Are Stablecoins FDIC-Insured Like a Bank Account?

In the nascent digital finance market, serve as the gateway between the volatility of cryptocurrencies and the security of fiat, such as the U.S. dollar. Most people believe that because stablecoins are pegged to a secure asset, they enjoy the identical protection as a standard bank account. This is a common misconception that can have a significant impact on a person’s finances. 

This article dispels the myth of the relationship between stablecoins and the Federal Deposit Insurance Corporation (FDIC). We’ll explain why stablecoins are not the identical as bank accounts and when (if ever) parts of them might be protected.

Key Takeaways

• Stablecoins are not insured by the FDIC, which is designed to protect depositors against the failure of an insured bank.

• Underlying cash reserves can be deposited in FDIC-insured accounts via the “pass-through” loophole; however, this does not protect the token holder.

• If the company that issues the stablecoin fails due to mismanagement, fraud, or a run on its reserves, there is no FDIC protection to cover those losses.

Fundamentals of Stablecoins and FDIC

To completely comprehend why stablecoins are not insured in the identical way as your checking or savings account, one needs to understand the diverse roles of the FDIC, banks, and stablecoin issuers.

How Are Stablecoins Supposed to Work?

Stablecoins are a type of cryptocurrency that remain stable in value by pegging their market value to an external benchmark, usually the dollar. The most common stablecoin is fiat-collateralized. In principle, there is an equal amount of fiat money (or very liquid and secure assets) locked up for every stablecoin released.

For example, if a company prints one million of its “USDCoin,” it should have one million U.S. dollars in a checking account or short-term government bonds that it can use to redeem those stablecoins at whim. This collateral is what is supposed to keep the stablecoin at or very near $1.00.

Stablecoins can be centralized (backed by an issuing company) or decentralized (algorithmic or backed by crypto reserves). Their role is often to assist users move in and out of volatile crypto positions, or as a “digital dollar” within crypto systems.

What does FDIC entail?

The FDIC is an independent agency of the United States government established in 1933 to preserve stability and public trust in the country’s financial system. It does so by ensuring deposits at savings associations and member banks. If an insured bank fails, the FDIC will reimburse up to $250,000 per depositor, insured bank, or account ownership category. It is free for any person who opens a deposit account in an FDIC-insured bank and covers products such as checking accounts, savings accounts, and certificates of deposit.

Essentially, FDIC insurance covers deposits in banks, not investments or other financial assets, including stocks, bonds, mutual funds, and cryptocurrencies. It does not extend automatically to anything outside the insured deposit structure.

Why Stablecoins Are Not Automatically FDIC-insured

1. They are not bank deposits: If you are holding stablecoin, you own a token issued by a stablecoin issuer, not an account at an FDIC-insured bank. There is no direct connection that converts that token into an insured bank liability.
2. Legal and regulatory restrictions: Stablecoins are not legally considered as bank deposits or credit union shares. The (United States stablecoin law) clarifies that stablecoins are not backed by federal deposit insurance or share insurance. Issuers cannot misrepresent their tokens as FDIC-insured.
3. Risk of issuer insolvency or reserve failure: Even if an issuer keeps its cash in secure accounts, token holders may not receive the full value during . Unlike bank deposits, there is no broad securety net like FDIC protection.

When Would Stablecoin Reserve Components Be FDIC-Insured?

Although the stablecoin token is not FDIC-insured, peculiar cases exist where the fiat reserves backing the token may have some level of protection. Some of them include:

“Pass-Through” Deposit Insurance

Some stablecoin issuers hold their fiat reserves in an FDIC-insured bank. Under certain arrangements, they may offer “pass-through” deposit insurance to token holders. For this to apply to individual holders, the stablecoin issuer must have a clear legal and accounting structure that shows it is holding these funds on behalf of its customers.

For example, (issuer of USDP and USDH) states that while “USD Stablecoins themselves are not FDIC insured,” they may deposit their fiat reserves into FDIC-insured bank accounts. Some portion of those reserves may be eligible for pass-through insurance if you opt in and if the deposits are within FDIC limits.

However, the following could be a limitation:

• Only fiat cash reserves (not U.S. Treasury securities or other assets) may qualify.

• It depends on how those reserves are held, whether the depositor’s rights are properly “passed through,” and whether they stay within insured limits.

• It does not protect you against failure of the stablecoin issuer itself.

Use of Deposit Networks

Some issuers use deposit placement networks (including IntraFi) to spread reserves in many banks to maximize FDIC coverage. This minimizes concentration risk and increases the overall insured coverage. Nevertheless, protections are only applicable at the reserve level, and not for tokens or the issuer’s operations.

Bottom Line

Regulators are increasingly focused on the risks posed by stablecoins. The lack of direct insurance and the potential for runs on issuers have prompted calls for greater oversight. Recent legislative proposals have aimed to bring more clarity and protection to the stablecoin market, but as of now, there is no comprehensive federal framework that provides the identical level of security as a traditional bank deposit.

Before using any stablecoin, it is wise to research the issuer, understand how their reserves are managed, and read their terms of service to view what, if any, protections are in place. While stablecoins offer innovative answers for digital transactions, they do not yet come with the ironclad securety net of the FDIC.