New US Encryption Legislation: Opportunities and Risks Coexist

Recently, the United States passed the important digital currency legislation known as the GENIUS Act, while the CLARITY Act has also been approved by the House of Representatives. These initiatives position the U.S. to become a major hub for encryption activities. However, proponents of the new legislation should proceed with caution to avoid counterproductive outcomes.

The encryption industry has gained significant political influence through political donations and other means. Therefore, the design of these new bills seems intended to obstruct reasonable regulation, which could lead to a severe boom-bust cycle.

Historically, the main advantage of the U.S. financial markets has been their relatively high transparency, which allows investors to better understand risks and make informed decisions. Additionally, the U.S. has established strict anti-conflict of interest regulations that require fair treatment of investors and limit the risks that financial companies can undertake.

This regulatory framework did not form by chance, but is the result of wise laws and regulations established after the Great Depression in the 1930s, and has continued to evolve since then. These rules are a major reason why the United States has become a startup and innovation-friendly country.

Although some entrepreneurs or emerging industries may be dissatisfied with these rules, the risks brought about by financial innovation affect the entire financial system. The focus of regulation is to protect the overall interests. Many major economies have experienced severe financial turmoil, one of which led to the Great Depression that began in 1929. Avoiding a repeat of this has always been an important policy goal.

However, the "GENIUS Act" does not seem to advance the realization of this goal. The Act creates a framework for stablecoins issued by U.S. and foreign companies. Stablecoins are an emerging digital asset designed to maintain a stable value against a specific currency or commodity. They are useful for cryptocurrency traders and may also be favored by non-financial companies looking to bypass existing payment systems.

The business model of stablecoin issuers is similar to that of banks, as they earn interest rate spreads by investing reserve funds. New legislation may incentivize issuers to invest a portion of their reserves in high-risk assets to achieve higher returns, which will become a major source of vulnerability.

From a systemic perspective, the main flaw of the "GENIUS Act" is its failure to effectively address the inherent run risks of stablecoins, as it restricts the ability of regulatory agencies to implement robust safeguards. How to prevent issues from spilling over into the real economy when any stablecoin issuer encounters difficulties remains an unresolved question.

It is worth noting that the bill allows foreign issuers to invest their reserves in non-dollar assets such as high-risk government debt in their own countries. This could lead to asset mismatches and trigger a liquidity crisis and a run on the bank when the dollar appreciates significantly.

If the Senate passes any version of the CLARITY Act, the situation could become even more severe. This legislation could condone unprecedented conflicts of interest and self-serving transactions since the 1920s. More concerning is that these bills could facilitate the use of stablecoins and even broader encryption for illegal financial transactions.

While the United States may become the global encryption currency center, the new legislative framework may benefit a few while exposing the U.S. and the world to the risk of a recurrence of financial panic. This could lead to severe economic damage, resulting in mass unemployment and wealth evaporation.