Banks Are TERRIFIED of This Crypto Loophole (And They Can't Stop It)

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My name is Guy and if you're seeking unbiased in-depth information about Bitcoin,

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I hope you enjoy today's episode.

Banks and crypto used to wage their regulatory battles behind closed doors.

Well, not anymore. The fight is completely in the open now,

and it's getting hairy. Previously, the battle was over whether crypto was legal.

This time, it's about whether crypto can pay interest,

and that's a fight banks absolutely cannot afford to lose.

JP Morgan, the American Bankers Association, Coinbase, and Circle are at war

over a technical loophole in the Genius Act.

The law that was supposed to legitimize stablecoins,

but accidentally turned yield into a new battlefield.

Banks say stablecoin yield will drain trillions from the financial system.

Crypto says banks should compete on price, not regulation.

It's a trillion dollar fight over who gets to hold the American savings account in the 21st century.

Banks have figured out that if they lose this battle, they don't just lose customers.

They lose the ability to create money through fractional reserve lending,

and they're not about to take that sitting down.

My name is Lewis and you're watching the Coin Bureau.

Now, before we get into it, you need to know that nothing in this video is financial advice.

This is just our take on the new regulatory showdown between banks and crypto,

and what it means for the financial system.

If you find our videos useful, we'll smash that like button and let's dig in.

So, last summer, President Trump signed the Guiding and Establishing National Innovation for

US Stablecoins Act. Quite the mouthful, but they got the acronym they wanted.

The Genius Act, as so it's called, was supposed to end the regulatory chaos around Stablecoins.

That should mean no more exchanges exiled off shore.

No more questions about whether Circle was operating a shadow bank,

and hopefully no more Terra implosions wiping out billions overnight.

The law brought issuers like Circle and Paxos within the Federal regulatory perimeter

and with clear rules.

The core stipulation is a one-to-one reserve requirement for dollar-piged Stablecoins.

So, for every unit of USDC or other dollar-stablecoins in circulation,

there must be a physical dollar or short-term treasury bill, 90 days or less,

held in a segregated account. Lending or reinvestment of this collateral is also forbidden.

So, there should be no fractional reserve shenanigans.

Unlike traditional banks, which can lend out 90% of deposits and only keep 10% on hand,

Stablecoin issuers must maintain full liquidity at all times.

This is the safety mechanism designed to prevent another Terra-style algorithmic collapse.

To get the bill passed, the banking industry demanded a huge concession.

The act explicitly prohibits Stablecoin issuers from paying interest directly to holders.

This was specifically done to pigeon hold Stablecoins as payment instruments

and stop them from doubling as investment products that could compete with savings accounts.

The banks want Stablecoins to be dumb pives for moving money, nothing more.

However, it looks like they didn't think the language all the way through,

because there's a pretty glaring loophole in the Genius Act.

The provisions about paying interest directly to holders are binding on Stablecoin issuers,

like Circle, Ripple, PayPal, and so on and so forth.

But there is no explicit mention of Stablecoin distributors.

There is nothing in the act to prohibit third-party intermediaries from taking the revenue generated

by those treasury reserves and passing it through to users.

Now, who might those intermediaries be?

Oh, well, I don't know. Maybe crypto exchanges?

You know, the places where most people actually get their Stablecoins?

So, maybe issuers can't pay interest.

But what if, say, Coinbase starts paying rewards or loyalty incentives

funded by that same treasury interest?

Well, apparently, it's that easy to throw to America's banking sector.

Crypto exchanges spotted this workaround a mile off,

and started offering annual percentage yields on Stablecoin holdings of four to five percent.

Banks called this loophole.

Crypto calls it innovation.

Either way, it's now the core battleground in the war between Trafi and crypto.

Banks got the regulatory framework they wanted.

They just didn't get the outcome that they expected.

Now, it's worth taking a moment to trace the money and see yield bearing Stablecoins work.

Say you've got $100, and you want to park it somewhere safe.

You open a crypto exchange, let's use Coinbase as an example,

and you buy $100 worth of USDC, and you just leave it there.

The issuer of USDC, Circle, takes your $100 and buys treasury bills yielding around 5 percent.

That's the current risk-free rate the US government pays on short-term debt.

Now, Circle doesn't just sit on that 5 percent yield.

They've got revenue sharing agreements with the exchanges that list their stablecoin.

So, Circle pays Coinbase a marketing fee or distribution incentive.

Call it what you want, sourced from that treasury yield.

Then Coinbase turns around and passes roughly 4.5 percent of that

through to you as rewards for holding USDC on their platform.

To you, this looks and functions exactly like a high yield savings account.

You see 4.5 percent APY accruing daily.

You can move the money instantly.

It's got the liquidity of a checking account with a yield of a certificate of deposit.

The only thing missing is FDIC insurance.

But given that the reserves are supposed to be held one to one in treasuries,

the risk profile is arguably better than a regional bank anyway.

And here is where the semantic food fight begins.

Banks look at this flow and call it regulatory arbitrage.

They say it's interest by another name, a duck that quacks like interest,

walks like interest, and pays like interest.

The crypto industry insists these are activity-based rewards.

They're compensating users for network participation,

for providing liquidity, for marketing loyalty.

To the regulator trying to parse the law, it's a marketing incentive.

To the user watching their balance grow, it's obviously interest.

And if it's not clear yet, why banks care so much about this?

Well, let's take a look at the competitive spread.

Traditional US banks pay 0.01 percent on checking accounts.

Some of the big ones are slightly more generous with a savings account,

maybe 0.5 percent if you're lucky.

Stablecoins have been paying 4.5 percent.

Banks can't compete on price because of their cost structures.

Branch networks scattered across the country,

armies of compliance staff, deposit insurance premiums,

legacy IT systems held together with duct tape and prayers.

So, instead of competing on price,

they're lobbying to suppress the competition via regulation.

Ban the yield.

Banished stablecoins back to the dumb payment rails from once they came.

But for Coinbase, this isn't some nice to have feature

that they could just compromise away.

With trading fees getting compressed by competition from other crypto exchanges

and platforms like Robinhood,

yield pass-through model has become a critical source of revenue.

Regulating it out of existence,

threatens the core economics of their platform model.

That's why they suddenly walked away from the Clarity Act

when they saw what was in it.

The scale of what's at stake becomes clear when you run the numbers.

Circle has approximately 70 billion in collateral

backing USDC.

At 5% yield, that generates $3.5 billion in annual revenue

without taking any credit risk or making a single loan.

And when you're printing billions from doing basically nothing,

you're going to fight to keep that business model.

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Now, I know what you're thinking.

Oh no, won't somebody think of those poor banks' profits?

How will they cope?

Now that their customers can earn more interest on their savings

than the Cheeto does that they've been paying out?

Trust me, I feel you.

But it is worth listening to their argument

because, well, there are interesting macroeconomic implications here

beyond their own margins.

The banks have been making a case

about the mechanics of credit creation

and what happens to the financial system

when deposits migrate from fractional reserve banks

to fully reserved stablecoins.

The core concern is something called deposit substitution.

Traditional banks rely on what you might call sleepy deposits.

All those checking accounts paying 0.01%

that customers leave sitting there

out of inertia or convenience.

Banks use these deposits as cheap funding to make mortgages,

small business loans, and other forms of private credit.

The spread between what they pay to positors

and what they earn on loans is how they make money.

If rational actors wake up and move those funds

to stablecoins paying higher yields,

banks lose their cheap funding base.

And when funding costs rise, lending capacity contracts.

This phenomenon was modeled last year

by the economist and federal reserve board of governors,

member Jesse Wang.

In a research note titled,

Banks in the Age of Stablecoins,

she shows a money multiplier effect working in reverse.

For every dollar that leaves a bank deposit for a stablecoin,

bank lending drops by $1.26.

In a high adoption scenario, Wang's model predicts

the aggregate supply of credit in the US

could decline by $600 billion to $1.26 trillion.

Several research by economist Jeff Hutter and Yikai Wang

for the American Bankers Association

puts numbers on the funding cost problem.

If stablecoin adoption hits $2 trillion,

banks will need to replace cheap deposits

with expensive wholesale funding,

raising their cost of funds by 24 basis points.

If stablecoins can pay interest

and adoption reaches $4 trillion,

that jumps to 42 basis points.

Jesse Wang's Fed research shows

that banks will pass approximately 60%

of these increased funding costs directly to borrowers

through higher interest rates.

This would hit mortgages

and small business lending hardest.

Firstly, because they're not able to bypass this

by, say, issuing bonds like large corporations can.

And also, because there's are the banks' least profitable loans,

the loans that get cut first

when funding gets expensive.

All of this gets at the broader macroeconomic concept

banks keep talking about, the narrow bank problem.

Stablecoins function as narrow banks.

They take deposits, but hold 100% liquid assets

in the form of treasuries instead of making loans.

This removes capital from what economists call

the money multiplier.

When you deposit $100 in a traditional bank,

that bank lends out $90,

which gets deposited somewhere else,

which gets lent out again and so on and so forth.

Your initial $100 creates several hundred dollars

of credit in the broader economy.

But when you put $100 into a stablecoin,

it sits in a treasury bill and goes nowhere.

Money in a stablecoin backs federal debt.

Money in a community bank backs local businesses

and, by extension, local jobs.

If everyone moves to stablecoins,

it's great for funding the US deficit,

but terrible for getting a loan

to build something productive.

The independent community bankers of America

warns that $6.6 trillion in transaction deposits

are at flight risk.

The pitch is that every dollar that flows

from a community bank to a stablecoin

is a mortgage that doesn't get rid.

A small business loan that doesn't happen

and so on and so forth.

Is it bank propaganda?

Well, absolutely, but is it true?

Well, quite possibly.

Mass adoption of stablecoins as a savings vehicle

could well sterilize capital from productive lending

into sovereign debt financing.

And that implies a structural shift

where the US economy becomes dependent on federal borrowing

rather than provide credit creation.

The banks even have an intellectual sparring partner

to point to paradigm, the crypto venture capital firm.

They recently joined Coinbase and PayPal

in funding research that claims stablecoins

are neutral for bank lending,

meaning that they don't actually reduce credit supply.

Paradigm held this finding in a blog post

only to have the posts savaged by the bank policy institute

on the grounds that the research was a misrepresentation

of data that actually pointed to a much more negative conclusion.

That study funded by Paradigm at all

is based on earlier modeling

that shows yield bearing stablecoins are neutral

for bank lending so long as they exist only

as a hypothetical competitive threat to banks

and are not actually in circulation.

In such a scenario, banks might see the threat on the horizon

and get nervous about losing their customers.

To prevent people from leaving,

they might proactively raise their own deposit interest rates

or increase their lending to capture more of the market

while they still can.

But the model shows that if yield bearing stablecoins

are actually launched, circulating

and offering four to five percent rewards,

rational customers would draw their bank deposits

and park the money in stablecoins instead.

Since those deposits are the bank's source of funding

for loans in the fractional reserve model,

their ability to lend is drained a dollar for dollar

or if you adopt Jesse Wang's model,

dollar for $1.26.

So as the BPI points out,

Paradigm is making a weird flex here

because if you check out the data the research they funded is based on,

it shows that the moment stablecoins achieve real adoption,

they suck liquidity out of the traditional system,

increasing the bank's cost of funds

and reducing the total supply of credit.

And whether you think this is a legitimate concern

or a protectionist fear of mongering probably depends on

whether you think fractional reserve banking

is a critical economic infrastructure

or a rent-seeking arrangement that deserves to be disrupted.

Okay, so the banks don't like yield on stablecoins

and they want us to be scared.

They dunked on Paradigm pretty hard,

but fortunately for crypto,

the industry has other stronger arguments

and favor of yield-bearing stablecoins.

The core argument from Brian Armstrong and others at Coinbase

is pretty straightforward.

Banks have enjoyed a government granted monopoly

on low risk yield for decades.

They take your deposits, earn 5% from the Federal Reserve

on those same reserves, pay you back 0.5% if you're lucky

and they just pocket the spread.

That's a structural advantage

baked into the regulatory framework for an industry

that has apparently had little incentive to innovate.

Stablecoins in crypto is telling simply close that gap

by passing the treasury rate through to the end user.

Armstrong's position is that the banks are the ones

distorting the market

and stablecoins are actually correcting it.

Circle, for their part, have framed this

as a matter of dollar dominance.

Their argument is essentially,

if the US banned stablecoin yield,

the market doesn't disappear.

It moves offshore.

European platforms operating under MECA regulations

can still offer yield.

Tether, which is already the largest stablecoin

by market cap, operates outside US jurisdiction entirely.

If American consumers can't earn treasury rates

on their digital dollars domestically,

they'll find a way to do it somewhere else.

Circle's position is that this doesn't just hurt crypto.

It actively undermines the dollar's position

in the digital currency war by pushing demand away

from US regulated products

and towards less transparent alternatives.

Interestingly, the crypto industry

isn't entirely unified here.

Tether CEO Paulo Ardoino has publicly stated

that Tether doesn't have, quote,

much beef in this fight because it doesn't share yield.

The yield battle is primarily Coinbase's war

because Coinbase is the one whose business model

depends on passing treasury yield

through to US-based customers.

For offshore issuers, a US yield ban is actually good news.

It sends American consumers looking for alternatives.

Then there's the technical argument

about what yield actually is in crypto.

The industry draws a sharp line

between passive interest and rewards for services.

When you stake assets on a proof of stake network,

you're not just sitting on your hands,

you're validating transactions, securing the network

and providing a technical service.

Compensation for that work is categorically different

from a bank paying you to leave money

in a savings account.

Crypto's position is that lumping all yields together

as interest shows a fundamental misunderstanding

of how these networks function

and that regulating staking rewards out of existence

would gut the DeFi ecosystem.

The consumer argument is the simplest one

and probably the most politically potent.

Why should access to risk-free treasury rates

be restricted to institutions and wealthy investors?

Banks earn that rate on your money

and they keep most of it.

Stable coins pass it through.

If someone wants to hold digital dollars

and earn what the government actually pays

on short-term debt,

what market failure justifies stopping them?

So that's where both sides stand.

Banks warning about systemic credit contraction.

Crypto arguing it's about efficiency and consumer choice.

And right in the middle,

Congress tries to settle it with the Clarity Act,

which would have explicitly banned exchanges

from paying yield solely for holding a stable coin.

Coinbase, however,

took one look at the tax and walked away

and the Senate Bank of Committee canceled the markup.

The White House was reportedly furious.

So the Genius Act solved the safety problem

but created a competition problem.

The Clarity Act then proved neither side

is willing to blink.

The question that remains is this,

does the US financial system stay bank-centric

where deposits fund private credit

or does it shift toward a narrow bank stable coin model

where digital dollars back to sovereign debt

and banks have to compete for customers like everyone else?

We make it an answer this year

and maybe sooner or rather than later.

So make sure you're subscribed

and keep your eyes peeled on this channel

because we'll keep you updated every step of the way.

That's it for me for now though.

As always, thank you so much for watching.

The Spin Lewis and I'll see you in the next video.

Hello, Guy again.

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