The enactment of the Guiding and Establishing National Innovation for U.S. Stablecoins (GENIUS) Act established the nation’s first federal prudential framework for “payment stablecoins,” mandating 1:1 reserve backing and explicitly prohibiting issuers from paying interest.[1] This legislative bargain was clear: Stablecoins would receive a formal regulatory status in exchange for operating solely as neutral payment instruments. However, the statute’s silence on the activities of third-party intermediaries has spawned regulatory arbitrage.[2]

Digital-asset service providers, particularly major centralized exchanges, now offer “rewards” on stablecoin holdings that are economically indistinguishable from the interest payments Congress sought to prohibit.[3] In a new paper, I argue that the yield-restriction provision in the latest draft of the Responsible Financial Innovation Act (RFIA) is not a novel constraint but a necessary correction that closes this unintended loophole in the GENIUS framework.[4] By restricting yield to specific “identifiable activities,” the RFIA seeks to restore the original policy bargain and prevent the emergence of an unregulated shadow-banking system.

The Macroeconomics of Deposit Flight and Credit Contraction

High-yield stablecoin rewards programs create a powerful incentive for deposit flight, siphoning low-cost retail deposits away from banks. Analysis suggests that if such rewards remain unrestricted, the banking system could face a contraction in lending capacity exceeding $1.5 trillion.[5] This risk falls hardest on community banks, which depend on retail deposits to fund relationship-based lending to small businesses and farms.[6] Rather than a simple shift in financial intermediation, the migration of these core deposits would represent a net contraction in the credit most vital for local economic growth.

The “Identifiable Activity” Filter

The RFIA’s corrective mechanism creates a legal taxonomy to distinguish permissible from prohibited yield. The draft legislation permits rewards only when they are generated by and directly tied to an “identifiable activity” undertaken by the holder, fundamentally banning compensation for the passive holding of a stablecoin asset.[7]

• Permissible “Transactional Rewards”: The first permissible activity is staking or transaction validation, where a user commits assets to participate in the consensus mechanism of a proof-of-stake blockchain network. The reward is compensation for performing the identifiable, verifiable work of securing the network. The second category is direct liquidity provision, where a user deposits assets into a transparent, on-chain liquidity pool (e.g., an automated market maker on a decentralized exchange) to facilitate peer-to-peer trading. The yield here is generated from identifiable trading fees paid by other network participants.
• Prohibited “Passive Interest”: Any reward program that generates returns from the opaque reinvestment of user assets by a centralized intermediary falls on the prohibited side of the line. This includes the prevailing model where an exchange, acting as a custodian, aggregates user stablecoins and earns yield through off-chain lending, repurchase agreements, or proprietary trading.[8] The user performs no identifiable network service; the user’s return is purely a function of the platform’s investment skill and risk-taking, making the program a deposit substitute in all but name. The distinction is crucial: It seeks to ensure yield is a payment for service within a transparent protocol, not a return on capital managed by an opaque intermediary.

This legal filter exposes the core of the current arbitrage. As analyzed, platforms like Coinbase market “rewards” for holding USD Coin in custodial wallets.[9] Under the Uniform Commercial Code framework adopted in their own user agreements, the exchange, not the end customer, is the legal “holder” of the asset.[10] When a stablecoin issuer like Circle shares reserve income with the exchange based on custodial balances, it is effectively paying interest to the holder, a practice that appears to contravene the GENIUS Act’s intent.[11] The RFIA’s activity filter would render such arrangements non-compliant, forcing a fundamental restructuring of the stablecoin yield market.

Financial Stability and the Ethena Case Study

The October 2025 de-peg of the Ethena (USDe) “synthetic dollar” protocol is a powerful case study.[12] USDe’s high yield was generated not from identifiable user activity but from a complex and fragile derivatives strategy (funding “cash and carry” trades). When cryptocurrency volatility spiked and funding costs inverted, the protocol’s economic model broke, triggering a loss of peg and a rapid digital-bank run as users raced to redeem. This event illustrated several critical dangers: the extreme sensitivity of algorithmic yield models to market stress and the potential for contagion as forced liquidations spill over into correlated markets. While USDe was not a GENIUS Act-regulated payment stablecoin, its collapse exemplified the risk the RFIA seeks to preempt: the emergence of high-yield, deposit-like crypto products whose failure could force fire sales of underlying assets (e.g., U.S. Treasuries) and transmit instability to the core financial system, echoing the dynamics of the 2008 money market fund crisis.[13]

The Consumer Welfare Paradox

The RFIA’s firewall presents a consumer welfare trade-off. Proponents argue it establishes a crucial safety floor, preventing the “yield-chasing” behavior that led to catastrophic losses on platforms like Celsius and the Terra/Luna collapse.[14]

Critics, however, contend the approach is overly paternalistic and protectionist. They argue it deliberately stifles innovation to shield traditional banks from competition, forcing consumers to accept near-zero interest on bank deposits while denying access to alternative returns in a higher interest-rate environment.[15] Furthermore, they warn the “activity” requirement may backfire, pushing retail users toward complex, non-custodial DeFi protocols or unregulated offshore entities to seek yield, potentially increasing exposure to technical and smart contract risks. The challenge is to guide innovation toward transparent models, not merely restrict it.

Toward a Coherent and Level Playing Field

The yield-restriction provision in the RFIA draft is necessary to close the unintended arbitrage created by the GENIUS Act’s focused scope. For a genuine consumer benefit, this must be part of a broader strategy. The firewall should be coupled with regulatory modernization that allows traditional banks to compete more effectively, perhaps through the development of novel, transparent digital asset services. Ultimately, the goal should be a coherent financial architecture that closes loopholes and allows  competition over yield to occur on a level playing field defined by equitable access to financial infrastructure.

ENDNOTES

[1] Guiding and Establishing National Innovation for U.S. Stablecoins (GENIUS) Act, Pub. L. No. 119-27, § 4(a)(11), 139 Stat. 419, 425 (2025).

[2] See Lee Reiners, Circle, Coinbase, and the Prohibition on Interest Under the GENIUS Act, CLS Blue Sky Blog (Dec. 11, 2025), https://clsbluesky.law.columbia.edu/2025/12/11/circle-coinbase-and-the-prohibition-on-interest-under-the-genius-act/ (analyzing the statutory silence that enables third-party “rewards”).

[3] See, e.g., Brookings Institution, Interest by any other name should be regulated as sweetly 2 (Sept. 10, 2025), https://www.brookings.edu/articles/interest-by-any-other-name-should-be-regulated-as-sweetly/ (noting Coinbase markets “4.1% rewards” for holding USDC); Adam Willems, The Loophole Turning Stablecoins Into a Trillion-Dollar Fight, Wired (Sept. 3, 2025), https://www.wired.com/story/genius-act-loophole-stablecoins-banks/.

[4] Lummis-Gillibrand Responsible Financial Innovation Act, S. ___, 119th Cong. § 403 (Draft 2026) [hereinafter RFIA Draft].

[5] Andrew Nigrinis, Study: Deposit Flight Driven by Interest-Paying Stablecoins Would Hit Community Banks Hardest, BPI Insights (Oct. 18, 2025), https://bpi.com/bpinsights-october-18-2025/.

[6] Id.

[7] RFIA Draft, supra note 4, § 403(b) (defining “qualified staking or transactional reward”); See also Sarah Wynn, Senate Banking Committee’s Crypto Market Structure Bill Text Sets Up Showdown Over Stablecoin Rewards, The Block (Jan. 13, 2026), https://www.theblock.co/post/385427/senate-banking-committee-crypto-market-structure-bill-text-showdown-stablecoin-rewards.

[8] See Brookings Institution, supra note 3, at 3 (comparing the model to money market mutual funds and noting the lack of guardrails).

[9] Reiners, supra note 2.

[10] Id. (analyzing Coinbase’s User Agreement designating it as a “securities intermediary” under U.C.C. Article 8).

[11] Id. (arguing Circle’s payments to Coinbase based on USDC holdings likely violate the GENIUS Act’s prohibition on issuers paying interest to holders).

[12] See generally David Krause, The Hidden Fault Line: How Centralized Exchange Infrastructure Amplifies Stablecoin Risk, ResearchGate 8-12 (Oct. 31, 2025), DOI: 10.13140/RG.2.2.10064.98567 (analyzing the Ethena (USDe) de-pegging event of October 2025 as a case study in synthetic yield risk).

[13] Brookings Institution, supra note 3, at 4–5 (drawing direct parallels to the role of money market mutual funds in the 2008 financial crisis).

[14] See Jiageng Liu, Igor Makarov & Antoinette Schoar, Anatomy of a Run: The Terra Luna Crash (Nat’l Bureau of Econ. Rsch., Working Paper No. 31160, 2023) (concluding absence of regulation encourages market-driven monitoring).

[15] Cf. Blockchain Association, Letter to Senate Committee on Banking, Housing, and Urban Affairs Regarding Stablecoin Rewards Provisions in the RFIA 3–4 (Dec. 18, 2025) (arguing restrictions limit consumer choice and innovation).

David Krause is an emeritus associate professor of finance at Marquette University.