Genius wins the Senate

Some welcomed bright lines, but fuzzy edges linger (DeFi, white labelling, and the yield loophole)

If the GENIUS Act clears the House (no small feat) and earns President Trump's signature, we will need further rulemaking, and eventually litigation, to iron out all of the material questions raised by the act’s application to various aspects of crypto operations. In the interim, lawyers will need to navigate ‘tween Scylla and Charybdis, as we are accustomed. A few of the questions that I continue to contemplate include:

Impact on DeFi (issuance and trading)

Issuance

Are decentralized networks that issue payment stablecoins subject to GENIUS? I think that depends. Some of you may be asking why I’m even speaking of GENIUS-governed stablecoins in connection with decentralized issuers. Payment stablecoins are fiat-backed by centrally-managed near-term treasuries and reverse repos, and therefore anathema to DeFi, right? The simple answer: Not exactly.

First, a payment stablecoin is not defined by its reserve management or asset-backing qualities. These are matters of relevance to permitted payment stablecoin issuers. A payment stablecoin, at the asset level, is any token that: (i) ”is, or is designed to be, used as a means of payment or settlement”; (ii) is intended to be convertible, redeemable, or repurchasable for a fixed amount of monetary value by the issuer, at the will of the holder; and (iii) the issuer represents will maintain a stable value relative to the value of a fixed amount of monetary value. That’s it (aside from the requirement that the token also not be a nation’s currency, a bank deposit or a security).

Second, there are projects pursuing the execution of notionally centralized reserve management functions in decentralized environments. Over the next 12 months, that may look like a decentralized issuer “off sourcing” reserve management to an offchain actor or it may involve a project that natively and programmatically manages T-bill portfolios onchain via tokenized treasury products.

Whether a decentralized issuer of a payment stablecoin is subject to GENIUS turns upon the question of whether said issuer is a “person” since, Section 3(a) of the act makes it unlawful for “any person other than a permitted payment stablecoin issuer to issue a payment stablecoin in the United States.” (Emphasis mine).

“Person” is defined expansively: “an individual, partnership, company, corporation, association, trust, estate, cooperative organization, or other business entity, incorporated or unincorporated.” Essentially, anything through which a human might exert agency, whether formally organized or not.

Where a DAO, via governance, elects to issue and support (via secondary liquidity, for example) a payment stablecoin, I believe the DAO would generally be subject to GENIUS, irrespective of whether it is wrapped or unwrapped. Where a payment stablecoin is not issued, supported or managed by the governance of human token holders or a foundation council, however, but rather is issued solely via a peer-to-protocol transaction, then I think there is a very strong argument that the issuance of such a payment stablecoin would not be restricted by, nor subject to, GENIUS. More specifically, where a payment stablecoin is only issued via preprogrammed, non-discretionary response by a smart contract or AI agent to a narrow band of transactional stimuli then I would be hard pressed to credibly argue that such lines of static code amount to a “person” under the act.

The take away is that it is possible (at least arguably) for “payment stablecoins” to be issued in the US by actors not governed by GENIUS.

Trading

DEXs and DeFi lending protocols that fall outside of the definition of “digital asset service provider” are not subject to GENIUS. In other words, such platforms would be able to freely deal in payment stablecoins of non-compliant issuers (without exposure under GENIUS).

This exemption applies to:

• distributed ledgers
  • defined as “technology in which data is shared across a network that creates a public digital ledger of verified transactions or information among network participants and cryptography is used to link the data to maintain the integrity of the public ledger and execute other functions.”
• distributed ledger protocols
  • defined as “publicly available and accessible executable software deployed to a distributed ledger, including smart contracts or networks of smart contracts.”
• immutable and self-custodial software interfaces, which are not further defined
• and operators of:
  • distributed ledgers
  • distributed ledger protocols and
  • self-custodial software interfaces (not defined).

The Rules of Construction relating to Section 3 of Genius (Issuance and treatment of payment stablecoins) potentially offer further evidence of intent carve out DEXs and DeFi lending platforms since it exempts “the direct transfer of digital assets between 2 individuals acting on their own behalf and for their own lawful purposes, without the involvement of an intermediary.” (Section 3(h)(1)(A)). Note, however, that “intermediary” is not defined in Genius and there may be valid arguments on both sides as to whether a smart contract equates to an intermediary for this specific purpose.

So we’ve covered the secondary offer/sale of payment stablecoins by decentralized exchanges and platforms. But what about the secondary offer/sale of decentralized payment stablecoins by centralized exchanges? A payment stablecoin issued by a non-person (as discussed above) would arguably not be subject to GENIUS, but since the digital asset qualifies as a “payment stablecoin” issued by an issuer that is not a “permitted stablecoin issuer,” a CEX (a “digital asset service provider”) would not be allowed to offer the token.

Summing up, the, somewhat potentially wonky, results are that:

• a payment stablecoin must be issued by a permitted payment stablecoin issuer, unless the issuer is a non-person.
• a DEX would be allowed to offer/sell a payment stablecoin, even if its issuer is in violation of GENIUS.
• a CEX would not be permitted to offer/sell a truly decentralized payment stablecoin (after the 3 year grace period) even if it is not violative of GENIUS.

Impact on white labeling

From the very first version of GENIUS, critics fretted over the potential the bill would encourage global technology and consumer goods companies to leverage their massive networks to issue a banking-like product to captive audiences without any of the attendant prudential regulations that entangle banks.

The final version of GENIUS puts that concern to rest (at least with respect to public companies) with the addition of a new Section 4(a)(12) which includes a prohibition against public companies that are not “predominantly engaged” in one or more “financial activities” (as defined in Section 4(k) of the Bank Holding Company Act of 1956) from issuing the a payment stablecoin (unless the public company obtains a unanimous vote of the Stablecoin Certification Review Committee").

After this new prohibition came to light, I saw a few conversations in legal and stable circles turn to whether (and how) this prohibition could be circumvented via white label arrangements. I was one of those initially suggesting that white labeling would not only continue, but would likely accelerate post-passage, to provide fintechs (and possibly even non-fintechs) exposure to stablecoin economics. The more I began to play devil’s advocate, however, the more I began to wonder whether Section 4(a)(7) (limitation on issuer activities) might act as a bar to white labelling.

White labeling comes in numerous flavors, especially with respect to royalty logic, but a generic arrangement would involve a permitted stablecoin issuer issuing a version of its stablecoin wrapped in the IP of another company (for example a video game studio). The issuer would be responsible for GENIUS compliance and all token operations in connection with the GamesCo stablecoin. The stable would fuel economies within the GameCo’s gaming ecosystem and, while the GameCo could not share in the issuer’s reserve interest, it would receive an IP royalty from the issuer (likely one that varied in correlation to outstanding issuer liabilities in order to incent market cap expansion).

Section 4(a)(7)(A) of GENIUS potentially brings the viability of this arrangement into question. It provides that a “permitted payment stablecoin issuer may only:

1. issue payment stablecoins
2. redeem payment stablecoins
3. manage related reserves
4. provide custodial or safekeeping services for payment stablecoins, required reserves, or private keys of payment stablecoins and
5. undertake other activities that directly support any of the activities described in clauses (1) through (4).

Clearly, IP management/reporting/monitoring (all typical activities of a licensee under an IP license) are not contemplated in 1-4 above. Whether they might constitute “other activities that directly support” is likely to be highly fact-sensitive. Additionally, the Rule of Construction relating to this section states: [n]othing in subparagraph (A) shall limit a permitted payment stablecoin issuer from engaging in payment stablecoin activities or digital asset service provider activities specified by this Act, and activities incidental thereto, that are authorized by the primary Federal payment stablecoin regulator or the State payment stablecoin regulator, as applicable…” (Emphases added).

While white label arrangements might reasonably be argued to be “incidental” to permitted activities enumerated in GENIUS, it seems a stretch to me to that such incidental activities would qualify as the type which would be authorized by Federal and State banking regulators. Despite the open question, I believe there is probably a way, with some clever and careful structuring to preserve white label deals unless we get downstream guidance that such activity is strictly non-permitted.

Yield loop hole

The stablecoin yield saga that has played out over the development of this bill has been interesting. My bias is clear to any who know me, or who read this substack. I think GENIUS could very easily have encompassed yield-bearing stables delivering better economics and stronger consumer protections to main street holders than they are left with under this version. Nonetheless, the anti-yield crowd won out. The extent to which they won out is something I have not yet resolved.

The first iteration of GENIUS made no mention of yield, whatsoever. It simply banned permitted stablecoins from being securities. As the yield discussion intensified, the bill was amended in March to include an outright ban of yield/interest at the token level. The final version removed the ban on yield at the token level and replaced it with a ban of delivery of interest at the issuer level. Specifically, Section 4(a)(11) states that “[n]o permitted payment stablecoin issuer or foreign payment stablecoin issuer shall pay the holder of any payment stablecoin any form of interest or yield (whether in cash, tokens, or other consideration) solely in connection with the holding, use, or retention of such payment stablecoin.”

At minimum, this reveals an unequivocal intent to block retail end users from receiving stablecoin yield from issuers. I suspect legislators were briefed on the relative ease with which asset-level yield restrictions could be bypassed via various user programs and commitments.

What is less clear to me is whether this final amendment was also intended to restrict marketing incentive-based distributions of stables by issuers to exchange partners, which is a common industry practice. Section 4(a)(11) prohibits “any form of interest or yield” (Emphasis) (neither interest nor yield are defined) being paid to “any holder.” A literal reading of the text would result in exchange partners being swept up into the plain meaning of “holder” (which is also not defined).

In closing

As ever in crypto, textual analysis is where our job often begins and rarely does it end there. GENIUS delivers some overdue clarity, but leaves just enough ambiguity to keep regulatory risk alive and well across decentralized and hybrid architectures. Between legal personhood, platform exemptions, and yield distribution workarounds, the line between compliance and circumvention may come down not to code or legislative intent, but to who’s holding the bag. For lawyers navigating this terrain, the winds haven’t calmed. They’ve just shifted.