The GENIUS Act - Crypto Regulation...
With A Crowdfunding Twist
Part II
Ok Disruptor Nation.
We owe you an apology.
We know we left you hanging last time.
So… We’re sorry.
This story is just too big, so we broke it into two parts.
Now for the good stuff!
There are still key questions to answer.
First, what is a stablecoin?
And second, how will their regulation (and more importantly, LEGITIMIZATION) help do for crowdfunding what Robin Hood did for stock market investing?
Let’s dig in.
Now What’s All This About Stablecoins?
Ok, so the government is finally regulating stablecoins.
So what?
What’s a stablecoin?
Stablecoins are a special subcategory of cryptocurrency that is supposed to hold a STABLE value.
And why would somebody want that?
Well, when you’re using the dollar as your medium of exchange, you don’t want the value swinging all over the place from day to day like Dogecoin or the host of other “s**t-coins” out there.
Even the big dog, Bitcoin itself, has had a tendency to be pretty volatile at times.
For a kind-of-sort-of-currency-but-also-an-investment, maybe that’s fine.
But what if you really want to use your cryptocurrency of choice AS AN ACTUAL CURRENCY to underpin transactions and commerce?
What if you want to buy 10 of a certain coin now, and in.. let’s say..
Three months…
Or a year…
Or five years…
Sell them and get roughly the same amount of money back?
If that’s what you want, you want stability.
Stablecoins are an effort to create trust in the space, and to help people achieve one of the original visions of cryptocurrency:
A more secure, private and potentially (if you do it right) even more trustworthy alternative to government fiat currency.
So…
Just how do you accomplish that? How does somebody make a crypto-coin stable?
Turns out, there are a couple of different things you can do.
Usually, the process involves “pegging” (linking) the stablecoin to a real-world asset like the US Dollar, the euro, or gold.
Things whose value tends not to flop around all over the place like some penny stock.
Some popular ways of achieving this include fiat-backed, crypto-collateralized and algorithm-powered stablecoins.
Fiat-backed stablecoins are mostly what we discussed above. The minter of the coins holds enough collateral of the other currency on reserve to be able to cover the value of the stablecoin on a 1-for-1 basis.
If you’ve heard of USDC, that’s how it works. USDC’s minter—a company called Circle—keeps as many actual dollars on its books as there are outstanding USDC coins.
And that’s about as guaranteed a protection as you could want.
At least to the extent that the USD itself is stable, that is…
Crypto-collateralized stablecoins operate using a similar approach, except their minters use other cryptocurrencies like Bitcoin or Ethereum as collateral.
But here, because the underlying collateral itself is somewhat volatile and therefore less reliable, the minters OVERcollateralize. Maybe they hold 1.5 or 2 units of the reference crypto for every one unit of the stablecoin.
Not perfect, but not crazy either.
Algorithm-powered stablecoins represent the more speculative end of the stablecoin spectrum.
These use software, market incentives and other tricks to try to force stability on the coin.
But they don’t hold any actual collateral.
And some of them have blown up in pretty spectacular fashion.
A Very Stable GENIUS
So now that you understand how stablecoins can be set up, you pretty quickly start to see how they could benefit from some standards in terms of what’s acceptable and what isn’t.
At least if you expect the market to trust them, that is.
And that’s what the GENIUS Act does.
Without getting too deep into the weeds, the GENIUS Act:
-Sets up a class of entities who are allowed to issue stablecoins for payment purposes. This includes banks, but there’s also a pathway for non-bank crypto companies who agree to abide by bank-like compliance standards;
-Imposes a 1-to-1 backing requirement using safe, liquid assets (such as cash, Treasuries and money market assets) as collateral, and a ban on comingling those assets with other funds or assets;
-Bans the payment of interest, to avoid speculation;
-Puts stablecoins squarely under banking regulation, as opposed to the SEC or CFTC; and
-Sets up reporting, consumer protection and anti-money laundering standards.
The establishment of these rules should help make the use of stablecoins more commonplace and mainstream.
It also tells folks in the crypto space exactly what they need to do if they want to be a stablecoin issuer—WITHOUT the risk of getting into big trouble.
And that means we could see a whole lot more companies getting involved in stablecoins soon.
Ok, so great.
Stablecoins are coming.
As an alternative investing fan, what’s the big deal?
Why should you care?
Just Put It On My Card
Well, in addition to trading on crypto exchanges, powering “DeFi” (decentralized finance) apps and helping folks in countries with unstable currencies hedge against inflation, as noted earlier, the main use case for stablecoins is as a faster, cheaper way to do business online.
Use the coin like money.
BUY stuff with it.
Now of course, the main thing that comes to mind when we say THAT is e-commerce.
Amazon, DoorDash, etc.
But crowdfunding is a small but growing segment of e-commerce as well.
And—it turns out—crowdfunding can be EXPENSIVE.
It doesn’t HAVE to be.
But from a practical standpoint, for the vast majority of folks who do it, it IS.
Crowdfunding platforms and issuers can accept payment in a pretty wide variety of ways.
Check…
Wire transfer…
ACH…
Even crypto…
But far and away the most common way people invest in crowdfunding deals is through credit and debit cards.
The exact numbers are a little murky unless you’re seeing real-time data on a particular deal.
But having spent time working for several groups responsible for processing these investments over the years, and by maintaining ties to groups who still do it today, I can tell you that the numbers are EXTREMELY slanted toward credit/debit.
On the low end, I’ve seen crowd deals raise 60% of their capital through credit/debit.
More frequently, credit and debit transactions can run as high as 85% for a given crowd offering.
So it’s a lot.
It makes sense if you think about it.
For many, dropping $500 into a crowd deal tends to have a lot more of the feel of an impulse buy than a serious, thought-out decision.
Most people don’t want to stop, contact their bank and fill out a bunch of paperwork to make it happen.
By the time they’re ready to invest, they’re excited.
They just want to get it done.
And they’re doing this online.
So they just put in on their card.
Because that’s what people do.
But again, THAT can get expensive.
The obvious thing—and something no one should EVER do—is buy crowd shares on credit, and then wait to pay AFTER interest charges hit.
Interest rates (annual percentage rates or APRs) on credit cards are running near record highs, at an average of more than 24%, and with maximums in some instances cracking 29%.1
And while you don’t get hit with the full APR each month, letting interest accrue on a crowd investment is a really stupid thing to do, because you’re essentially messing up your cost basis—the purchase price against which you measure your return—each month you let it slide.
These deals are speculative enough as it is.
You don’t want to make it that much harder to make money on a crowd investment if and when it finally does hit.
So, let’s say you’re not investing on credit.
You’re investing through your checking account, with real money you already have.
You’re just using your bank account-linked debit card to do it.
Here’s where things get a little…
I hate to use the word…
Insidious.
It’s time to talk a little bit about how middlemen in the crowd industry make money.
Gross Crowdfunding Games
First, let’s think about how credit card processors make money.
Most people realize that credit cards charge a processing fee to the businesses that accept them, for each transaction.
The businesses can eat those fees or, if they’re particularly frugal or if times are tough, the businesses can opt to add the charge to a customer’s bill and pass it through to them.
We’ve all shopped at enough small businesses to have seen those little signs…
“All credit card purchases will be assessed an additional 3% fee.”
And that’s why they’re doing it.
Turns out, processing crowd investments on a debit card is no different.
Well…
It’s a LITTLE different.
For one thing, Visa and Mastercard don’t provide services to the crowdfunding world.
It’s a new type of business.
The issuers themselves are typically NOT established companies with long track records.
There’s a much larger chance that purchasers will get buyer’s remorse and want a refund.
In short, it’s riskier.
And those huge companies don’t like risk.
So they avoid crowd.
Fortunately, some other smaller companies—Stripe primarily—have come in to fill that void.
But for their trouble, they charge a premium.
Again, the numbers can vary, but oftentimes you might be looking at a 3.5% or so additional charge to invest in a crowd deal using your card.
Just for processing the investment.
Not counting any interest charges.
But remember, these deals are all coming through a regulated middleman.
And they’re not the credit card processor.
Somebody’s gotta eat that fee.
Sometimes the middleman absorbs it.
If they do, that means they’re going to pass it through to the issuer as part of how they price their services.
Which makes raising capital more expensive and more inefficient.
Which makes it that much harder for a given crowd issuer to succeed, because it’s getting less money to use to grow.
At the next level of gross, some of these intermediaries…
And I’ll tactfully decline to say which ones…
But it’s some MAJOR players…
Take the credit card fee from the processor, and mark it up outright to the issuer.
So they just piggyback some free money out of every credit card transaction.
Maybe now that number for processing jumps up to 5 or 6%.
And again, oftentimes these middlemen are already being paid in other ways, so it’s just found money.
Gross.
Up ‘til now, we’ve just been talking about inefficient capital market problems.
They have an INdirect effect on you as an investor, but that’s about it.
But wait, it gets worse.
SOMEtimes, an issuer sees these numbers in the middleman’s term sheet, and pushes back on them.
“This is ridiculous.”
“We’re not paying this.”
“Ok, ok, waaaaait!” says the middleman.
“It’s fine.”
“We’ve got you.”
“Why don’t you just PASS THE FEE ALONG TO YOUR INVESTORS?”
And sometimes, the issuer goes for it.
And the investor is you.
So right off the bat, if you happen to have the misfortune to have invested into one of these particular deals, you might start out 6% in the hole.
If you put it on credit and wait ‘til an interest charge hits to pay, maybe you’re 10% in the hole.
And as an investor, where every percentage point counts, you know…
That’s not where you want to be.
Coming Full Circle
So how does the GENIUS Act—and the likely proliferation of stablecoins to come—help with all of this?
Remember how Robin Hood came along with no-commission trading and absolutely broke the stock brokerage business model?
This is going to be a lot like that.
Stablecoins fuel transactions.
Particularly online transactions.
And in that way, they are essentially a 21st century alternative to credit cards.
As we saw in the overview of the Act, banks themselves are allowed to get in on this action.
But so are a lot of other companies.
There’s very likely soon going to be an explosion of stablecoin issuers.
A lot more companies like Circle and its USDCs.
And at least SOME of them are going to get involved in crowd.
And because stablecoin transactions are SO much cheaper than the high fees credit card companies charge (instead of a percentage, stablecoin processing fees are typically fixed, and normally run less than $1 whether someone is moving $100 or $1 million)2, there’s a very high chance that those processing fees will soon start getting beaten into oblivion.
And when THAT happens…
Those crowd middlemen are going to be forced to take a cold, hard look at their business models…
And bring those costs down.
And when THAT happens…
Your effective breakeven on crowd investments will improve accordingly.
‘Til Next Time!
Sean Levine
Managing Editor
Disruptor Nation
DISRUPTOR NATION RECEIVED NO COMPENSATION FROM—NOR HOLDS ANY POSITION IN—ANY CROWD ISSUER OR OTHER COMPANY MENTIONED IN THIS ARTICLE.
1 https://www.lendingtree.com/credit-cards/study/average-credit-card-interest-rate-in-america/
2 https://help.tokenpocket.pro/en/wallet-operation/stablecoin/stablecoin-payment
