Author: SIMON JOHNSON

Compiled by: 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 U.S. 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 supporting new legislation should be cautious not to reap what they sow.

Unfortunately, the crypto industry has gained such immense political power — primarily through political donations — that the designs of the (GENIUS Act) and (CLARITY Act) aim to prevent reasonable regulation. The likely result is an epic boom-bust cycle.

Historically, the main advantage of the U.S. financial markets compared to other countries lies in 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 firms can undertake.

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 significant disaster) in the 1930s, which have subsequently evolved in a reasonable manner. These rules are the main reasons 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, or even potential emerging industries (like cryptocurrencies), may feel dissatisfied with these rules, claiming they are different from anything the world has seen. However, the risks brought by financial innovation affect the entire financial system, not just individual investors. The focus of regulation is to protect the whole.

Many major economies — including the U.S. — only learned this through painful lessons. Over the past 200 years, they have experienced severe financial turmoil and even systemic collapses. One of these collapses 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 has long been an important policy goal.

However, the (GENIUS Act) does not advance the realization of 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 traditional (non-crypto) financial systems. We should anticipate huge 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 a spread by investing their reserves, and under this legislation, the interest they pay on stablecoins is zero. This gives stablecoin issuers sufficient motivation to invest at least part of their reserves in higher-risk assets for higher returns. This will become a major source of vulnerability, especially when issuers are licensed by loose state-level agencies.

In fact, from a systemic perspective, the major 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 — encounters difficulties, who will intervene, and with what authority to prevent the problem from spreading to the real economy, as was the case in the 1930s?

Simply applying bankruptcy laws 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, as its proponents claim, to maintain the U.S. dollar's status as the global reserve currency and boost demand for U.S. Treasury bonds, why does Clause 15 of the act allow foreign issuers to invest reserves in their own (high-risk) government debts, even if these debts are not denominated in dollars?

It is foreseeable that regulatory agencies in various countries will inevitably acquiesce to or even encourage such operations. What absurd situation will we face then: a so-called 'stablecoin' burdened with dollar redemption obligations, yet its reserve assets largely consist of non-dollar assets — should the dollar appreciate significantly (spoiler alert: liquidity crises, solvency doubts, and bank runs will follow), this absurd asset mismatch will undoubtedly be exposed.

A bigger crisis is still to come — especially if the Senate passes any version of the (CLARITY Act). This legislation will condone conflicts of interest and self-serving transactions, the likes of which have not been seen since the 1920s. More severe are the national security concerns: the (GENIUS Act) and (CLARITY Act) may even facilitate the continuous use of stablecoins (and broader cryptocurrencies) for illegal financial transactions.

The U.S. is likely to become the global cryptocurrency hub, under its emerging legislative framework, a small number of wealthy individuals will undoubtedly become even richer. But as Congress eagerly caters to the demands of the crypto industry, it exposes the U.S. and even the world to the real risk of a financial panic reoccurring — which could lead to severe economic damage, massive unemployment, and wealth evaporation.