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as Congress debates crypto market structure legislation, one issue has emerged as especially contentious: whether stablecoins should be allowed to pay yield.
On one side, you have banks fighting to protect their traditional hold over consumer deposits that underpin much of the U.S. economy’s credit system. On the other side, crypto industry players are seeking to pass on yield, or “rewards,” to stablecoin holders.
On its face, this looks like a narrow question about one niche of the crypto economy. In reality, it goes to the heart of the U.S. financial system. The fight over yield-bearing stablecoins isn’t really about stablecoins. It is indeed about deposits, adn about who gets paid on them.
For decades, most consumer balances in the United States have earned little or nothing for their owners, but that doesn’t mean the money sat idle. Banks take deposits and put them to work: lending, investing, and earning returns. What consumers have received in exchange is safety, liquidity, and convenience (bank runs happen but are rare and are mitigated by the FDIC insurance regime). What banks receive is the bulk of the economic upside generated by those balances.
That model has been stable for a long time. Not because it is certain, but because consumers had no realistic alternative. With new technology, that is now changing.
A shift in expectations
the current legislative debate over stablecoin yield is more a sign of a deeper shift in how people expect money to behave. We are moving toward a world in which balances are expected to earn by default, not as a special feature reserved for sophisticated investors. yield is becoming passive rather than opt-in.
the crypto promise of yield
Crypto protocols, particularly those in the decentralized finance (DeFi) space, have demonstrated that it’s possible to earn significant returns on balances simply by holding them. This is achieved through mechanisms like lending, staking, and providing liquidity to decentralized exchanges. Thes activities weren’t previously accessible to most consumers.
Stablecoins, designed to maintain a 1:1 peg to a fiat currency like the U.S. dollar, became a natural bridge between the traditional financial system and DeFi.They allowed users to access these yield-generating opportunities without directly holding volatile cryptocurrencies.
Why banks are worried
Banks are understandably concerned about this development. If stablecoins can offer competitive yields, consumers may shift their balances from traditional bank accounts to stablecoins. This would reduce the pool of deposits available for banks to lend, perhaps increasing the cost of credit and impacting their profitability.
The core of the banking business model relies on the spread between the interest paid on deposits and the interest earned on loans. Yield-bearing stablecoins threaten to compress that spread, forcing banks to either raise deposit rates (reducing profits) or lose market share.
The regulatory crossroads
The debate over yield-bearing stablecoins has led to several proposed regulatory approaches. Some lawmakers favor prohibiting stablecoins from paying yield altogether, effectively preserving the traditional banking model. Others propose allowing yield, but with strict regulations to ensure consumer protection and financial stability.
One key concern is the potential for stablecoins to become “shadow banks” – entities that perform bank-like functions without being subject to the same regulatory oversight. This could create systemic risks, as demonstrated by the collapse of TerraUSD (UST) in 2022.
Potential solutions and compromises
Several potential solutions could strike a balance between fostering innovation and protecting the financial system:
- Regulation as Banking: Treat stablecoin issuers as banks, subjecting them to similar capital requirements, liquidity rules, and supervisory oversight.
- FDIC Insurance: Extend FDIC insurance to stablecoins, providing consumers with the same level of protection they receive from traditional bank deposits. This would likely require significant changes to the FDIC’s mandate.
- Risk-Based Framework: Implement a risk-based regulatory framework that differentiates between stablecoins based on their underlying collateral, redemption mechanisms, and operational practices.
- Yield Caps or Restrictions: Limit the amount of yield that stablecoins can offer, or restrict the types of activities
