Stablecoin - Regulation and Interest Mechanics

Policy and Regulatory Issues in Stablecoins Introduction Stablecoins operate at the intersection of cryptocurrency innovation and government financial oversight. As stablecoins have grown in adoption and use, regulators worldwide have begun implementing frameworks to address both the opportunities and risks they present. This section explores the major regulatory concerns driving policy decisions, the specific frameworks different jurisdictions have implemented, and how regulations address the question of whether stablecoins should generate returns for their holders. Major Policy Concerns Money Laundering and Terrorism Financing Regulators have identified stablecoins as a growing concern for financial crime. Stablecoins facilitate illicit activities through three key characteristics: liquidity (they can be quickly converted to other assets), cross-border ease (they move across countries without traditional banking infrastructure), and price stability (their fixed value makes them easier to value in criminal transactions). <extrainfo> The Financial Action Task Force and United Nations reports have specifically flagged Tether USD (USDT) as a tool favored by organized crime groups in East and Southeast Asia for cyber-fraud and money laundering, highlighting how stablecoins with established market infrastructure can become vehicles for financial crime. </extrainfo> Erosion of Monetary Sovereignty When a foreign currency-backed stablecoin (particularly US dollar-pegged stablecoins) becomes widely adopted, it can undermine a country's ability to control its own monetary policy. Central bank officials in South Africa, France, and other regions have warned that widespread adoption of dollar-backed stablecoins could weaken their domestic currencies' demand and reduce the effectiveness of their monetary policy tools. This concern prompted discussions around legislation like the US GENIUS Act, which paradoxically raised concerns among European policymakers about the dominance of the dollar through a new regulatory structure. <extrainfo> Russia's attempt to launch the A7A5, a rouble-pegged stablecoin, was explicitly designed to circumvent international sanctions and enable cross-border payments despite financial restrictions—demonstrating how stablecoins can be weaponized to avoid regulatory controls. </extrainfo> Global Regulatory Frameworks Different countries have taken markedly different approaches to stablecoin regulation, reflecting their economic priorities and institutional structures. China's Approach China takes the most restrictive stance: stablecoins are declared illegal, and the country has explicitly banned the issuance of Renminbi-denominated stablecoins. Chinese authorities treat the issuance of currency-linked instruments as an exclusive function of the government and central bank. This reflects a broader principle that stablecoin issuance directly competes with sovereign monetary authority. The European Union's Regulatory Framework The European Union's Markets in Crypto-Assets Regulation (MiCAR), which became effective on June 30, 2024, created the world's first comprehensive harmonized regulatory regime for stablecoins. Key features include: Reserve requirements: Stablecoin issuers must hold 100% of the reference asset in reserve (meaning if they issue one million dollars of USD-stablecoin, they must hold exactly one million dollars in actual assets) Cross-border operations: Issuers must obtain a "passport" to operate across multiple EU member states Unified supervision: MiCAR creates consistent rules across all EU member states, preventing regulatory arbitrage (issuers shopping for lenient regulators) United States Approach The US passed the GENIUS Act in July 2025, which represents a permissive but structured approach. The law allows banks and financial institutions to issue fiat-backed stablecoins or stablecoins collateralized by high-quality assets such as US Treasury securities. This framework legitimizes stablecoins while ensuring they're backed by real, stable assets. <extrainfo> An interesting economic side effect: Federal Reserve officials have noted that stablecoin adoption increases demand for US Treasuries, which slightly lowers three-month Treasury bill yields by approximately 2 to 2.5 basis points. This reflects how even regulatory decisions in one currency's stablecoin market can have measurable macroeconomic effects. </extrainfo> Japan's Bifurcated Approach Japan's Financial Services Agency makes a key regulatory distinction based on backing type: Fiat-backed stablecoins require issuers to register and meet regulatory requirements Algorithmic stablecoins (those without full fiat backing) are treated as regular crypto-assets and have no registration requirement This approach reflects different risk assessments—Japan treats fiat-backed stablecoins as more systemically important because they're meant to function as money. Singapore's Reserve Framework Singapore's Monetary Authority finalized a Stablecoin Regulatory Framework in November 2023 with a straightforward core requirement: issuers must hold reserve assets denominated in the same currency as the stablecoin's peg. This ensures the stablecoin remains fully backed and redeemable at its stated value. United Kingdom Policy The Bank of England has called for stablecoins to be regulated like traditional money, emphasizing the need for robust oversight to protect financial stability and consumers. This reflects the principle that if stablecoins function like money, they should be regulated like money. The Interest-Rate Question: Why Stablecoins Don't Pay Yield One of the most important and sometimes confusing aspects of stablecoin regulation involves whether stablecoins can pay interest to their holders. Understanding this requires knowing how financial regulation categorizes different instruments. Why Most Stablecoins Don't Pay Interest Most stablecoins do not pay interest to holders because doing so would fundamentally change their regulatory classification. If a stablecoin pays interest, regulators classify it as a financial security rather than a payment instrument or money substitute. This classification subjects it to much stricter regulation—similar to bonds or investment funds. This creates a regulatory trap: the moment a stablecoin pays yield, it loses the permissive regulatory treatment available to simple payment stablecoins. As a result, stablecoin issuers must choose between: Non-interest-bearing stablecoins → simpler regulation, but cannot offer returns Yield-bearing stablecoins → can offer returns, but face security regulation and stricter compliance requirements Explicit Prohibition of Yield-Bearing Stablecoins Multiple major jurisdictions have resolved this question by explicitly prohibiting regulated issuers from offering yield-bearing stablecoins. The US GENIUS Act, the EU's MiCAR, and Hong Kong's Stablecoin Bill all contain clauses preventing regulated stablecoin issuers from offering yield on payment stablecoins. Australia takes a different approach: the country treats yield-bearing stablecoins as managed investment schemes, placing them under investment fund regulation. Alternatives for Earning Yield on Stablecoins Even though stablecoins themselves don't pay interest, users haven't been left without options for generating returns. However, these alternatives operate differently and carry different risks. Yield Through Crypto-Asset Service Providers Some crypto-asset service providers have found a workaround: they allow users to earn interest by lending their stablecoins to institutional borrowers. The service provider shares the earnings with the user after deducting a management margin. However, this strategy faces regulatory restrictions: The European Union and Hong Kong prohibit crypto-asset service providers from offering such yield on payment stablecoins Singapore permits these arrangements only for institutional investors and under strict conditions The regulatory hesitation reflects concerns about consumer protection—lending stablecoins introduces counterparty risk that pure holding does not. Yield Farming on Decentralized Finance Platforms A second alternative is yield farming: users can supply stablecoins as liquidity on decentralized finance (DeFi) platforms and receive a share of the transaction fees generated by traders using that liquidity pool. Important caveat: Yield farming is not risk-free. Participants in yield farming are effectively lending assets into a protocol, and they can suffer losses if the protocol fails. The most notable example is the Anchor protocol, which offered extremely high yields (around 20%) on TerraUSD stablecoins. When Terra collapsed in 2022, investors lost their entire stablecoin deposits. This demonstrates that the returns in yield farming come from real economic risk—there is no free yield.