The cryptocurrency industry celebrates the GENIUS Act passed by the US Senate, regulating stablecoins for the first time. Yet concerns rise over its potential to trigger a global financial crisis through corporate-issued digital currencies.

The cryptocurrency industry celebrated the US Senate’s adoption of the Guiding and Establishing National Innovation for US Stablecoins Act (GENIUS Act) in mid-June this year as a significant win.

With this legislation, the United States intends to regulate a sort of cryptocurrency known as a stablecoin. However, a deeper analysis indicates that it may lead to a new economic catastrophe.

Decentralisation is the foundation of cryptocurrencies

To comprehend the GENIUS Act, let’s go back to the beginnings of cryptocurrency. They originated as a decentralised currency, with a sophisticated, globalised computer system determining their supply and hence value rather than the Federal Reserve or the European Central Bank.

The first and most prominent cryptocurrency was Bitcoin (2009). The idea was that it would be a gold-like asset, which could be mined to provide a (nearly) constant supply, offering a return to the era of the gold standard, when the value of any currency was determined by the value of gold, not national economies.

That was then. Today, the most benign way to define cryptocurrencies is as a casino. In fact, people invest in crypto precisely because it isn’t stable and reliable like gold; its value is volatile and can lead to huge returns on investment (but also huge losses).

Since the factors that determine their price are often unclear, investing in cryptocurrencies is essentially a roll of the dice. Profiting from them can be as likely as winning at roulette.

The credibility of cryptocurrency

The cryptocurrency sector recognised that the extreme volatility (and unpredictability) posed a barrier to recruiting more conservative investors. To establish a sense of stability, firms began developing stablecoins, which are cryptocurrencies with values tethered to a currency.

So, suppose a business called “T” develops its own cryptocurrency, dubbed “t-coin,” and pegs it to the US dollar at a 1:1 exchange rate. If I buy a t-coin, the price will be the same as the dollar, and I know I can return to Company T and exchange my cryptocurrency for $1. But if the corporation cannot give me with that $1, both the currency and the company will fail, and investors who purchased t-coins would lose money.

This kind of catastrophe is not imaginary. In South Korea, the US dollar-pegged stablecoin Terra plunged in 2022, causing a disaster that wiped out almost $60 billion from worldwide cryptocurrency markets overnight.

Are there any safe cryptocurrencies?

Several years ago, I went to a Las Vegas casino. Upon entering, I swapped dollars for chips (tokens), which I used instead of currency within the casino. If I had any remaining chips at the end of the night, I could swap them for the exact amount I paid for them. A stablecoin is essentially the same thing, but it uses electronic tokens rather than casino chips.

With the GENIUS Act in the US Senate , major companies like Amazon and Walmart are already planning to issue their own stablecoins for their customers to use. But the idea of companies having their own currency raises serious questions. Will Amazon tokens be able to be used to pay at Walmart (or vice versa)? Will the value of Walmart tokens be the same if I use them to pay at Amazon? If every major US company decides to create its own token , which token will be used for each transaction?

Since the GENIUS Act will regulate stablecoins , people may believe they are all equally secure. However, this is impossible to guarantee, and it’s also unknown how companies will leverage their stablecoins for their own benefit.

Back to the casino: During my visit, I wasn’t worried that when I went to exchange my tokens for dollars, the establishment wouldn’t honor its end of the deal. However, let’s imagine I take the chips, return to the casino the next night, and find it’s closed or doesn’t have enough dollars to pay me. That’s the problem.

The next financial crisis?

The world has suffered several currency crises in which a country, rather than a company, issues a currency linked to its economy. Argentina is a classic example. From 1991 to 2002, its central bank established an exchange rate of one peso to one dollar. This artificial and imposed exchange rate distorted trade relations with other non-dollarized economies and ultimately produced a massive crisis that worsened when the peso/dollar peg was finally eliminated.

Consider that a huge firm in the United States creates 100 billion stablecoins and pegs them to the dollar. The corporation is prosperous and has sufficient assets (such as US Treasury bonds or bills) to ensure the currency’s worth. It continues to issue stablecoins, but its financial situation worsens.

This would cause a chain reaction. Investors would eventually realise that the business had issued more stablecoins than the value of the US Treasury bonds it claimed to possess. They would begin repaying the stablecoins, prompting the corporation to liquidate its bonds in an attempt to reassure (probably unsuccessfully) concerned investors.

The impacts would quickly spread. A major sell-off in US bonds would lower the bond prices, resulting in an increase in US interest rates. A quick, unexpected, and severe hike in US interest rates could easily lead to a worldwide financial catastrophe, with banks and governments all over the world suddenly facing the US solvency dilemma.

Regulation is no assurance

Obviously, this does not have to happen. Under the new legislation, firms that issue stablecoins will be regulated, and authorities will guarantee that they have enough reserves to keep their pledges if investors panic.

However, financial regulators are not perfect. Just a few years ago, in 2023, they failed to recognise that Silicon Valley Bank had too many assets at risk. This negligence eventually contributed to the bank’s failure.

As a result, it is easy to foresee a scenario in which numerous organisations produce an excessive number of stablecoins. If this occurs, the repercussions might be severe, not just for the United States but also for the world economy.

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