GENIUS stablecoin bill reveals shocking loopholes! The Federal Reserve warns: risk of repeating the FTX collapse.

Michael Barr, a member of the Federal Reserve Board of Governors, delivered a speech on Thursday at the Washington Fintech Week, warning that the GENIUS stablecoin bill exposes the risk of providing “regulatory arbitrage” incentives. He emphasized that the bill leaves a gap for products that are referred to as stablecoins but are not protected by GENIUS, which could create confusion and lead consumers to rely on payment tools that they believe are regulated but actually lack prudent protective measures.

GENIUS stablecoin bill core content

The “Guidance and Establishment of the American Stablecoin Innovation Act” (GENIUS), signed by President Donald Trump this summer, aims to establish a federal regulatory framework for stablecoins. The bill requires that stablecoins must be fully backed by U.S. dollars or similar liquid assets, mandates annual audits for issuers with a market capitalization exceeding $50 billion, and establishes guidelines for overseas issuance.

Barr acknowledged that the GENIUS stablecoin bill is a meaningful improvement that helps mitigate the risk of runs. If designed properly, stablecoins can reduce remittance costs and accelerate global trade. However, Barr stressed that federal banking agencies and states should work together to establish a set of rules to fill significant gaps in order to protect users and reduce risks in the financial system.

GENIUS stablecoin bill's three core requirements:

Fully Backed: Stablecoins must be 100% backed by US dollars or similar liquid assets.

Mandatory Audit Mechanism: Issuers with a market capitalization exceeding 50 billion USD must undergo an annual independent audit.

Overseas Issuance Regulations: Establish clear guidelines for cross-border issuance to prevent regulatory arbitrage.

These requirements seem strict, but Barr pointed out that there are still significant loopholes at the practical implementation level in the bill.

Regulatory Arbitrage Risks: The Fatal Flaw of the GENIUS Stablecoin Bill

Barr stated that the GENIUS stablecoin bill exposes the risks of incentivizing “regulatory arbitrage.” “In fact, issuers might argue that as long as they make relevant statements and conduct appropriate accounting, the bill allows them to engage in all activities carried out by FTX,” Barr said. This statement reveals the most dangerous loophole: the possibility of being formally compliant but substantively non-compliant. The collapse of FTX stemmed from the misappropriation of customer funds for high-risk investments, while the superficial financial statements showed a healthy status.

“Unless state and federal agencies coordinate carefully, this could lead to some state or federal regulatory bodies allowing a range of activities that may expose stablecoin issuers to greater risks,” Barr warned. The dual regulatory system in the United States is already complex, and under the GENIUS stablecoin bill, issuers might choose to register in states with the most lenient regulations and then operate nationwide. This regulatory competition could expose the entire stablecoin market to systemic risks.

Moreover, different regulatory bodies may have varying interpretations of “appropriate accounting practices” and “relevant disclosures.” A stablecoin issuer deemed compliant in one state may have actual risk exposures that far exceed the standards of another state. This inconsistency will create significant room for regulatory arbitrage, and the ultimate victims will be the consumers and businesses that rely on these stablecoins.

Blank Bill: Unprotected “stablecoin” Products

Barr pointed out that the GENIUS stablecoin bill leaves a gap for products that are called stablecoins but are not protected by GENIUS. “This could create confusion and may lead consumers to rely on payment tools that they believe are regulated, but these payment tools do not have any prudent protective measures,” Barr said.

This definitional ambiguity may lead to the emergence of a large number of “quasi-stablecoin” products in the market, which claim to be pegged to the US dollar but do not actually meet the regulatory requirements of the GENIUS stablecoin bill. For example, some issuers may launch “algorithmic stablecoins” or “partially collateralized stablecoins,” which may not fully comply with the bill's requirement of being “fully backed by US dollars or similar liquid assets.”

More concerning is that products not protected by the GEN stablecoin legislation may enjoy greater flexibility and lower compliance costs in the market, thus gaining a competitive advantage. This reverse incentive will encourage issuers to evade the GEN regulatory framework, thereby undermining the effectiveness of the legislation.

Reliability Requirements for Stablecoins: The Key to Redemption Mechanisms

Bal warned that stablecoins must be reliable. “Stablecoins will only remain stable if they can be reliably and timely redeemed at face value under a range of conditions, including under market pressure, where even the value of highly liquid government debt can come under pressure, as well as in situations where individual issuers or their related entities are under stress,” Bal stated.

This passage reveals another potential issue with the GENIUS stablecoin bill: while the bill requires full reserve backing, it does not clearly specify the redemption mechanism under extreme market conditions. When a liquidity crisis occurs in the market, even highly liquid assets such as U.S. Treasuries may face price pressure and redemption difficulties.

In addition, if the issuer or its related entities face financial pressure, the redemption capability of the stablecoin may also be affected. Although the bill requires annual audits, audits are retrospective oversight and cannot prevent issuers from misappropriating funds or taking on excessive risks in real-time. The lack of real-time monitoring and early warning mechanisms may lead to problems accumulating to an irretrievable extent before they are discovered.

The Regulatory Stance of Baer and the Role of the Federal Reserve

Before the passage of the GENIUS stablecoin bill, Barr pushed for regulation of stablecoins and stated that the central bank “strongly hopes to ensure that any stablecoin issuance operates within an appropriate federal prudential regulatory framework.” Barr was previously appointed by former President Biden as the Vice Chair for Supervision of the Federal Reserve, later resigned from that position but continued to serve as a member of the Federal Reserve Board of Governors.

Bal's warning reveals a deep-seated issue: the GENIUS stablecoin bill may be a product of political compromise rather than legislation based on best regulatory practices. The Trump administration's push for the bill's passage may have been aimed at establishing a basic regulatory framework without overly restricting innovation. However, this compromise may have left dangerous loopholes that could ultimately require amendments or additional regulatory rules to address.