- What's at stake: Stablecoin failure could echo throughout the banking system.
- Forward look: The Senate will debate market structure legislation next month.
- Expert quote: "No one wants to hear about this" – Senate Banking Committee ranking member Elizabeth Warren, D-Mass.
WASHINGTON — As Congress prepares to debate sweeping market structure legislation this fall, one glaring question remains unaddressed: what happens when a major stablecoin collapses?
Lawmakers spent months crafting the GENIUS Act, which President Donald Trump signed into law in July, creating the first comprehensive framework for stablecoin legislation. That legislation passed despite objections from Democratic lawmakers and
But the biggest of those concerns is what would happen to the financial system if a stablecoin issuer —
"I actually have had some of this conversation with Republicans as well, and no one wants to hear it," Sen. Elizabeth Warren, D-Mass., ranking member of the Senate Banking Committee, told American Banker in July. "Nobody wants to hear this."
How it starts
The idea of a single company, or a small number of companies, going under and taking all or a significant part of the entire financial system with it are usually fringe cases.
Bankruptcies are rare, and big financial companies going under are even rarer. That said, it does happen, most recently with the collapse of Silicon Valley Bank in 2023, which set off a broader crisis of market confidence among large regional banks.
A stablecoin issuer failing would be very different from a bank failure or large nonbank bankruptcy. Consumers, should the industry grow, may increasingly park their money in stablecoins just as they do with bank deposits, except the treatment of stablecolins is different from deposits should the entity holding them fail.
Lawmakers' attempt to address this was to require payment stablecoin issuers to set aside reserves to ensure stablecoin holders would be able to redeem them at par relatively seamlessly. The idea is that the presence of those reserves would limit fears of a run and thus prevent panic and keep the system afloat.
But if stablecoin issuers fail anyway, stablecoin holders get priority over other creditors for the failed institution's remaining assets. That provision is meant to ensure public confidence in stablecoins, said Chris Boone, a partner with Venable LLP.
"The idea behind having holders with first priority over all other creditors is to make that as strong as possible, to shore up the kind of financial backing of this structure as a whole," Boone said.
But Hilary Allen, a bank law professor at American University, said it does not take a vivid imagination to find situations where those preventative measures prove insufficient.
"So the reason why we have a special bankruptcy regime for banks is that the usual bankruptcy regime is too slow, and that is not a good response to when you're dealing with a run, and time is of the essence," she said. "In other words, people who are trying to cash out of their stablecoins will probably succeed in destroying the value of the stablecoin before a bankruptcy can kick in, and what that inevitably invites is a bailout."
Another risk that could trigger a run on a stablecoin includes a scenario where a bank that holds stablecoin reserves — rather than the stablecoin issuer itself — fails. Those reserves would likely be uninsured, so if the bank failed, those stablecoin holders could experience losses.
"There are conceivable scenarios where the reserve assets fall below 100% of the stablecoin liabilities they're supposed to back," said Andersen Institute economist Rashad Ahmed. "So in my view, stablecoins are not risk-free for the holder, even though they have this senior priority."
How it spreads
Financial industry experts use Silicon Valley Bank as an early test case for how a large stablecoin-related failure could be a problem for the wider financial system.
Nonbank stablecoin issuers, like Circle, have to park their reserve cash at a bank. In Circle's case, it held a large amount of uninsured deposits at Silicon Valley Bank. When Silicon Valley Bank failed, regulators stepped in and invoked a
That relationship between bank and nonbank stablecoin issuer contains risk that runs both ways, Allen said.
"If there had been a run on Circle and it had to pull out billions of dollars of reserves from Silicon Valley Bank, even if Silicon Valley Bank was fine to start with, that probably would have hurt and potentially could have caused a run on the bank," she said.
The interconnectedness between stablecoins, cryptocurrency and Treasury bonds would exacerbate these issues, Ahmed said. If there's a shock in the crypto market that causes a market crash, he said, that would put more redemption stress on stablecoin issuers, and could also start a chain reaction.
"Issuers, in hopes of making these redemptions and making stablecoin holders whole, would turn around and either claw down on their deposits, or they stop buying or downright selling their Treasury bills, or they would exit reverse repo positions and exit repo markets," Ahmed said.
The interconnectedness between banks and stablecoin issuers could also present liquidity stress for banks.
"I think the fact that the banking system is going to be holding the deposits for these large stablecoin issuers, that's one direct connection through which the banking system is going to be exposed," Ahmed said. "Banks have to maintain liquidity coverage ratios, and the amount of liquid assets a bank is going to hold against runnable liabilities is going to depend on the runoff assumptions that that bank makes for those different deposits."
So if a bank has a higher proportion of uninsured deposits, they have a higher run risk and the bank will have to hold more liquid assets against that risk.
"But even when you have a lot of liquid assets … that's not always enough," Ahmed said. "Then the bank is forced to sell securities to make those deposits and that can trigger volatility across other markets."
How it ends
In the case of a bank stablecoin issuer, the bank is likely able to tap liquidity facilities, borrowing from the Fed discount window or the Federal Home Loan Banks.
The picture is less clear for nonbank stablecoin issuers. The GENIUS Act doesn't designate a lender of last resort for nonbank stablecoin issuers, so there is no obvious way for them to stem panic should they find themselves in trouble.
"If the issuer is a bank, then the banking regulators could, in theory, step in," Boone said. "It's less clear what would happen if the issuer is a nonbank. I mean, that's just kind of completely uncharted territory."
Lawmakers have at times brought up the Fed's emergency lending abilities, laid out in
"It's sort of the original sin of money market mutual funds being replicated again, right?" Allen said. "So once you essentially allow deposit taking equivalents to happen outside of the banking industry, then you will inevitably set yourself up for having to bail out those deposit equivalents."
