The passage of the GENIUS Act and the ongoing debate around the CLARITY Act have cemented a new reality: stablecoins are becoming a permanent feature of the financial system. Today, the largest issuers collectively hold hundreds of billions of dollars in reserves, much of it invested in short-term U.S. Treasuries. But does backing a digital asset with government debt automatically make it safe?
A new working paper from the Bank for International Settlements (BIS), Making Stablecoins Stable(r): Can Regulation Help?, argues that it does not. Instead, the paper identifies a structural weakness at the heart of the stablecoin business model and proposes a new framework for how regulators should address it.The problem begins with what economists call a liquidity mismatch. Stablecoin issuers promise instant redemption, 24 hours a day, seven days a week. Yet the assets backing those tokens are not always instantly available. While cash can be used immediately, much of an issuer’s reserves are typically invested in interest-bearing assets such as Treasury bills.
The Hidden Vulnerability: Liquidity Mismatch
This creates a powerful incentive problem. Left unregulated, issuers maximise profits by holding as little cash as possible and as many yield-generating assets as possible. The BIS models the resulting behaviour as a “shark-fin” pattern. During normal periods, redemptions are met using a small cash buffer. But when redemptions surge, that cash quickly runs out. The issuer is then forced to sell Treasury holdings into the market. If enough investors redeem at once, those sales can occur at discounted prices, eroding the issuer’s capital and potentially transmitting stress into broader financial markets. In other words, the same Treasury reserves that make stablecoins appear safe can become a source of instability during a digital run.
The BIS Solution: Liquidity and Capital Requirements
The BIS’s proposed solution is a combination of liquidity and capital regulation. Liquidity requirements would force issuers to hold a minimum amount of cash, while capital requirements would ensure they maintain equity capable of absorbing losses. The paper’s most important contribution, however, is not the existence of these requirements but how they should operate.
The Breakthrough Idea: Usable Buffers, Not Hard Constraints
The authors argue that liquidity and capital requirements must function as usable buffers, not rigid constraints. This is a significant departure from traditional regulatory thinking. If an issuer is required to hold cash but is effectively prevented from using that cash during a crisis, the buffer loses its purpose. The BIS demonstrates that strict, inflexible requirements can actually increase the likelihood of failure.
Instead, issuers should be allowed to draw down their buffers during periods of stress. Breaching regulatory thresholds would trigger market discipline, through disclosures, investor scrutiny, or redemption pressure; but not immediate regulatory sanctions. This preserves the stabilising function of the buffers while still encouraging prudent behaviour in normal times.
The paper also uncovers an important asymmetry. Liquidity requirements mainly increase cash holdings. Capital requirements, by contrast, increase both capital and cash, because holding more liquidity reduces the forced asset sales that would otherwise destroy capital during a run.
Why This Matters for the CLARITY Act Debate
These insights speak directly to the CLARITY Act debate. Policymakers are increasingly concerned that stablecoins could become a channel through which shocks spread into Treasury markets. The collapse of Silicon Valley Bank in 2023 offered a real-world warning. When USDC disclosed that part of its reserves were trapped at the bank, the stablecoin briefly lost its peg, demonstrating how quickly confidence can evaporate even when reserves are largely intact.
The Bottom Line
The BIS paper’s message is clear: holding safe assets is not enough. Stablecoins remain vulnerable to runs unless issuers maintain cash and capital buffers that are both adequate and genuinely usable. As lawmakers refine the next generation of stablecoin rules, that lesson may prove critical to ensuring that digital dollars are as stable as their name suggests