Around the world, stablecoins are subject to a fairly consistent and convergent regulatory regime. They must be backed by real, high-quality assets, be subject to regular audits, and issuers are prohibited from paying interest on stablecoin balances. The prohibition on interest payments appears in the GENIUS Act in the US, in the regulation of cryptoasset markets (MiCA) in the European Union, as well as in similar laws in Hong Kong and Singapore.
Enforcing the ban on interest payments may prove difficult. A much-discussed driver of this ban on interest payments is the idea that it will help maintain liquidity within the traditional banking system, where regulators and supervisors have a better understanding of risk management. However, whether the argument is good or not, it is unlikely to be effective and, worse still, efforts to circumvent it could have some unintended consequences.
While they don’t call it “interest,” some crypto exchanges already offer “rewards” that appear to approximate interest rates for holding stablecoin assets. Additionally, if no rewards are offered, it is also quite easy to quickly move assets in and out of yield-generating offerings like AAVE. Some payment services, like Metamask’s Mastercard debit card, will even do this instantly and automatically when you make a purchase, so you can leave your assets in an offer that generates returns every time.
In Europe, the rules incorporated in MiCA give regulators greater freedom to prohibit final solutions to the ban on interest payments, such as rewards and automated portfolio management. This would prohibit stablecoin providers from bundling these types of solutions or offering rewards. However, stablecoins are considered “bearer assets” (e.g. very similar to cash) in most major markets and that means, among other things, that users can move them and do with them whatever they want. Unlike bank deposits, which remain at least partly under the control of the bank in which they are deposited.
In practical terms, this means that regulators can prohibit stablecoin issuers from paying interest, but they cannot prevent the coin’s owners from connecting those assets to DeFi protocols that do pay interest.
Right now, with US and European interest rates for even basic accounts hovering around 3-4%, it’s worth even paying a small transaction fee to put your assets into a yield-generating DeFi protocol. Earning a 4% APR on $1,000 for 28 days is worth $3.07, much more than the likely cost of converting to and from stablecoins, at least on the most efficient blockchain networks. Obviously, if we return to an era of zero interest rates, the value proposition gradually disappears.
If people end up switching between stablecoins and interest-bearing assets, one concern that could arise in the future is large, sudden movements of money between stablecoins and yield accounts. One could imagine large-scale liquidations as people pay their bills each month, followed by large-scale purchases as people receive income.
At this time, there is little risk of this happening as the asset value and on-chain transaction volume are still small compared to traditional banking. That may not be the case in a few years. As the blockchain ecosystem continues to mature, the ability to execute millions (or billions) of these automated transactions seems more feasible every day. The Ethereum ecosystem already handles around 400,000 complex DeFi transactions each day and thanks to all the Layer 2 networks running on the mainnet, there is a huge amount of excess capacity that remains available for growth.
If, somehow, the ban on stablecoin interest payments is effectively implemented, one potential on-chain beneficiary could be tokenized deposits. Deposit tokens have been overshadowed by the focus on stablecoins, but they are an interesting idea championed by JPMorgan Chase (JPMC). While stablecoins are a bearer asset, a deposit token is a claim on a bank deposit. Since deposit tokens are an on-chain presentation of a bank account, they can offer yield, although they carry counterparty risk.
The current JPMC pilot on Ethereum uses a standard ERC-20 token for the currency, but restricts transfers to an approved list of customers and partners. Users will have to balance the benefits of built-in performance with the restrictions that come with trying to use a permissioned asset on a network without permission.
Interestingly, fights over interest payments on bank deposits are not new. In the wake of the stock market crash of 1929, the United States government dramatically tightened banking and financial regulations. One of the new rules implemented in the Banking Act of 1933, also known as Glass-Steagall, was the prohibition on paying interest on checking accounts.
This ban lasted until 1972, when Consumer Savings Bank of Worcester, Massachusetts, began offering a “negotiable withdrawal order” account. Basically, a savings account that paid interest automatically linked to a deposit account. Within a couple of years, these accounts were generally available nationwide in the United States.
Why did it take so long for banks to find this solution? It was simply not practical before the widespread computerization of the banking system. There will be no such barrier in a blockchain-based world.
Either way, the restriction on paying interest to stablecoin users seems easy to circumvent. Which makes me wonder: why do we choose to repeat history instead of learning from it and simply letting stablecoin providers pay interest like any bank would?
The views reflected in this article are those of the author and do not necessarily reflect the views of the global organization EY or its member firms.
