GENIUS Act Banned Stablecoin Yields, but Banks Still Lose to Competition

The GENIUS Act includes an important rule that prohibits stablecoin issuers from paying interest directly to holders. Although this provision was likely intended to protect banks from loss of deposits, it unintentionally created a highly profitable regulatory loophole.

This regulation opens up business opportunities for crypto exchanges and fintech distributors. They can now capture this revenue and turn it into a powerful engine for innovation.

Avoiding stablecoin yield bans

The main feature that has caused great debate in light of the GENIUS Act is that it prohibits stablecoin issuers from paying interest or yield directly to stablecoin holders. In doing so, the law strengthens stablecoins as simple payment methods rather than investments or stores of value that compete with bank deposit accounts.

This provision was seen as a conciliatory feature to keep bank lobbyists happy and ensure passage of the GENIUS Act. However, stablecoin sellers have found loopholes in the fine print of the law and are thriving by exploiting them.

The law only prohibits issuers from paying yield; it does not prohibit third parties, such as virtual currency exchanges, from paying yield. This gap allows for a useful workaround.

The issuer receives interest from the underlying reserve assets, such as U.S. Treasury securities, and passes that income on to the seller. Distributors then use this yield as a direct funding source to provide high interest rewards to users.

Coinbase is a key example of this phenomenon. Issuers like Circle and Tether receive a cut of the revenue they earn for services and customer acquisition. It then offers a high annualized yield of 4.1% to users who hold USDC or USDT on the platform.

This approach creates a competitive advantage over traditional banks by offering more attractive yields and user experience. The banking sector has responded to this challenge with a clear voice of opposition.

Banks warn of huge deposit outflow

In August, the Banking Policy Research Institute requested that Congress, which is deliberating the virtual currency market structure bill, tighten regulations on stablecoins.

“Absent an explicit prohibition applicable to exchanges acting as distribution channels for stablecoin issuers and affiliates, the requirements of the GENIUS Act could easily be circumvented and violated by allowing indirect interest payments to stablecoin holders,” the letter reads.

Bank deposits will be hit the hardest. A report released by the Treasury Department in April estimated that stablecoins could lead to deposit outflows of up to $6.6 trillion. Deposit flight could be even greater as third-party sellers can pay interest on stablecoins.

Since banks rely on deposits as the main source of funding for loan issuance, a decline in deposits will necessarily limit the banking sector’s ability to extend credit.

But banks have faced similar existential threats in the past.

Lessons from the 2011 Durbin Amendment

According to an X thread by FinTech expert Simon Taylor, the impact of the GENIUS law loophole on banks mirrors the impact of the 2011 Durbin Amendment.

Congress passed this law to reduce the fees merchants have to pay banks when customers use debit cards. Before the amendment was passed, these fees were unregulated and high. For banks, this was an important and stable source of income to fund things like free checking accounts and perks programs.

For banks with more than $10 billion in assets, exchange fee caps were set very low. However, there was a loophole in the exception that explicitly excluded banks with less than $10 billion in assets from the fee cap.

These smaller “Durbin exempt” banks may still charge previous unregulated fees.

Fintech startups looking to develop low- or no-cost consumer products quickly recognized the opportunity. Companies like Chime and Cash App quickly partnered with these smaller banks and were able to issue their own debit cards.

Partner banks will receive high interchange revenues and share them with fintech companies. This important revenue stream has allowed fintech companies to offer fee-free accounts as they have earned significant revenue from shared swipe fees.

“Traditional banks couldn’t compete. They were Durbin-regulated and earned half Interchange’s share on every transaction. Meanwhile, neobanks partnered with community banks and built multibillion-dollar businesses on the spread. The strategy is that distributors capture value and share it with customers,” Taylor wrote in X.

A similar pattern is emerging with stablecoins.

Will banks resist or adapt?

Loopholes in the GENIUS law for stablecoin sellers enable powerful new business models that provide embedded funding sources for new competitors. As a result, innovation beyond the traditional banking system will accelerate.

In this case, crypto exchanges and fintech startups will be freed from the cost and complexity of banking regulations. Instead, it focuses on consumer-facing aspects such as user experience and market growth.

The income from the yield delivered by stablecoin issuers allows distributors to offer more attractive customer rewards and fund product development. The result is a product that is objectively better, cheaper, and faster than deposits offered by traditional banks.

While these banks may be successful in closing this loophole in future market structure legislation, history shows that new gaps will inevitably emerge and fuel the next wave of innovation.

Rather than fighting this new structure and regulatory resistance, it may be a wise long-term strategy for incumbent banks to adapt and integrate this new layer of infrastructure into their operations.

The GENIUS Act Banned Yield on Stablecoins – But Banks are Still Losing Against The Competition appeared first on BeInCrypto.