Around the world, stablecoins are subject to a fairly consistent and convergent regulatory regime. They must be backed by real, high-quality assets, are subject to regular audits, and issuers are prohibited from paying interest on stable balances. The prohibition on interest payments appears in the GENIUS Act in the United States, the Markets in Crypto-Asset Regulations (MiCA) in the European Union as well as similar legislation in Hong Kong and Singapore.
Enforcing the ban on interest payments could prove difficult. One of the main arguments for banning interest payments is the idea that it would help maintain liquidity within the traditional banking system, where regulators and supervisors have greater control over risk management. However, whether the argument is good or not, it is unlikely to be effective and, worse, efforts to circumvent this situation could have unintended consequences.
Although they don’t call it “interest,” some crypto exchanges already offer “rewards” that appear to approximate interest rates for holding assets in stablecoins. Additionally, if no rewards are offered, it is also quite simple to quickly move assets in and out of yield offerings such as AAVE. Some payment services, like Metamask’s Mastercard debit card, will even do this instantly and automatically for you when making a purchase so you can simply leave your assets in a yield-producing bid at any time.
In Europe, the rules embedded in MiCA give regulators greater latitude to prohibit circumventions of the ban on interest payments such as rewards and automated portfolio management. This would prevent stablecoin providers from bundling these types of solutions or offering rewards. However, stablecoins are considered “bearer assets” (e.g., just like cash) in most major markets, which means, among other things, that users can move them around and do whatever they want with them. 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 owners of the coins from connecting those assets to DeFi protocols that pay interest.
Right now, with US and EU interest rates for even basic accounts around 3-4%, even paying a small transaction fee to put your assets into a yield-bearing DeFi protocol is worth it. Earning 4% APR on $1,000 for 28 days is worth $3.07, far more than the likely cost of converting to and from stablecoins, at least on the most efficient blockchain networks. Obviously, if we go back to the 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 and sudden money movements between stablecoins and yield accounts. You might imagine large-scale liquidations when people pay their bills each month, followed by large-scale purchases when people receive income.
Currently, there is little risk as the asset value and volume of on-chain transactions are still low compared to traditional banking. This may no longer 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 by the day. The Ethereum ecosystem already handles around 400,000 complex DeFi transactions every day and thanks to all the Layer 2 networks running on top of the mainnet, there is a huge amount of excess capacity that remains available for growth.
If somehow a ban on stablecoin interest payments is indeed implemented, a possible 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). Where 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 coin but restricts transfers to an approved list of clients and partners. Users will need to balance the benefits of built-in yield with the restrictions of using a permissioned asset on a network without permission.
Interestingly, struggles over payment of interest on bank deposits are not new. Following the stock market crash of 1929, the U.S. government significantly increased banking and financial regulations. One of the new rules implemented in the Banking Act of 1933 – aka Glass-Steagall – was the ban 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 few years, these accounts were generally available nationally in the United States.
Why did the banks take so long to find this solution? This simply wasn’t practical before the widespread computerization of the banking system. Such a barrier will not exist in a blockchain-based world.
Either way, the restriction on paying interest to stablecoin users seems easy to circumvent. Which leaves me wondering: why are we choosing to repeat history instead of learning from it and simply letting stablecoin providers pay the same interest as any bank?
The views reflected in this article are those of the author and do not necessarily reflect those of the global EY organization or its member firms.
