Unnecessary and Unstable: Why Stablecoins are Bad

The current financial policy debate in the US is increasingly fixated on the purported necessity of bespoke regulation for stablecoins (particularly the proposed S.394 GENIUS Act), with proponents arguing that such frameworks would foster responsible innovation and integrate these digital tokens into the broader financial system. This perspective, however, is profoundly misguided. Rather than ushering in an era of enhanced financial efficiency, the legitimization of stablecoins through bespoke regulation would serve primarily to institutionalize inherently fragile financial structures, proliferate risk, and ultimately provide a novel vector for systemic crises, all in service of a financial product that offers no net aggregate good for the economy. The assertion that stablecoins are essential for modernizing money transmission is a fallacy; existing, robust, and regulated mechanisms already fulfill this function with far greater security and accountability.

The argument against stablecoins doesn't stem from Luddism, but a measured assessment of their intrinsic risks and impact on consumers and the financial system. Stablecoins, despite their name, are demonstrably unstable. Their brief history is littered with instances of de-pegging, runs, and the evaporation of billions in investor capital. This is not an aberration but a feature. Any financial instrument designed to mimic the stability of sovereign currency, yet lacking the explicit, unconditional guarantee of a central bank and a sovereign government, is inherently prone to run risk. Unlike central bank money, which maintains "unicity" (i.e. the same value and acceptance everywhere through the central bank's role as payment overseer and ultimate settler), stablecoins cannot guarantee consistent value across all contexts and jurisdictions. The attempts to engineer stability through various collateralization models have all proven fallible.

The three principal archetypes of stablecoins each present unique and severe vulnerabilities. Off-chain collateralized stablecoins, often pegged to the U.S. dollar, purportedly maintain their value through reserves of assets like cash, U.S. Treasury securities, or commercial paper. However, the composition and true liquidity of these reserves are often shrouded in opacity. Issuers frequently alter reserve compositions and disclosure practices with little to no advance notice, introducing significant uncertainty. The inclusion of cash equivalents, which can encompass short-term investment securities like commercial bonds, introduces credit and market risk. If these reserve assets depreciate or become illiquid during periods of market stress, a common occurrence, the stablecoin's ability to maintain its peg is compromised, triggering redemptions and potential runs. The failure to rigorously safeguard these assets, or even accurately represent their holdings, undermines confidence and acts as a catalyst for instability. The events surrounding FTX and Silicon Valley Bank, which precipitated de-pegging and runs on even prominent stablecoins like Tether and USDC, serve as stark reminders. The question is not if such stablecoins will depeg under stress, but when and with what magnitude.

On-chain collateralized stablecoins attempt to achieve stability by holding other cryptocurrencies as collateral. This model introduces a pernicious feedback loop: the collateral itself is subject to extreme price volatility relative to the real currency it is meant to back. A downturn in the crypto markets can rapidly erode the value of the collateral, triggering margin calls and forced liquidations, which in turn can de-stabilize the stablecoin and exacerbate the broader market decline. This design is akin to building a house on shifting sands. Arguably the most dangerous variant, non-collateralized, or algorithmic, stablecoins eschew tangible reserves entirely, relying instead on complex algorithms and smart contracts to manage supply and demand in an attempt to maintain a peg. These are, in essence, perpetual motion machines of finance. The catastrophic collapse of TerraUSD in May 2022, an eighteen billion dollar algorithmic stablecoin, erased vast sums of capital and sent shockwaves through the crypto ecosystem, demonstrating the inherent infeasibility and extreme risk of such unbacked constructs.

A cornerstone of the stablecoin illusion is the promise of at-par redemption at any moment; in practice, this is often far from guaranteed. Issuers frequently impose significant constraints on redemption rights, including high minimum redemption thresholds that render them inaccessible to ordinary retail users. Furthermore, public disclosures regarding redemption terms are often insufficient or misleading. Notably, some of the largest stablecoin issuers do not offer a direct right of redemption to investors who acquire their tokens on unregulated cryptocurrency exchanges, leaving these holders reliant on the liquidity and solvency of those secondary market platforms, themselves often fragile entities. Terms of service, frequently mischaracterized by issuers, can further restrict or delay redemptions, particularly during periods of market stress when liquidity is most needed.

So why would anyone use stablecoins if they are unstable and worse than existing payment systems? The answer lies in their singular distinguishing feature: unlike bank deposits, which are subject to comprehensive regulatory oversight and reporting requirements, the ownership and disposition of stablecoins remains pseudonymous. This anonymity is precisely what makes them valuable to those seeking to circumvent legal frameworks—offshore gamblers, money launderers, extortionists, drug traffickers, sanctions evaders, and other criminal enterprises who require the digital equivalent of unmarked bills with global transmission capabilities.

The crypto ecosystem functions as an offshore casino offering products prohibited within traditional financial systems, and stablecoins serve as the necessary chips to participate. Strip away the technological veneer, and stablecoins reveal themselves as sophisticated tools designed explicitly to evade the anti-money laundering and know-your-customer requirements that undergird legitimate finance. In essence, the primary—and arguably only—economic rationale for stablecoins is to facilitate criminal activity, providing a pseudonymous payment rail for those whose operations cannot withstand the scrutiny of regulated financial systems.

The parallels between stablecoins and the pre-FDIC banking system are deeply unsettling. The devastating bank runs of the 1930s led to the creation of federal deposit insurance and strict regulation of bank risk-taking - protections that stablecoins deliberately circumvent as a new form of shadow banking. While stablecoin issuers attempt to reassure holders by maintaining large reserves of U.S. government debt, this creates a dangerous feedback loop: a run on stablecoins would force issuers to conduct a fire sale of Treasury bills, potentially destabilizing the U.S. government debt market and driving up interest rates. Even money market funds, which are far more regulated and transparent than stablecoins, experienced catastrophic runs during both the 2008 Financial Crisis and March 2020 turmoil, requiring massive government intervention to prevent broader market collapse. Stablecoins, with their greater opacity and weaker oversight, present an even more acute systemic risk. Most alarmingly, their ability to absorb vast amounts of foreign capital would create a direct channel for overseas instability to violently propagate into U.S. Treasury markets - threatening the bedrock of the global financial system, all while primarily serving to facilitate criminal activity.

The bank failures of early 2023, including Silvergate, Silicon Valley Bank, Signature, and First Republic, provided a grim preview of how crypto-related activities can destabilize regulated financial institutions. These banks held substantial uninsured deposits from crypto firms, and withdrawals by these firms during the crypto downturn directly contributed to bank runs. Integrating stablecoins more formally into the U.S. financial system through bespoke regulation would effectively build a high-speed conduit between the largely unregulated crypto casino and the rule-bound, regulated financial sector. This would not foster responsible innovation but rather create new channels for contagion, allowing chaos from the crypto sphere to infect the core financial system.

The value of stablecoins' reserves is deeply intertwined with the safety and stability mechanisms of conventional finance. These reserves are custodied at banks, held in money market funds, and managed through repo arrangements; which derive their security from Federal government regulations and oversight. This interdependence was starkly illustrated when stablecoin issuer Circle held $3.3 billion (8% of its USDC stablecoin reserves) in uninsured deposits at Silicon Valley Bank. When regulators closed SVB, USDC's value plummeted to 88 cents, only recovering after the U.S. government announced emergency measures to protect uninsured depositors. The purported independence from central banks becomes particularly ironic in light of recent developments, including an anticipated Executive Order that would compel the Federal Reserve to provide Fed bank accounts to certain crypto firms. Far from being independent, stablecoins are parasitic on the very financial infrastructure they claim to disrupt.

Stablecoins currently exist in a regulatory twilight zone, neither fully inside nor outside the financial perimeter. This ambiguous status itself poses unique financial stability risks. Crucially, there is a profound lack of clarity regarding whether the U.S. government would or could intervene to bail out a failing stablecoin, particularly one that has achieved systemic importance. Such ambiguity is precisely what fuels bank runs: uncertainty about counterparty exposure and the potential for cascading collapses causes market participants to freeze activity and hoard liquidity. A stablecoin crisis could either necessitate a taxpayer-funded bailout, creating immense moral hazard and socializing losses, or, if no bailout is forthcoming, inflict substantial losses on holders and potentially destabilize international dollar-based payment systems if foreign users have significant exposure.

Moreover, the proliferation of U.S. dollar-pegged stablecoins carries a profound risk of fostering a de facto, involuntary dollarization of foreign economies. This occurs without the consent or democratic deliberation of the affected nations, effectively eroding their monetary sovereignty and capacity to conduct independent economic policy. Such a development is inherently imperial in nature, extending U.S. monetary influence globally through private channels and creating new vectors for financial contagion on a global scale. If these dollar-denominated private monies become deeply embedded in other economies, it not only increases the moral hazard by potentially implicating U.S. authorities in stabilizing foreign markets reliant on these instruments but also dangerously intermingles U.S. domestic policy considerations with the economic stability of numerous international partners. This ultimately curtails the ability of other sovereign nations to enact effective fiscal and monetary policies tailored to their specific domestic economic conditions, making them more vulnerable to external shocks and U.S. policy shifts leading to a more fragile and brittle global economy.

The fundamental justification offered for stablecoins, efficient money transmission, is demonstrably false. The existing global financial system, for all its complexities, already facilitates vast volumes of domestic and international payments through established, regulated channels like the ACH, wire transfers, card networks, and correspondent banking relationships. The Federal Reserve's payment systems have demonstrated remarkable reliability, with only a single 3-hour outage in their history. The Fed's launch of FedNow in 2023, despite its admittedly slow development, now enables instant payments, delivering funds to households and businesses in seconds. Additional options like The Clearing House's real-time payments and various private firms offering non-crypto instant ACH transfers further enhance the ecosystem. Stablecoins offer no net improvement in aggregate economic welfare in this domain; they merely introduce a new layer of risk, rent seeking, and intermediation while providing less reliability than existing systems.

Furthermore, sanctioning the proliferation of private monies coexisting with the U.S. dollar is a dangerous regression. History is replete with examples, from the chaotic Free Banking Era in the U.S. to company scrip, where private currencies proved inefficient, prone to counterfeiting, and often exploitative. Legislating stablecoins into a recognized form of payment risks repeating these historical errors. The very act of holding vast sums in stablecoin reserves ties up safe and liquid assets like U.S. Treasuries that could otherwise be used by banks to satisfy regulatory capital and liquidity requirements or to support lending. This could lead to artificial shortages of high-quality liquid assets, increasing their cost and potentially constricting credit availability for productive economic activities like mortgages and small business loans as customer funds migrate from insured bank deposits to digital wallets.

Finally, the utility of stablecoins in facilitating illicit activities cannot be ignored. Their pseudonymous nature and cross-border transferability make them attractive instruments for money laundering, sanctions evasion, and terrorist financing. The dominant stablecoin outside U.S. jurisdiction, Tether, is persistently used by criminal enterprises for evading interdiction by law enforcement. Services like crypto mixers, designed explicitly to obscure transaction trails, are routinely implicated in laundering stolen funds for entities like North Korean hackers, narcotics cartels, pig butchering scammers, and terrorist organizations.

The proposed regulatory frameworks for stablecoins create dangerous opportunities for regulatory arbitrage and consumer confusion. Proponents advocate a bifurcated resolution regime where bank-chartered stablecoin issuers would face FDIC receivership (albeit without FDIC insurance) while non-bank issuers would fall under a new bankruptcy chapter. This hybrid approach invites misunderstanding, as consumers will inevitably conflate protections for stablecoins with those for traditional bank deposits. The situation is further complicated by bankruptcy provisions limiting customer recovery to the stablecoin's value at the time of failure—likely less than the promised dollar peg. Even more concerning is the potential for payment services like PayPal, Venmo, or Zelle to exploit these new frameworks by migrating their operations to blockchain-based systems (or alleging to do so), circumventing established federal consumer protection laws that govern money transfers.

The prospect of large technology companies and retailers issuing stablecoins raises serious concentration risks. These risks mirror the very concerns that led to the Bank Holding Company Act's restrictions on mixing banking and commerce. Major platforms like Meta or Twitter could leverage stablecoins to expand their surveillance capabilities and manipulate consumer behavior. They could monitor individual transactions and offer preferential treatment to stablecoin users, all while amassing vast pools of customer deposits.

The financial stability implications are equally concerning. If one of these tech giants were to face distress, the failure of their stablecoin could rapidly spread contagion throughout the broader market. Congress's proposed parallel regulatory regime, with its weaker oversight and consumer protections, would effectively create a backdoor. This would allow financial services firms to circumvent decades of carefully crafted consumer protection requirements.

Proponents often resort to the thought-terminating cliché that "blockchain is here to stay" to shut down critical analysis of the technology's actual utility and legitimacy. After fifteen years, blockchain has failed to demonstrate any significant legal use case beyond speculation and gambling. The continued existence of cryptocurrencies and stablecoins is not evidence of their inevitability or permanence, but rather of temporary regulatory forbearance and political capture. Indeed, the largest stablecoin, Tether, operates primarily through a single custodial relationship with Cantor Fitzgerald for its Treasury holdings. The entire crypto ecosystem could effectively cease to function tomorrow if regulators simply restricted access to the Treasury markets that these products parasitically depend upon. Claims about blockchain's inevitability are less statements of technological reality than expressions of hope by those heavily invested in its continuation.

Attempting to render stablecoins safe through bespoke regulation feels akin to a food regulatory agency, confronted with a restaurant teeming with rats, deciding not to close it down but instead to issue elaborate directives on "Customer-Rodent Interaction Minimization Protocols." One can picture the detailed circulars on "Acceptable Rat Frequency Per Square Meter of Dining Area" or requirements for "Transparent Disclosure of Rodent Fecal Matter Levels on Menus." Just as such measures would fail to address the fundamental problem of an unsanitary establishment, stablecoin regulation that attempts to make inherently unstable financial products "safe" through disclosure requirements and capital controls merely obscures the core issue: these are fundamentally flawed instruments that should not exist within the regulatory perimeter.

The push for bespoke stablecoin regulation is a solution in search of a problem, and a dangerous one at that. It seeks to legitimize and integrate financial instruments that are inherently unstable, offer no compelling economic advantages over existing systems, and pose significant systemic risks. Regulation cannot transmute a fundamentally flawed concept into a sound one; it can only provide a veneer of legitimacy that encourages wider adoption and thus amplifies the potential fallout when, not if, these structures fail. Instead of crafting new rules to accommodate these risky constructs, policymakers should recognize stablecoins for what they are: speculative instruments with a high propensity for instability, run risk, and limited legitimate use cases that are not already better served by the regulated financial system. The focus should be on reinforcing the resilience and efficiency of existing payment and financial infrastructures, not on inviting a new, poorly understood, and demonstrably fragile class of assets into the heart of the financial system. To do otherwise is to knowingly plant the seeds for a future financial crisis, fueled by the false promise of an unnecessary innovation. The prudent course is to allow these structures to remain on the periphery, subject to existing anti-fraud and securities laws where applicable, rather than granting them a bespoke regulatory framework that would signal endorsement and invite another financial crisis.