• The GENIUS Act bans stablecoin issuers from paying yield, but distributors like Coinbase exploit a loophole to offer interest.
• This workaround lets fintechs capture yield from reserve assets, creating a funding edge that drives innovation over banks.
• Banks warn of major deposit outflows and credit tightening, echoing disruption patterns seen after the 2011 Durbin Amendment.

The GENIUS Act includes a key rule that bars stablecoin issuers from paying interest directly to holders. While this provision was likely intended to protect banks from losing deposits, it has unintentionally created a highly profitable regulatory loophole.

The rule carves out a business opportunity for crypto exchanges and fintech distributors. They can now capture this yield and turn it into a powerful engine for innovation.

Bypassing the Stablecoin Yield Ban

A key feature that has sparked significant debate in light of the GENIUS Act has been its ban on stablecoin issuers from paying any interest or yield directly to the person holding the stablecoin. By doing so, the Act reinforces stablecoins as a simple payment method instead of an investment or store of value that competes with bank savings accounts.

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The provision was seen as a settlement feature to keep bank lobbyists content and ensure the GENIUS Act’s passage. However, stablecoin distributors have found a loophole in the legislation’s fine print and are thriving off of it. 

The law only bans the issuer from paying yield but doesn’t prohibit a third party, like a crypto exchange, from doing so. This gap enables a profitable workaround. 

The issuer, which earns interest from the underlying reserve assets like US Treasury Bills, passes that income to the distributor. The distributor then uses this yield as a direct funding source to offer high-interest rewards to users.

Coinbase is a key example of this phenomenon. It receives a portion of the yields issuers like Circle and Tether make for services and customer acquisition. It then offers users holding USDC or USDT on its platform a high annual percentage yield of 4.1%. 

This approach creates a competitive advantage against traditional banks by providing a more attractive yield and user experience. The banking sector has responded to this challenge by voicing clear opposition.

Banks Warn of Massive Deposit Outflows

In August, the Banking Policy Institute urged Congress, which is currently debating a crypto market structure bill, to tighten stablecoin regulations.

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“Without an explicit prohibition applying to exchanges, which act as a distribution channel for stablecoin issuers or business affiliates, the requirements in the GENIUS Act can be easily evaded and undermined by allowing payment of interest indirectly to holders of stablecoins,” the letter read. 

Bank deposits will be hardest hit. In April, a Treasury Department report estimated that stablecoins could lead to as much as $6.6 trillion in deposit outflows. With third-party distributors able to pay interest on stablecoins, the deposit flight is likely greater. 

Because banks rely on deposits as their main source of funding for issuing loans, a decline in those deposits inevitably limits the banking sector’s capacity to extend credit. 

However, banks have faced similar existential threats in the past.

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Lessons from the 2011 Durbin Amendment

According to a thread by FinTech expert Simon Taylor on X, the consequences of the GENIUS Act loophole for banks mirror the effects of the 2011 Durbin Amendment.

Congress passed this legislation to reduce the fees merchants had to pay to banks when a customer used a debit card. Before the Amendment’s passage, these fees were unregulated and high. For banks, this represented a significant and stable source of revenue that funded things like free checking accounts and rewards programs. 

The interchange fee was capped at a very low rate for banks with over $10 billion in assets. The loophole, however, lay in the exception that explicitly excluded any bank with less than $10 billion in assets from the fee cap.

These small, “Durbin-Exempt” banks could still charge the old unregulated fee.

Fintech startups, looking to build low-fee or no-fee consumer products, quickly realized the opportunity. Companies like Chime and Cash App soon started to partner with these small banks to be able to issue their own debit cards.

The partner bank would receive the high interchange revenue and share it with the FinTech company. This significant revenue stream allowed FinTechs to offer fee-free accounts because they earned so much from the shared swipe fees. 

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“Traditional banks couldn’t compete. They were Durbin-regulated, earning half the interchange per transaction. Meanwhile, neobanks partnered with community banks and built billion-dollar businesses on the spread. The playbook: distributor captures value, shares it with customers,” Taylor wrote on X.

A similar pattern is now emerging with stablecoins. 

Will Banks Resist or Adapt?

The loophole in the GENIUS Act for stablecoin distributors enables a powerful new business model that provides a built-in funding source for new competitors. As a result, innovation outside of the traditional banking system will accelerate. 

In this case, crypto exchanges or fintech startups are freed from the cost and complexity of a banking charter. Instead, they focus on consumer-facing aspects like user experience and market growth.

Distributors’ income from the yield passed down to them from stablecoin issuers enables them to offer more attractive customer rewards or fund product development. The result is an objectively better, cheaper, and faster product than the deposits provided by legacy banks.

Though these banks may succeed in closing this loophole with the upcoming market structure bill, history suggests another gap will inevitably appear and fuel the next wave of innovation.

Instead of fighting this new structure with regulatory resistance, the smarter long-term strategy for established banks may be to adapt and integrate this emerging infrastructure layer into their operations. 

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