Insolvency for Payment Stablecoin Issuers

This is the first in a series of blog posts investigating the GENIUS Act’s insolvency provisions and offering considerations for those interested in issuing payment stablecoins.

By Doug Landy & Todd Phillips

Although all permitted payment stablecoin issuers (PPSIs) are regulated by the GENIUS Act, organizers’ choice of corporate charter carries significant consequences. Charter selection affects not only the activities a PPSI may undertake, but also how insolvency is addressed. This decision can have significant implications for the holders of its payment stablecoins, as well as organizers’ reputations and legal risk.

The Corporate Charter Question

For nearly two centuries, banks have been unique in that they usually cannot organize under states’ general incorporation laws.(1)Whereas most corporate organizers apply to secretaries of state for licenses and are subject to general corporate laws, banking organizers must obtain charters from the OCC or state banking commissioners and are subject to state banking laws or the National Bank Act. 

Among the many effects of this bifurcation is how the law treats institutions’ insolvency. Insolvent corporations are generally placed into bankruptcy and dealt with according to the federal bankruptcy code. Insolvent banks are placed into receivership by their regulators and resolved outside the bankruptcy process, generally by the Federal Deposit Insurance Corporation. Insolvent corporations can declare bankruptcy; insolvent banks cannot delay creditors with voluntary insolvency.

Three Options for PPSI Insolvency

Although the GENIUS Act requires PPSIs to be regulated by federal or state banking regulators, it does not require them to obtain banking charters. PPSIs can be run-of-the-mill corporations (or LLCs, partnerships, or any other business form). In addition, the GENIUS Act prevents insured banks from issuing payment stablecoins directly, instead requiring them to do so only through nonbank subsidiaries (or via nonbank affiliates). Organizers of a PPSI therefore have three options for chartering, each with a different treatment of insolvency and a different consequence for customers.

Subsidiary of an Insured Bank: The GENIUS Act requires that an insured bank that wishes to issue payment stablecoins must do so through a subsidiary. Although the Act does not dictate the bank subsidiaries’ charters, previous bank subsidiaries have been corporations or LLCs, and there is no reason to suspect a bank would choose otherwise here. Because the FDIC is, by law, the receiver for insolvent insured banks, the FDIC will decide whether to place the PPSI subsidiary into traditional bankruptcy or manage the resolution itself.

The most effective resolutions are likely to be those managed by the FDIC, which has nearly a century of experience in managing depository institutions’ receiverships. Depositors get repaid quickly, and there is reason to believe that FDIC-managed receiverships of insured banks’ PPSI subsidiaries would be similarly well-managed. Of course, the FDIC only resolves insured banks and other systemically important financial institutions, and obtaining a full-service bank charter with deposit insurance is far more difficult than either of the other options.

Uninsured Bank or Trust Company: An insolvent PPSI that is a national trust bank or uninsured state bank will be placed into receivership by the OCC or the state bank regulator, as applicable. The regulator will be in charge of hiring a receiver to manage the resolution or managing the resolution directly. 

Having an arm of a government—even if it is not the FDIC—overseeing the resolution process is likely to be better for payment stablecoin holders than the bankruptcy alternative. Regulators have the funds to perform resolution activities, meaning tokenholders are likely to be paid quickly, even if they receive a haircut. That said, there are questions about how effective these regulators will be in performing the receivership process; because the FDIC has been the go-to receiver for banks for decades, these regulators have not used their receivership muscles for some time and their skills are likely to have atrophied. And with State banking regulators, there may be 50 different processes for holders to consider before committing funds to any one PPSI.

Nonbank: A PPSI that is chartered under a state’s general incorporation statute must be resolved according to that statute, which means bankruptcy. Either the PPSI’s executives file for bankruptcy protections directly, or a creditor (presumably a stablecoin holder) will petition a court to replace the PPSI’s management with someone who will. 

The bankruptcy process is well-trod but time-consuming, meaning that holders of payment stablecoins are unlikely to be paid for some time. Leaving retail customers in legal limbo for a significant period of time poses significant risks, as was recently observed with the Synapse bankruptcy—customers were left without their funds for months. GENIUS attempts to address this issue by providing holders priority over issuers and third parties holding issuer assets, but it is unclear whether these provisions will actually expedite the process given that bankruptcy judges can provide equitable relief to other, conflicting parties.

Moreover, there are significant questions about whether the GENIUS Act’s provisions allow receivers to be paid for their work, which would make it difficult for the resolution process to conclude once it’s been started.

Considerations for PPSI Organizers

GENIUS attempts to make the choice of PPSI charter largely standard for potential issuers; however, there are significant differences in how an insolvent PPSI will be handled. Although the managers of PPSIs will no longer be running their companies in the event of insolvency, their decisions still matter for holders of their payment stablecoins. Institutional buyers cognizant of how their holdings will be treated in insolvency will consider PPSIs’ choice of charter when deciding which payment stablecoins to purchase.

The easiest chartering option for organizers is to obtain general incorporation charters. This leaves PPSI managers in charge of their fates by allowing them to file for Chapter 7 bankruptcy, but comes with an insolvency process that is the most fraught for tokenholders, as was shown by the crypto insolvencies of 2022-23. The bankruptcy process does not fit well with the business model of financial institutions. The most complex option is to become an insured bank. The insolvency process is likely to work best for stablecoin holders, but permits regulators to put the bank into receivership against the will of the PPSI’s management. And we haven’t even discussed the potential issues that could arise from a third-party service provider’s insolvency, especially those regulated entities holding PPSI funds, such as broker-dealers.

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(1) Although not discussed here, discussion of banks and the FDIC also applies to credit unions and the National Credit Union Administration.