Stablecoin Bill Spells ‘Huge Disaster’ for Consumers, American’s Allen Says

The bill proposes that stablecoins are offered FDIC receivership without needing to pay deposit insurance premiums.

(Bloomberg) — As Congressional stablecoin legislation designed to legitimize and clarify many aspects of the mostly fiat-backed coins moves along, it’s drawing cheers from the crypto industry — and criticism from the traditional finance world.

The 179-page bill was introduced by Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) last week amid a renewed push to pass such legislation as soon as next month. The bill bans so-called algorithmic stablecoins, which aren’t backed by full fiat reserves. It also creates a mechanism for FDIC conservatorship and resolution if an issuer becomes insolvent.

Many of the measures introduced in this version and prior ones — as well as issues not discussed at all — are worrying Hilary Allen, an associate professor at American University’s Washington College of Law who has written and spoken extensively about how various crypto products can undercut the stability of the financial system.

“It will be a huge disaster when any of them are passed,” Allen said in an interview.

Allen says that stablecoins aren’t robust enough to be a viable form of payment: Blockchains underlying them aren’t reliable or have enough throughput, for one, she said. And the FDIC receivership aspect of the bill could lead to a major ramp-up of banking fees for all US consumers, Allen argued.

Stablecoins, a form of crypto token often pegged to another asset, use reserves to support their value. They are integral to the way crypto markets operate, acting as a less volatile alternative for traders looking to swap between digital assets and to store their wealth.

The bill proposes that stablecoins are offered FDIC receivership without needing to pay deposit insurance premiums. The thinking is, fiat-based stablecoins are backed by full reserves. The problem is, many stablecoin reserves contain repurchase agreements, with their counterparty risks.

“There’s always the unexpected,” Allen said. “I think it’s very dangerous to be saying that no deposit insurance premium will be needed. The danger is that the FDIC makes up that difference with the deposit insurance fund. Who pays it — the banks. When banks are charged more for deposit insurance, they pass on fees to customers.” The current text of the bill says that the FDIC “may use the capital of the payment stablecoin issuer and any returns on required payment stablecoin reserves to fund the costs of a receivership or conservatorship.”

As concerning, and unaddressed, is the fact that many stablecoin issuers have tight relationships with specific crypto exchanges, which get a revenue share when the coins are used in trading, Allen said. An example is Coinbase Global Inc.’s revenue sharing agreement with Circle on USDC stablecoin. That creates a conflict of interest, she said.

“That’s a very conflicted relationship that would be like New York Stock Exchange having its own mutual fund,” Allen said. “There’s nothing in any of the bills that says anything about this relationship requiring separation or disclosures.” The bills also don’t address whether exchanges are allowed to trade unregistered stablecoins, she said.

Also, the bills don’t tackle what happens if a blockchain a stablecoin runs on stops functioning, Allen said. Most stablecoins run on multiple chains: Tether, for example, runs on more than 70 chains, according to data tracker DeFi Llama. In traditional finance, the Dodd Frank Act mandates that traditional financial infrastructure is overseen by the Federal Reserve.

“Here, they are pretending they are going to be fine,” Allen said. Blockchains from Solana to Ethereum have been clogged up over the years, and some blockchains, like Solana, have had outages. Public blockchains are also, by design, relatively slow and expensive to use. To make them less so, developers have been building so-called Layer 2 systems on top of them — but those tend to be more centralized, with much of the development driven by a single team or company.

“To think that [a public blockchain] could process significant volumes of transactions is silly, unless you are going to have a centralized entity that sits on top of it, at which point you are trusting that centralized entity,” Allen said. “And what does that get us that we don’t already have?” Blockchains were supposed to be a way to avoid using systems with centralized intermediaries.

The most glaring issue of all, perhaps: While stablecoins are promoted as a new, frictionless way of sending payments around the world, they are primarily used for something else: speculation, Allen said.

“From what I’ve seen, the primary use case for stablecoins is not to buy real-world goods and services, but to stake stablecoins into crypto applications,” Allen said. “They are being used as on-and-off ramp to other types of crypto trading. These are all speculative uses cases. On margin they are used for payment. I just don’t see them currently or ever becoming a viable form in payment so it’s worth giving them government support.”

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