Washington, D.C., is beset by legislative gridlock, but stablecoins—a type of crypto-asset pegged to the U.S. dollar—have become a bipartisan priority for all the wrong reasons. Both the Senate Banking Committee and House Financial Services Committee have advanced legislation to create a bespoke, light-touch regulatory framework for stablecoins; the full Senate is expected to begin considering its stablecoin legislation this week. As they consider this legislation, members of Congress should be fully aware of the risks stablecoins pose to U.S. national security and its financial system.
The legislative and entrepreneurial frenzy around stablecoins is part of the broader embrace of crypto following the re-election of U.S. President Donald Trump. In anticipation of stablecoin bills soon becoming law, the Trump family’s World Liberty Financial crypto business announced plans to create a Trump-branded stablecoin. It will be used in transactions by the Emirati sovereign wealth fund, facilitated by Binance, a crypto company that has previously pled guilty to money laundering and sanctions evasion. El Salvador-based Tether—the issuer of the world’s most popular and most notorious stablecoin—recently said the stablecoin legislation will allow it to issue its first stablecoin in the United States.
How the Illusion of Decentralization Facilitates Illicit Finance
Crypto assets are financial assets like any other, except that their ownership is recorded on a type of ledger or database known as a “blockchain.” But the Trump administration and Republican congressional majority are treating crypto as if it is exceptional and therefore exempt from long-standing financial laws. Under new Republican-appointed leadership, the Securities and Exchange Commission (SEC) is dropping extant lawsuits against major crypto exchanges and signaling it will not enforce the securities laws when crypto-assets are concerned. Similarly, the U.S. Treasury Department recently removed Tornado Cash, a notorious cryptocurrency “mixing” service, from its list of sanctioned entities. The Trump administration and the crypto industry argue that deregulating crypto will help promote the competitiveness of the U.S. financial industry and enhance the U.S. dollar’s status as the global reserve currency. In truth, these actions will only prove self-defeating by facilitating more illicit financial activity, undermining the stability of the U.S. financial system.
Blockchains are supposed to facilitate autonomous and “decentralized” crypto transactions that do not require intermediaries. What distinguishes the “public permissionless blockchains” used for bitcoin, ethereum, and other crypto transactions from the ledgers used in traditional finance is that only trusted intermediaries are authorized to update the ledgers used to record traditional financial transactions. Theoretically, anyone can add new transactions to blockchains, with intentionally inefficient game theory-based validation mechanisms used to discourage bad actors from doing so. In reality, though, large unregulated—and sometimes even unidentified—intermediaries play a significant role in the crypto asset ecosystem.
These intermediaries range from crypto exchanges to founders and funders who retain significant control over crypto projects, to transaction validation companies, like the bitcoin mining operations that the Trump family’s business is eyeing. But a misleading decentralization narrative has created legal uncertainty and convinced some government authorities that they lack jurisdiction over the crypto industry.
Crypto mixing services like Tornado Cash offer a vivid illustration of the illicit finance risks of crypto and the broader deregulatory ethos motivating this project. Mixers are services operated using software programs known as smart contracts that attempt to mask the parties to crypto transactions. Mixers accept funds from a transferor wallet, pool batches of transactions, and then send a corresponding crypto payment to the transferee wallet. In August 2022, Treasury’s Office of Foreign Asset Control (OFAC) sanctioned Tornado Cash, a crypto mixing service created by a group including individuals with ties to Russian security services, for violating the International Emergency Economic Powers Act (IEEPA). Tornado Cash allegedly facilitated $7 billion in money laundering transactions with sanctioned entities, including criminal North Korean hacker groups.
Individual software program developers affiliated with Tornado Cash and backed by the Coinbase crypto exchange challenged OFAC’s determination, arguing in Van Loon v. Department of Treasury that its purportedly decentralized structure means it cannot be subject to designation under IEEPA. Specifically, they claimed the joint work coding Tornado Cash’s smart contracts was not a common enterprise, and that developers do not have a property interest in the smart contracts. In August 2023, the U.S. District Court for the Western District of Texas rejected these arguments. But, in November 2024, the U.S. Court of Appeals for the Fifth Circuit reversed the district court, holding decentralized smart contracts are not subject to IEEPA sanctions because individuals that design and utilize the contracts do not have a requisite “interest in property.”
Rather than appealing the Fifth Circuit’s erroneous decision, the Trump administration’s Treasury Department delisted Tornado Cash. While Treasury reiterated that illicit financing laws continue to apply to parties doing business with sanctioned entities, the reality is that its accommodative stance toward crypto “innovation” leaves a crypto-sized hole for criminal groups, terrorist organizations, and hostile foreign actors—including Russia and North Korea—to exploit. Tether, the company looking to expand in the US, reportedly failed to comply with OFAC’s Tornado Cash sanctions when they were in place, continuing to process transactions while the Van Loon litigation was pending. The big crypto platforms have not been much better–in 2023, the U.S. government imposed a $4.3 billion penalty on Binance (one of the President’s new business partners, remember) for violations of sanctions and anti-money laundering requirements. There is no reason to think the crypto industry will take anti-money laundering and sanctions seriously when compliance is based on the honor system, and the stablecoin legislation does nothing to change the status quo in this regard.
When Crypto Crashes
Although using crypto is often framed as a matter of personal choice, it risks affecting the vast majority of people who have never opened an account with a crypto exchange. Crypto’s public harms will come into even clearer focus if–or more likely when–a crypto crash triggers a financial crisis with cascading effects for the broader economy. Such an outcome is likely because blockchain-based finance replicates and exacerbates all the flaws of traditional finance, while adding new kinds of operational vulnerabilities, such as increased opportunities for cyber hacks and manipulation.
The root of the problem is that an unlimited supply of crypto assets can be created out of thin air, resulting in a theoretically unlimited supply of assets to borrow against. Out-of-control leverage was one of the key causes of the 2008 financial crisis, but at least in 2008 there were real assets involved in the form of real estate. The crypto industry has found a way to dispense with the need for tangible assets, meaning the resulting technologically-complex unbacked crypto-assets are even more ripe for manipulation and uncertainty. The biggest players in the crypto industry are at least as interconnected as traditional financial institutions were in 2008, and transactions pre-programmed using smart contracts are even more rigid and unforgiving than the mortgage-backed securitization contracts that functioned as “suicide pacts.”
There are also new kinds of risks associated with crypto, though. Blockchains and smart contracts are software, and like any software, they need to be maintained and kept secure from hackers and cyberattacks. The individuals who maintain these blockchains could have serious conflicts of interest: without proper vetting and due diligence, they might even be funded by hostile nation states who want to see blockchain infrastructure crash. Unlike the ledgers used in traditional finance, there is no one who can be held accountable if the maintenance and security of public permissionless blockchains are neglected—especially if other courts adopt the Fifth Circuit’s flawed reasoning in Van Loon.
Indeed, Crypto markets have crashed twice already, causing significant harm for investors. The so-called “ICO bubble” popped in 2018. Then, in 2022, there were seven different runs on crypto assets that resulted in five crypto platforms—including the infamous FTX—declaring bankruptcy, with more than four million customers filing claims to recover their lost or frozen funds. Both times, the ripples fortunately stopped before reaching the traditional financial system and the broader economy, primarily because banks and pension funds were cautious about exposures to crypto (caution that was encouraged by regulators during the Biden administration). Under the Trump, however, regulators are encouraging banks to do business with crypto firms and the administration has proposed that the government maintain a “strategic crypto reserve,” effectively making U.S. citizens the bagholders-of-last-resort for wealthy crypto investors.
Stablecoin Threats
The growth of stablecoins is only likely to increase the integration of crypto and traditional finance. Stablecoins gained traction as a means to sidestep the volatility characteristic of other crypto assets, typically relying on a reserve of non-crypto assets (including cash and government securities) to keep their value pegged to the U.S. dollar. Their predominant use case is to facilitate the trading of other crypto assets, and there is little evidence that stablecoins are used to pay for real world goods and services in any meaningful volume. However, the stablecoin legislation that Congress is considering could change that.
If enacted, the stablecoin bills currently before Congress would encourage the everyday use of stablecoins for regular payments, while leaving the government responsible for this “private” form of money. The bills take a light-touch approach to regulation, proceeding on the excessively optimistic assumption that stablecoins’ underlying reserves of cash and government securities will always be sufficient to support their $1 peg, despite research that shows that all stablecoins lose their pegs regularly. If a stablecoin loses its peg and panic ensues, it seems inevitable that government authorities would provide emergency financial support—i.e., bailouts—to the industry. In fact, the government has already stepped in to support stablecoins: when Silicon Valley Bank failed in 2023, federal regulators invoked a “systemic risk exception” to guarantee all of the bank’s deposits, $3.3 billion of which were reserves of a stablecoin issued by the company Circle.
This legislation is therefore poised to leave taxpayers on the hook as it benefits stablecoin issuers (including, once again, the Trump family’s World Liberty Financial). If passed, the stablecoin bills before Congress would also provide an entrée for tech platforms like X and Meta to issue their own stablecoins as functional equivalents to bank accounts. If these tech platforms disrupt the traditional banking industry—as their Chinese equivalents Alibabla and Tencent did—banks will have fewer deposits to lend out to households and businesses, and that will limit the Federal Reserve’s ability to increase or decrease the supply of money and credit. In short, sanctioning the creation of private money equivalents raises issues of monetary sovereignty and the government’s control over the money supply.
Crypto’s Risks Undermining Democratic Values
The Trump administration’s embrace of crypto also threatens democratic governance more broadly. Rampant corruption, illicit finance, and the fallout from financial crises can all undermine trust and feed an anarcho-libertarian worldview. If people are made more economically vulnerable by a crypto crash—whether directly or indirectly—more political extremism is likely to follow. Research has shown that the 2008 financial crisis, for example, exacerbated political polarization, and crypto is itself an expression of anarcho-libertarianism that emerged out of the 2008 crisis.
The national security and financial stability threats posed by crypto can only be justified if one believes that whatever bad things the crypto industry facilitates, they are preferable to what a democratically-elected government or central bank might do on their own. In his 2016 book The Politics of Bitcoin: Software as Right-Wing Extremism, David Golumbia observed that “Bitcoin and the blockchain technology on which it rests satisfy needs that make sense only in the context of right-wing politics.” Consider the fact that El Salvador—the country run by an authoritarian government aiding the Trump administration in its illegal deportations—was the first nation to recognize bitcoin as a currency, an experiment that it ultimately abandoned earlier this year. Consider also that crypto advocates and investors are working to create autonomous economic zones, like Prospera in Honduras, that are privately governed and attract investment through low taxes and light regulation and rely on cryptocurrencies. Trump administration official and political mega donor Elon Musk recently stated his desire to “end the Fed,” meaning eliminate the United States’ central bank, and put government payments on the blockchain.
Because blockchain decentralization is an illusion, as we argued above, such steps would not eliminate the need for trusted intermediaries. Instead,they would ensure that the new intermediaries no longer have any democratic accountability. If Congress embraces crypto–and passing stablecoin legislation would be its first big step toward doing so–it will ultimately cede some of its own authority–alongside the Federal Reserve’s authority–over monetary policy to the crypto industry.
Steps Congress and Federal Agencies Can Take Now
While a ban on crypto would solve the problems outlined above (and, as one of us has previously explained, such a ban is feasible), it is unlikely that a ban will be implemented in the current political environment. Fortunately, Congress has other options that would address the most pressing risks presented by crypto assets.
The first step Congress can take is to reject legislative efforts to create a light-touch regulatory regime for stablecoins. The proposed bills seek to supercharge stablecoin usage and supply by giving them a patina of legitimacy, while failing to address their financial stability risks and the operational fragilities of public permissionless blockchains. Stablecoin issuers are already subject to anti-money laundering and sanctions requirements—these bills do nothing to expand those requirements to the exchanges on which they are traded or other crypto companies operating in legal gray areas. The status quo legislative environment is far preferable to the world these stablecoin bills are likely to usher in. And to rebut one popular argument in favor of the bills, there is no reason to think that increasing the volume of U.S. dollar-denominated stablecoins will protect the hegemony of the dollar. That hegemony derives from the United States’ geopolitical position, not the technology used to deliver dollars.
Second, if Congress wishes to promote the long-term viability of stable digital asset markets, it should focus on prohibiting the use of public permissionless blockchains for financial transactions. Many of crypto’s illicit finance and financial stability risks occur because of these permissionless blockchains. When other kinds of ledgers are used to host digital assets, there are individuals who can be held accountable for identity verification and for maintaining the security of the ledger. There is also no need to rely on potentially compromised miners or other validators using inefficient game theory-based validation mechanisms to process transactions. During the Biden administration, the banking agencies discouraged banks from offering their own crypto assets, and the industry worked on innovating regulatory compliant “tokenized deposits” in response. Congress should also address potential ambiguities in the application of anti-money laundering and sanctions laws to all of the entities in the crypto ecosystem by adopting legislative clarifications requested by Treasury during the Biden administration that would close the loopholes created by the Fifth Circuit in Van Loon.
Finally, federal agencies can address some crypto vulnerabilities now–without waiting for Congress. In 2023, Treasury proposed identifying virtual currency mixers as entities that pose “primary money laundering concern” under section 311 of the USA PATRIOT Act. Section 311 authorizes the Treasury Secretary to institute special measures against designated jurisdictions, financial institutions, or classes of financial accounts or transactions including requiring heightened transaction recordkeeping or information collection, or, if necessary, prohibiting the opening or maintaining of accounts involving designees. Treasury should resurrect this rulemaking, and potentially expand it to include other high-risk transactions such as those involving public permissionless blockchains. In addition, banking agencies should revert to Biden-era policies limiting bank exposures to crypto.
Global financial leadership requires robust economic growth and financial stability coupled with adherence to democratic values, stable institutions, and the rule of law. Unfortunately, the push by Congress and the Trump administration to deregulate crypto assets will only serve to further undermine these aims by exposing the public, regulated financial institutions, and the entire financial system to significant risks.
