Prohibiting interest on stablecoins repeats failed 1930's banking regulation. History shows such restrictions hurt consumers and only delay the inevitable.
The recently passed GENIUS Act includes the following provision:
PROHIBITION ON INTEREST.—No permitted payment stablecoin issuer or foreign payment stablecoin issuer shall pay the holder of any payment stablecoin any form of interest or yield (whether in cash, tokens, or other consideration) solely in connection with the holding, use, or retention of such payment stablecoin.These rates were set in the Federal Reserve’s Regulation Q
This restriction is simply stated and is not tied to any concern about financial stability. In fact, it is believed that the banking industry was the supporter of this prohibition. And therein lies an irony.
Interest payments on demand deposits by banks were prohibited by banking laws passed in the 1930s. The Federal Reserve was given the power to determine ceilings for interest rates that banks could pay on other deposits. These rates were set in the Federal Reserve’s Regulation Q. The regulation of interest on savings accounts was extended to saving institutions which financed most mortgages in this period. The restrictions did not matter much during the 1930s and 1940s, when interest rates were quite low, and even into the 1950s.
In the 1960s though, as inflation picked up, interest rates outside banks started to rise. What happened? It may seem surprising, but some people started to take their funds out of banks to purchase U.S. Treasury bills for themselves. Recall, money market funds did not exist, and at that time, the smallest Treasury bill was $1,000. Individuals had to go to teller windows at Federal Reserve Banks and buy them. And buy them they did. This created deposit outflows at the banks which resulted in “credit crunches.” Outflows also occurred at the savings institutions and these decreased the supply of new mortgages and thus housing construction.
The federal government responded to the decreases in deposits and increases in Treasury Bill purchases by raising the minimum value of a T-bill to $10,000, cutting off this alternative to low-interest paying bank deposits.
Banks also tried to attract deposits by working around the ceilings on interest rates on deposits. For a time, new depositors at banks received non-cash rewards for deposits, such as new toasters among other items. This encouraged depositors to withdraw deposits from one bank and deposit the funds in another. But then Regulation Q was revised to include non-cash payments to depositors, which outlawed this subversion of the ceilings.
Some financial institutions in the Northeast were outside the purview of the Federal Reserve’s Regulation Q and began paying interest on accounts called NOW accounts. While quite similar to checking accounts from a depositor’s perspective, there are enough differences that they are legally distinct. This, of course, created outflows at banks.
More ominously for Regulation Q, money market funds came into being in 1971. They were a way for investors to receive interest rates close to those on Treasury bills with the convenience of being more readily available than funds from selling Treasury bills. Accounts at money market funds were not subject to Regulation Q and were more convenient than holding Treasury bills directly. Furthermore, accounts at money market funds could be used as checking accounts for large payments, which made them a convenient checking and savings account. Securities firms also introduced cash management accounts which could serve most, if not all, the functions of a checking account. These accounts were a substitute for bank deposits, although they were relatively unimportant in the 1970s. The high interest rates at the end of the 1970s and early 1980s made money markets much more relevant . Investments in money market funds exploded when interest rates increased in the late 1970s and early 1980s. Investments in money market funds were 27 times higher in July 1981 than in July 1978.
No doubt at least partly due to this competition from money market funds and securities firms, ceilings on interest rates at banks were phased out from 1981 to 1986.
Interest rates on deposits at banks now are set by the banks themselves. However, coming full circle, the GENIUS Act’s prohibition of interest on stablecoins prohibits stablecoin issuers from doing just what the banks were previously prohibited from doing.
Just as with the ways banks worked around Regulation Q, stablecoin issuers already seem to have found a way to work around the GENIUS Act’s prohibition of interest on stablecoins.
Coinbase has announced that it will pay “rewards” for funds held at Coinbase in stablecoins even if the issuers cannot pay interest directly.
The Bank Policy Institute has come out firmly in favor of amending the GENIUS Act to prohibit these rewards for assets that compete with bank deposits.
Even if the GENIUS Act is amended to prohibit second-hand payment of “rewards,”this is not the end of the story. Stablecoin issuers will have an incentive to find another way to pay interest to attract funds, and they will do so. Then regulatory or legal changes will follow and further efforts to get around those new prohibitions will occur.
The prohibition of interest on stablecoins is likely to die sooner or later, just as interest rate ceilings on deposits at banks died. This regulation is detrimental to the general public’s well-being by depriving them of interest, and shifts asset holders’ holdings away from stablecoins and toward bank deposits solely due to a regulation to benefit banks. Besides that, the prohibition takes creative minds away from creating better products or services, instead using their imaginative energy to find ways to work around regulations, which is a net loss for everyone.
