GENIUS Act Bankruptcy Changes Give Holders Top Recovery Priority

The “GENIUS Act” represents one of the most significant amendments to US bankruptcy law since 2005, by allowing stablecoin holders to be repaid before all other creditors when reserves fall short.

The legislation (S. 1582), signed into law by President Donald Trump on July 18, is likely to upend certain core assumptions of the bankruptcy system. It risks administrative insolvency for stablecoin operators that file for Chapter 11, deters financing, and reshapes traditional creditor repayment hierarchies.

The newly-signed law is the first major legislative victory in Washington for crypto companies like Circle Internet Group Inc. It creates a regulatory regime for stablecoin issuers and enforcement authority for regulators, and clarifies that stablecoins aren’t securities or commodities.

While its modifications to bankruptcy law aren’t the focus of the measure, they’ve raised alarm bells for restructuring professionals.

“The GENIUS Act has serious bankruptcy problems,” said Todd Phillips, an assistant professor of legal studies at Georgia State University and a former Federal Deposit Insurance Corp. attorney. “In trying to ensure stablecoin holders are made whole during the bankruptcy process, Congress has inadvertently made it unlikely that token issuers will exit bankruptcy at all.”

New Priorities

Stablecoins are cryptocurrencies designed to maintain a stable value by being linked to traditional currencies. Under the legislation, permitted issuers are required to back stablecoins one-to-one with liquid assets.

Under the GENIUS Act, stablecoin reserves are treated as property of the customer, not that of the issuer or custodian, John B. Hutton of Greenberg Traurig LLP said.

If there’s a stablecoin reserve shortfall in a bankruptcy, stablecoin holders receive a superpriority claim to repayment ahead of lawyers and financial advisers, unpaid employees, tax authorities, and the Justice Department’s bankruptcy monitoring unit.

The priority scheme is “very unusual” and “not how the bankruptcy code currently works generally,” Douglas Mintz of Cadwalader Wickersham & Taft LLP said.

The core concept underlying the legislation—that when things go south, the stablecoin that an insolvent firm holds still belongs to the customer—is “perfectly sensible,” said Douglas Baird, a University of Chicago Law School professor.

But it upsets historic ideas that priority creditors like tax collectors and employees are paid before general creditors, he said.

“If you tell holders ‘sorry, if the issuer ends up becoming insolvent, you’re just going to be an unsecured creditor in bankruptcy holding a worthless IOU,’ you’re not going to see widespread adoption of stablecoins,” Deborah Kovsky-Apap of Troutman Pepper Locke LLP said in an email.

This act’s treatment of stablecoin holders is stronger than protections to secured creditors because the reserve is essentially a protected trust held outside of the estate and likely can’t be pledged to secure a loan, Hutton said.

But stablecoin holders can consent to prioritize other claims, potentially giving organized claimholders some flexibility to negotiate if they have a representative, he noted.

The measure also keeps reserves backing an issuer’s stablecoins separate from the property of the estate. Still, the automatic stay halting debt collection and litigation against debtors in bankruptcy would apply to prevent early redemptions that could trigger a run on reserves.

Courts will have 14 days after a bankruptcy filing to approve stablecoin payouts under the new law.

Payment Risks

The legislation leaves a big question unanswered: How will stablecoin bankruptcies be paid for?

Legal expenses can’t be paid out of reserves because those funds aren’t property of the company’s estate, and the funds can’t come out of non-reserve assets because there wouldn’t be a corresponding benefit to the estate, said Kovsky-Apap.

“Since no one is going to provide these services for free, I don’t see how it gets done under the current version of the bill, and many issuers would likely be administratively insolvent from day 1,” Kovsky-Apap said in her email.

While the proposal promises quick repayments for stablecoin holders, it risks that estates will be unable to pay legal professionals and secure funding when there’s a shortfall in reserves.

“Someone needs to pay for the undertakers,” Baird said.

Capital Threatened

The law will make it harder and more expensive for bankruptcy lenders to provide financing to stablecoin issuers, according to Mintz.

Those risks will likely get priced into the costs of the bankruptcy because even if large law firms adapt, it means more risk for them, he said.

“These provisions raise concerns over whether the legal wall inserted around the reserves will be so thick as to inhibit a successful or efficient reorganization or liquidation of the debtor issuer in a bankruptcy case,” law firm Morgan, Lewis & Bockius LLP said in a July 2 legal notice.

Morgan Lewis noted that some elements of the legislation could incentivize companies that aren’t eligible for bankruptcy to “opportunistically become eligible merely by issuing payment stablecoins to avoid otherwise applicable insolvency procedures.”

Crypto Winter Memories

The legislation moved forward in the aftermath of the “crypto winter” that began in 2022, which engulfed Celsius, FTX, Voyager, and TerraUSD, and gave crypto holders a crash course in financial collapse.

In the Celsius bankruptcy, a court ruled that stablecoins were property of the estate, not the users—leaving them frustrated unsecured creditors.

In FTX and Voyager’s cases, stablecoins were treated as customer assets. FTX plans to repay creditors using stablecoins.

The collapse in 2022 of “algorithmic stablecoin” TerraUSD, issued by Terraform Labs, “erased billions in market value and underscored the lack of legal protections for stablecoin users,” attorney Chazz Coleman of Pillsbury Winthrop Shaw Pittman LLP said.

“These cases revealed the risks stablecoin holders face when issuers or platforms collapse, particularly the absence of priority or segregation protections in bankruptcy,” Coleman said.