Forcing Bank Deposits to Subsidize Stablecoins: the GENIUS Act

The Senate is set to take up a vote on this Thursday on the GENIUS Act, the legislation to create a regulatory framework for stablecoins. Whatever else one might think about stablecoins or the GENIUS Act, its insolvency provisions are an absolute mess, both conceptually and in drafting. If the GENIUS Act becomes the law, we're in for a FUBAR situation when a stablecoin issuer ends up insolvent. Even more concerning, if a bank custodian for a stablecoin issuer's reserves ends up insolvent, the claims of the stablecoin investors will come ahead of the bank depositors. That's right. Crypto comes ahead of ma-and-pa. 

The effect: stablecoins are being subsidized by bank deposits. Now that's GENIUS.

There are two sections of the GENIUS Act that deal with insolvency. Section 11 deals with the insolvency of a stablecoin issuer and the problem of redemption rights, while section 10 deals with the insolvency of a custodian of a stablecoin issuer's reserves. Both have problems.

Stablecoin Issuer Insolvency

Section 11 provides that the reserves of a stablecoin issuer are not property of the issuer's bankruptcy estate, but extends the automatic stay to acts to redeem stablecoins, and provides that any stub claim after reserves are used up on redemptions has priority over everything. There are three problems here:

(1) The claims of stablecoin investors have priority over everything. That's a problem because there's no way to pay the bankruptcy professionals needed to run the case if the stablecoin investors come first. This is insolvency law 101:  you have to pay the gravedigger first. Without a provision for paying the professionals, there won't be a bankruptcy, just a grab race. 

(2) The stablecoin issuer's required reserves are deemed not to be property of the estate. I'm not entirely sure how that provision applies: how do we know if a particular Treasury bond owned by the issuer is part of the required reserves or is a side investment by the issuer? Even if we can figure out what is covered, excluding the reserves from the property of the estate is a problem because if an asset isn't property of the estate, then the estate has no business justification for doing anything with those reserves. It certainly should not be spending estate resources enabling a distribution of the reserves, and there's no authorization for a 506(c) charge or the equivalent. If the estate doesn't do anything with the reserves, it's going to be a mess for investors, who will end up in a grab race for the reserves. An investor might be owed $1 million, but the reserves might be in the form of a $10 million 10-year Treasury bond. Someone has to liquidate that bond, and doing so won't be free. So who is going to pay to liquidate the bond? How are those costs going to be shared among stablecoin investors? I have no idea.

(3) The automatic stay is extended to redemptions of the issuer's reserves, but can be lifted if reserves exist for a ratable distribution. But this conflicts with the reserves not being property of the estate. Again, why should the estate spend money to facilitate the redemptions? Why would the estate want to pay real value to reacquire the stablecoin? Indeed, unlike all other actions covered by the automatic stay, a redemption is not a unilateral collection act by a creditor, but is a bilateral action that requires the cooperation of the stablecoin issuer. Lifting the stay only allows investors to make redemption requests; it does not obligate the debtor-issuer to fulfill those requests.

(4) The lift stay provision envisions a final order to lift the stay being entered within 14 days of the lift stay hearing. I don't know how that interfaces with FRBP 4001, which generally requires a 14 day stay of any lift stay order, so we're looking at 28 days from the lift stay hearing, which itself could happen a month into the case. In other words, there could easily be 2 months of illiquidity for stablecoin investors (and then no guaranty of what they will recover). Again, an order to lift the stay isn't the same as an order to redeem the stablecoins, and I don't see any basis for a court to direct the issuer-debtor to undertake a (costly) redemption process.

Those issues alone will make any stablecoin issuer bankruptcy a complete mess. I have no idea how a court will work through them, but whenever you have unclear law, the result is more delay and more attorneys fees, none of which is good for stablecoin investors.

(Adding to the mess is some sloppy drafting: section 11 refers to an attestation that does not exist and requires (rather than merely allows), the Comptroller of the Currency to show up and be heard on any issue, meaning that the Comptroller has to make an appearance even if he has nothing to say. Every bill has some sloppy language, but here it is indicative of the bankruptcy provisions not being fully thought through.)

Stablecoin Issuer Reserve Custodian Insolvency

Then there's section 10, which deals with the effect of the insolvency of a custodian of the issuer's reserves. Section 10 says that the reserves are to be treated by the custodian as property of the stablecoin investors and that they are normally to be segregated, but it allows commingling of the reserves of different stablecoin issuers and allows cash reserves to be commingled with the cash deposits of other bank customers. Section 10 also says that the claim to the reserves of the stablecoin investors shall have priority over all other claims (absent consent). That means that in regard to cash deposits, the stablecoin investors will have priority over the claims of ma-and-pa for their bank deposits (and thus over the FDIC's subrogation claim when it pays ma-and-pa).

Yes, you read that correctly: Congress is about to put the claims of stablecoin investors ahead of ma and pa's bank deposits. That's just stunning. Now ma-and-pa's deposits are FDIC insured, so they'll be alright, but it means the FDIC's Deposit Insurance Fund is footing the bill. In other words, the GENIUS Act is subsidizing stablecoin issuance on the back of bank deposits. By subordinating the FDIC's subrogation claim in a bank insolvency to the claims of stablecoin investors, the GENIUS Act is effectively letting FDIC insurance leak out to cover uninsured stablecoins, without any insurance premiums paid. That's just wrong. Whatever the merits of stablecoins, they shouldn't be subsidized by the banking system. Satoshi would be turning in his grave to see his vision of an unintermediated p2p payment system be transformed into a centralized system that relies on a forced subsidy from the banking sector.