Adoption is key to stablecoin 'rewards' threat to bank deposits

• Key insight: Banks have been concerned that a broad takeup of stablecoins in the financial system could be a drain on core deposits, but experts say whether Congress bars stablecoin exchanges from offering rewards could be the key to broad adoption of stablecoins.
• Expert quote: "I found it quite cute that some of the trades waited until after the bill had been signed into law to really raise the magnitude of these problems." — Aaron Klein, Brookings Institution
• Forward look: Congress is considering a cryptocurrency market structure bill this fall that offers banks the best opportunity to resolve the issues around stablecoin exchange rewards. 

The Trump administration's embrace of the cryptocurrency industry and the enactment of a stablecoin law over the summer have raised concerns in the banking industry that stablecoins could drain their core deposits, a critical source of bank strength.

But whether that happens depends on how widespread public adoption of the technology is. Treasury Secretary Scott Bessent recently estimated that dollar-linked stablecoins could reach $2 trillion in market capitalization in the next few years.

"I think that 2 trillion is a very, very reasonable number, and I could see it greatly exceeding that," Bessent said at a Senate Appropriations Committee hearing in June.

Banks have complained that, while the GENIUS Act prohibited stablecoin issuers from offering interest on stablecoin holdings precisely to prevent them from displacing deposits in the banking system, the bill did not extend that prohibition to exchanges. Extending that provision is expected to be a matter under consideration when Congress takes up a cryptocurrency market structure bill this fall, but Aaron Klein, a senior fellow at the Brookings Institution, said the industry should have pushed harder before the stablecoin law was passed.

"I found it quite cute that some of the trades waited until after the bill had been signed into law to really raise the magnitude of these problems," said Aaron Klein, a senior fellow at the Brookings Institution. "Clearly, there was a strategy of not standing in the way of the crypto freight train, but it's much harder to fix a bill that's been passed than to fix a bill in committee."

Timothy Massad, formerly the chairman of the Commodity Futures Trading Commission and senior Treasury financial stability chief in the Obama administration, said the risks that stablecoin pose to bank deposits at the moment are small, but could be an increasingly important factor down the road. 

"I think the take up will be slower [than Secretary Bessent's estimate]," Massad said, adding he's skeptical that the financial system can operate entirely on a bearer-based model. "The deposit flight risk is not that great today, though if I were a bank, I wouldn't ignore it. I'd be thinking about what my digital strategy is."

Whereas stablecoins lack much of the functionality and simplicity of traditional checking and savings accounts, the use of bank deposits is well understood and adopted by the general public, Massad said. For that reason, he said it might be some time before offering rewards makes a meaningful difference in public adoption.

"Bank deposits and banking is a lot easier to use than stablecoins, it's frankly, not that user-friendly as a technology, yet it might become more user-friendly, that's one issue," Massad said. "Number two, bank deposits are very sticky, because banks do other things for you — and let's not forget, we live in a country where people wrote $10 billion in checks last year."

Crypto industry groups have pushed back against the bank industry's concerns, arguing that barring exchanges from providing customers rewards — similar to those credit cards offer — would undermine competition and consumer choice. In comments to the Senate Banking Committee submitted last month, the Crypto Council for Innovation and Blockchain Association stressed that payment stablecoins are distinct from bank deposits, money market funds, or securities and already face strict one-to-one reserve requirements under the GENIUS Act. They also disputed claims that yield-bearing stablecoins would drain trillions from banks, at least small banks. Citing research showing no statistically significant link between stablecoin adoption and deposit outflows from community lenders.

"Stablecoins operate under rigorous reserve, operational, and supervisory requirements, and their reserves largely remain in the traditional financial system, continuing to support liquidity and lending," the letter said. "Allowing responsible, robustly regulated platforms to share benefits with customers is not a loophole — it is a feature that promotes financial inclusion, fosters innovation, and ensures American leadership in the next generation of payments."

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A spokesperson for a leading banking trade group said while stablecoins were designed as payment instruments rather than securities, the crypto industry has undermined that position by rebranding interest as "rewards." While banks are not opposed to competition or crypto partnerships, the spokesperson warned that allowing banks and exchanges to operate under different regulatory frameworks while offering the same services threatens fair competition and even financial stability. Exchanges offering interest, they noted, could also confuse consumers about the lack of FDIC insurance coverage outside the banking system, exposing savers to losses if platforms fail.

Klein, who recently wrote a blog post calling for closing the loophole, says stablecoins are an asset masquerading as a payment instrument, and that exchanges' ability to pay "rewards" over the long term is questionable.  

"Stablecoins are not used to buy things other than crypto at the moment — when you promise somebody a full return and you promise redemption at par at any time, you need to have the goods to back it up," Klein said. "The economics of offering 5% interest, called 'rewards,' on an asset fully backed by Treasuries don't add up. We've seen this play out before with money market mutual funds."

A handful of bankers at fintech conference Finovate recently said they aren't considering stablecoins a major threat to deposits just yet, saying stablecoins have niche use cases and don't outweigh more pressing risks like deposit competition from large and challenger banks. 

Klein cautioned that crypto platforms hold risk profiles that are very different from banks, and that the risk of one or more crypto firms buckling in the coming years is high. While stablecoins are backed primarily by highly liquid Treasuries, recent experience has shown companies can still find themselves in trouble when dealing with safe assets.

"Companies will invest user money in cryptos, make money on the money, pay their interest, pay their rewards, IPO, pay themselves — but at some point there's going to be a correction and there's going to be a run, and I am very afraid as to what that looks like," Klein said. "Silicon Valley Bank showed that investing in treasuries doesn't prevent you from having interest rate risk or run risk."

Massad emphasized that ultimately, the regulatory treatment of stablecoins should hinge on how they are used, particularly distinguishing between transaction-based rewards.

"If you're talking about a token that pays you interest, if you hold it that should be classified as a security, triggering a whole other regulatory framework," Massad said. "I think the solution is to develop language along the lines of payments for the use of a stablecoin that reward people for transactions are okay — because why shouldn't they be allowed to do the same thing that credit card companies do? — but payments essentially that reward people for holding the stablecoin, or are essentially interest, are not allowed."