More than a century ago, Congress delegated substantial control over the nation’s money supply to a private institution (the Federal Reserve) and to the private banks connected to it. Banks create money in the form of new deposits when they extend credit to customers. When exercised prudently, this fuels economic growth. Unfortunately, the increasing prevalence of stablecoin exchanges offering yield on balances threatens to siphon deposits from traditional banks and into entities operated with few of the same obligations or guardrails.
To understand why guardrails matter today, especially in the emerging world of stablecoins, it’s essential to understand the process of money creation in the traditional banking system. The bulk of America’s more than $22 trillion money supply is not physical currency. Only about $2.4 trillion exists as bills and coins. Of the nation’s money supply, nearly $18.4 trillion exists as bank deposits, about eight times the amount of physical cash in circulation.
Banks do not simply lend out existing deposits in piecemeal fashion. When the “Bank of New Orleans” approves a $100,000 loan for Lennie’s Po-Boy Restaurant, it doesn’t search its vault for someone else’s money. Instead, the bank credits Lennie’s account with a new $100,000 deposit. That deposit is newly created money, backed by Lennie’s promise to repay. On the bank’s balance sheet, a new asset appears: Lennie’s loan. A new liability also appears: Lennie’s deposit. Meanwhile, Lennie holds a new liability (the loan he must repay) and a new asset: the checking-balance he may spend immediately.
This process is a defining feature of a modern economy. By expanding credit, banks expand the money supply, enabling families to purchase cars, workers to invest in education, and businesses to buy equipment or scale operations. Economic output grows not only from the investment of current savings but from the future earning potential that credit brings forward. New credit often funds productive activity, like a farmer buying machinery that doubles crop yields. An expanding money supply only becomes inflationary if the overall money supply expands faster than real production. If an expansion of the money supply via credit creation boosts output, inflation does not result. That is far different from the Federal Reserve’s COVID-era decision to finance unprecedented federal spending by purchasing government bonds. This injection of money into the system without a corresponding increase in economic output fueled the persistent inflation still affecting Americans today.
But money creation comes with risk. If banks extend credit recklessly, defaults rise, confidence collapses, and the financial system destabilizes. To maintain trust, banks hold reserves to meet withdrawal needs and maintain capital buffers so investors rather than depositors bear losses when loans sour. Some of the deposits are kept in reserve to meet withdrawal demands of depositors. Depositors participate voluntarily in order to access the spectrum of banking services and interest payments on their balances; with the understanding they can access the entirety of their deposits upon demand.
This system works only if deposits remain within it. If deposits shift away from regulated banks, those banks have less capacity to extend credit, which in turn threatens the economic activity their deposits make possible. That risk is no longer theoretical.
Stablecoin issuers, under existing and proposed regulatory frameworks, must hold a full dollar in reserve for every stablecoin issued. This ensures each token can be redeemed at par, on demand. But the exchanges that custody these stablecoins face no such requirement. Despite lacking the regulatory regime governing banks, some exchanges offer yields far higher than deposits at insured institutions.
Additionally, because of the strict “dollar for dollar” reserve requirements that make stablecoins “stable,” stablecoin exchanges cannot extend credit as banks can, thus breaking the virtuous cycle of lending to fuel economic growth. The anticipated deposit flight from banking institutions into stablecoin holdings could shrink credit creation and lending by 25%. This is a negative for the affordability and access of consumer credit for small businesses, farms, and families. Americans do not deserve this uncertainty.
The GENIUS Act marked genuine progress by providing a framework for regulating payment settlements made with stablecoins. But it also left a dangerous loophole. The law prohibits issuers from paying yield on stablecoins, yet it remains silent about exchanges, which can induce people to shift funds by offering attractive returns. In doing so, these exchanges morph from simple transaction facilitators into de facto credit intermediaries — lending out stablecoin balances while avoiding banking-sector capital requirements, reserve mandates, and risk standards.
This is not free-market dynamism. It is regulatory arbitrage dressed in techno-finance clothing.
The prohibition on stablecoin yields should apply to exchanges in addition to issuers. This prohibition should cover not just explicit interest payments but also any indirect economic benefit tied to a customer’s stablecoin balance. Unless regulators treat these arrangements as yield by another name, stablecoin exchanges will continue to capture deposits by circumventing the very system designed to make deposit-taking safe.
Past experience demonstrates that regulatory carveouts for favored deposit-holding institutions can create systemic risks, as seen in the savings-and-loan crisis, the money-market fund panic, and SVB’s collapse, sometimes spurring taxpayer-supported interventions.
Allowing stablecoin exchanges to offer yield without holding capital or reserves risks repeating those failures on a massive scale. If hundreds of billions migrate out of banks and into these high-yield “wallets,” traditional credit creation shrinks, the economy suffers, and the risk of a government backstop grows.
Congress can prevent that outcome by extending the yield prohibition already established in the GENIUS Act to its natural conclusion and include a similar provision in the market structure legislation that the Senate is currently considering. Stablecoins can improve payments, settlements, and financial efficiency. But the benefits of innovation do not include the right to recreate the banking system without the obligations that make banks safe.
It’s time to restore a level playing field and protect both the U.S. financial system and the taxpayers who ultimately bear the cost of regulatory blind spots.
