure for firms and consumers in countries with volatile currencies.

In this sense, the Genius Act represents a culmination of everything the crypto industry has been working on over the past five years: Ignoring the fact that the underlying product is largely useless for legitimate purposes, and putting a floor on the price of crypto through forcing the government to bail it out if things go sideways. In in the late 2010s, a wave of mania around “blockchain technology” began to take hold. Firms and governments all over the world were performing constant “experimentation” with blockchain for fear of looking like luddites. But because of the clunky nature of the technology (which is ill-suited for any use in which you need know the identity of another party, which is most things), the actual technology underlying cryptocurrencies was never actually deployed en masse.

Stuck with the realization that the actual product itself wasn’t a winner, the crypto industry decided its best bet to keep the hype cycle (and correspondingly high prices) going was to aggressively lobby Congress and the White House to remove guardrails for consumers participating in the frenzy and help stablecoins get a special bank charter, forcing the government’s hand in the event of a meltdown. Or more simply: embed crypto so deeply into the financial and economic system that violating “number go up” doesn’t just hurt crypto, it hurts everyone in America.

Though the crypto industry’s move to put everyone else in harm’s way to protect its profits is egregiously cynical, as is Congress’s and the president’s complicity, one does have to admit that in its own way, there is something genius about it.

Ryan Cummings is chief of staff at the Stanford Institute for Economic Policy Research.

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