Author: SIMON JOHNSON

Translation: Bitpush

After the passage of significant digital currency legislation (the "GENIUS Act") and with more bills under consideration (the "CLARITY Act" has passed the House), the United States is poised to become a major hub for cryptocurrency-related activities, and even—if taken literally by U.S. President Donald Trump—become the "crypto capital of the world."

But those who support the new legislation should be careful not to bring about their own downfall.

Unfortunately, the crypto industry has gained such immense political power—primarily through political donations—that the design of the "GENIUS Act" and the "CLARITY Act" aims to prevent reasonable regulation. The likely outcome is an epic boom-bust cycle.

Historically, the primary advantage of U.S. financial markets over other countries has been their relatively higher transparency, which allows investors to better understand risks and make more informed decisions. The U.S. also has strict anti-conflict of interest regulations that require fair treatment of investors (including protecting their assets through appropriate custodial arrangements) and limits the risks that many financial companies can take on.

This framework is not accidental, nor is it purely the result of market competition. Instead, it is the result of wise laws and regulations created after the Great Depression (following a major disaster) in the 1930s, which have since evolved in a reasonable manner. These rules are the main reason why it is so easy to do business in the U.S., bring new ideas to market, and raise capital to support various innovations.

Any individual entrepreneur, even a potential emerging industry (like cryptocurrency), may feel dissatisfied with these rules, claiming they are different from anything the world has seen. But the risks brought by financial innovation affect the entire financial system, not just individual investors. The focus of regulation is on protecting the whole.

Many major economies—including the U.S.—have only learned this lesson through painful experiences. Over the past 200 years, they have experienced severe financial turmoil and even systemic collapses. One such collapse was a major cause of the Great Depression, which began with the stock market crash of 1929 and spread to many banks (and other investments), destroying the wealth and dreams of millions of Americans. Avoiding a repeat of this has long been an important policy goal.

However, the "GENIUS Act" does not advance this goal. The law creates a framework for stablecoins issued by U.S. and foreign companies. Stablecoins are an important emerging digital asset designed to maintain a stable value relative to a specific currency or commodity (the U.S. dollar is the most popular anchor). Stablecoins are useful for investors active in cryptocurrency trading, allowing them to enter and exit specific crypto assets without having to go through the traditional (non-crypto) financial system. We should expect significant demand for stablecoins, including from non-financial companies (like Walmart and Amazon) looking to bypass existing payment systems.

The business model of stablecoin issuers is similar to that of banks: they earn interest rate spreads by investing their reserves, and under this legislation, the interest paid on stablecoins is zero. This gives stablecoin issuers sufficient incentive to invest at least a portion of their reserves in higher-risk assets for greater returns. This will become a major source of vulnerability, especially when issuers are licensed by lax state-level agencies.

In fact, from a systemic perspective, the main flaw of the "GENIUS Act" is its failure to effectively address the inherent run risk of stablecoins, as it prevents regulators from establishing strong capital, liquidity, and other safeguards.

When any stablecoin issuer—whether domestic or foreign—faces distress, who will intervene, and with what authority will they stop the problem from spreading to the real economy, as happened in the 1930s?

Simply applying bankruptcy law to failed stablecoin issuers will inevitably impose severe costs on investors, including long delays in recovering remaining funds. This will almost certainly exacerbate runs on other stablecoin issuers.

It is worth noting that if the "GENIUS Act" truly aims to maintain the dollar's status as the global reserve currency and boost demand for U.S. Treasury securities, why does Section 15 of the bill allow foreign issuers to invest their reserves in their own (high-risk) government debt—even if that debt is not dollar-denominated?

It is foreseeable that national regulators will turn a blind eye to or even encourage such practices. What absurd situation will we face then: a so-called "stablecoin" burdened with dollar repayment obligations, while its reserve assets are largely composed of non-dollar assets—should the dollar appreciate significantly (spoiler alert: liquidity crises, solvency questions, and runs will follow), this absurd asset mismatch will surely be exposed.

A greater crisis looms—especially if the Senate passes any version of the "CLARITY Act." This legislation will condone conflicts of interest and self-serving transactions to an extent not seen since the 1920s. More seriously, there are national security concerns: the "GENIUS Act" and the "CLARITY Act" may even facilitate the continued use of stablecoins (and broader cryptocurrencies) for illegal financial transactions.

The U.S. is likely to become the global cryptocurrency center, and under its emerging legislative framework, a few wealthy individuals will undoubtedly become richer. But as Congress eagerly caters to the demands of the crypto industry, it exposes the U.S. and the world to the real risk of a repeat financial panic—potentially leading to severe economic damage, massive unemployment, and wealth evaporation.

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