Protecting Consumers from Insolvent Stablecoin Issuers: An Analysis of Section 9 of the GENIUS Act…

Protecting Consumers from Insolvent Stablecoin Issuers: An Analysis of Section 9 of the GENIUS Act of 2025

The Guiding and Establishing National Innovation for U.S. Stablecoins of 2025 (GENIUS Act of 2025), introduced as S. 394 in the 119th Congress, represents a significant step toward regulating payment stablecoins in the United States. Among its provisions, Section 9: Treatment of Insolvent Payment Stablecoin Issuers stands out as a critical measure to protect stablecoin holders in the event of an issuer’s insolvency. This article provides a comprehensive analysis of Section 9, exploring its legal framework, implications for stakeholders, and broader impact on the stablecoin ecosystem.

Overview of Section 9

Section 9 establishes a framework for prioritizing claims of payment stablecoin holders in insolvency proceedings, ensuring their financial protection. It comprises three subsections:

1. Subsection (a): General Priority in Insolvency Proceedings
   Claims of individuals or entities holding payment stablecoins issued by an insolvent issuer take precedence over all other claims in any insolvency proceeding, whether under the Bankruptcy Code (Title 11, U.S. Code) or conducted by a primary Federal payment stablecoin regulator or state banking supervisor.
2. Subsection (b): Amendment to Bankruptcy Code
   This subsection amends Section 507 of the Bankruptcy Code by adding a new subsection (e), granting first-priority status to payment stablecoin holders’ claims over all other claims in bankruptcy proceedings, superseding existing priorities such as administrative expenses.
3. Subsection ©: Debtor Status
   Non-depository institution payment stablecoin issuers (as defined under the Federal Deposit Insurance Act) are explicitly recognized as debtors under the Bankruptcy Code, ensuring their eligibility for bankruptcy proceedings.

Legal Context and Purpose

Payment stablecoins, as defined in the GENIUS Act, are digital assets designed for payment or settlement, backed by reserves to maintain a stable value relative to a fixed monetary amount (e.g., U.S. dollars). Section 9 addresses the critical risk of issuer insolvency, which could undermine consumer confidence and destabilize the financial system. By prioritizing stablecoin holders’ claims, the Act aims to:

• Safeguard Consumers: Ensure holders can recover their funds ahead of other creditors, aligning with the expectation that stablecoins are redeemable at par.
• Enhance Financial Stability: Mitigate systemic risks, such as a “run” on stablecoins, by assuring holders of priority in asset recovery.
• Clarify Regulatory Treatment: Provide a tailored insolvency framework for stablecoins, which are excluded from securities and commodities classifications under Section 14 of the Act.

Detailed Analysis of Section 9

Subsection (a): General Priority in Insolvency Proceedings

Key Features:

• Applies to all insolvency proceedings, including those under the Bankruptcy Code and regulatory proceedings by Federal or state authorities.
• Grants stablecoin holders’ claims priority over all other claims against the issuer, including those of unsecured creditors, bondholders, and equity holders.

Implications:

• Consumer Protection: This provision ensures that stablecoin holders have the first claim on the issuer’s assets, such as reserves mandated under Section 4 (e.g., U.S. currency, Treasury securities, or demand deposits).
• Creditor Subordination: Non-stablecoin creditors face increased risk of non-recovery, potentially raising borrowing costs for issuers.
• Regulatory Scope: The inclusion of both Federal and state proceedings reflects the Act’s dual regulatory framework, ensuring consistency across jurisdictions.

Subsection (b): Amendment to Bankruptcy Code

Key Features:

• Introduces a new subsection (e) to Section 507, elevating stablecoin holders’ claims to super-priority status, above administrative expenses and other priority claims (e.g., wages, taxes).
• Modifies Section 507(a) to make existing priorities subject to this new rule.

Implications:

• Super-Priority Status: This unprecedented amendment places stablecoin holders above administrative expenses, which typically have first priority in bankruptcy. This could complicate bankruptcy administration, as funding for trustees and legal fees may be limited.
• Consumer Confidence: The super-priority status reinforces the expectation that stablecoins are fully backed by liquid assets, encouraging adoption as a reliable payment mechanism.
• Potential Challenges:
• Ambiguity: The Act does not clearly define the scope of “claims of a person holding payment stablecoins,” potentially leading to disputes over whether priority extends beyond redemption value to additional damages.
• Administrative Costs: Prioritizing stablecoin holders over administrative expenses may hinder efficient bankruptcy proceedings, requiring regulatory clarification.

Subsection (c): Debtor Status for Non-Depository Institutions

Key Features:

• Clarifies that nonbank payment stablecoin issuers (e.g., Federal qualified nonbank issuers) can be debtors under the Bankruptcy Code, distinct from depository institutions subject to special resolution regimes.

Implications:

• Orderly Resolution: Ensures nonbank issuers have a clear path to bankruptcy, facilitating structured asset distribution.
• Regulatory Alignment: Complements the Act’s oversight by the Comptroller of the Currency for nonbank issuers, ensuring consistency in insolvency treatment.

Implications for Stakeholders

1. Stablecoin Holders:

• Benefit: Super-priority status minimizes loss risk, assuming issuers maintain adequate reserves as required by Section 4.
• Adoption Boost: Enhanced protection could drive broader use of stablecoins for payments and settlements.

2. Stablecoin Issuers:

• Compliance Burden: Strict reserve and capital requirements (Section 4) are critical to avoid insolvency, but compliance costs may challenge smaller issuers.
• Operational Limits: Restrictions on reserve rehypothecation limit leveraging opportunities, potentially increasing costs.

3. Other Creditors:

• Increased Risk: Subordination reduces recovery prospects, which may deter creditors or raise financing costs for issuers.

4. Regulators:

• Oversight Role: Federal and state regulators must enforce reserve and reporting requirements to prevent insolvency.
• Rulemaking Needs: The 180-day rulemaking deadline (Section 4(d)(3)) requires swift coordination to address insolvency procedures and administrative expense conflicts.

5. Financial System:

• Stability: Prioritizing holders mitigates systemic risks, but concentration among large issuers could introduce new vulnerabilities.
• Interoperability: Section 10’s interoperability standards may support Section 9 by ensuring stablecoin functionality across jurisdictions, reducing insolvency-related disruptions.

Potential Challenges

• Claim Scope Ambiguity: The undefined scope of “claims” may lead to litigation over whether priority includes non-redemption damages.
• Administrative Expense Conflict: Prioritizing holders over administrative costs could delay or complicate bankruptcy proceedings.
• State-Federal Coordination: The dual regulatory framework may create inconsistencies for issuers transitioning to Federal oversight at a $10 billion market capitalization (Section 4(c)).
• Reserve Adequacy: The effectiveness of Section 9 hinges on issuers’ compliance with reserve requirements, necessitating rigorous oversight.

Comparison with Existing Law

• Bankruptcy Code: The super-priority for stablecoin holders is a novel departure from traditional bankruptcy priorities, unlike the treatment of bank depositors, where insured deposits are prioritized but not above administrative costs.
• Securities Law: By excluding payment stablecoins from securities definitions (Section 14), the Act removes securities law protections, making Section 9’s insolvency framework essential.
• Bank Secrecy Act: Section 4(a)(5) subjects issuers to anti-money laundering requirements, indirectly supporting stability by reducing illicit activity risks.

Policy Considerations

• Consumer Trust: Section 9 fosters confidence in stablecoins, critical for their role in digital payments.
• Regulatory Burden: High compliance costs may consolidate the market among larger issuers, potentially creating systemic risks.
• International Alignment: Section 15’s reciprocity provisions highlight the need for global coordination in insolvency frameworks to support cross-border stablecoin use.

Recommendations for Implementation

1. Define Claim Scope: Regulators should clarify that “claims” are limited to redemption value to avoid disputes.
2. Address Administrative Costs: Allow a limited reserve carve-out for bankruptcy administration to ensure efficient proceedings.
3. Harmonize Regimes: Federal and state regulators should align insolvency procedures, particularly for transitioning issuers.
4. Enforce Reserves: Regular audits and certifications (Section 4(a)(3)) are critical to ensure reserve adequacy.
5. Leverage Studies: The Section 11 study on endogenously collateralized stablecoins should inform broader insolvency rules.

Conclusion

Section 9 of the GENIUS Act of 2025 establishes a robust framework for protecting payment stablecoin holders in insolvency scenarios, reinforcing consumer trust and financial stability. By granting super-priority to holders’ claims, the Act ensures alignment with the expectation of 1:1 reserve backing. However, successful implementation requires clear rulemaking, rigorous oversight, and coordination between Federal and state regulators. As stablecoins gain prominence, Section 9 will play a pivotal role in shaping a secure and innovative digital asset ecosystem.

Author: Trent V. Bolar, Esq. (LinkedIn Profile)

Disclaimer: All content in this article is intended for general information only and should not be construed as legal or financial advice. Consult a qualified attorney for personalized guidance on legal matters. Information in this article may not constitute the most up-to-date legal or other information. The content in this article is provided “as is,” and no representations are made that the content is error-free. Use of, and access to, this article or any of the links or resources contained within does not create an attorney-client relationship between the reader, user, or browser and the author. All trademarks, logos, and service marks used in this article are the property of their respective owners. The use of such trademarks does not imply any affiliation with or endorsement of this article.

© 2025 Trent V. Bolar, Esq. | All rights reserved.

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