The Stablecoin Recovery Gap: How Standardized Rules Can Turn Frozen Assets into Restored Funds

The debate over stablecoin regulation in the United States is intensifying as prosecutors and lawmakers examine what some call a “recovery gap” in the proposed GENIUS Act. 

Critics argue that current provisions could allow issuers to freeze stolen funds without guaranteeing they are returned to victims, effectively leaving a critical step in the recovery process unaddressed.

However, industry experts say the issue is more operational than intentional—and that solutions are already emerging through private-sector coordination. 

Among those experts is Kieran Donnelly, chief of staff at the fintech firm Circuit and a regulation-focused lawyer working with Circle through its Alliance Program.

In a recent interview with Ecoinimist, he said that the conversation around stolen funds often overlooks what happens after assets are frozen.

Freezing Funds Is Only the First Step

According to Donnelly, the ability to freeze assets in a stablecoin system is only part of the recovery equation. The more difficult decision comes afterward, when legal or compliance teams must determine whether the funds should be released back to a claimant.

He noted that returning frozen funds is one of the most difficult calls for legal departments because once the assets are released, there is typically no practical way to reclaim them if the decision turns out to be wrong.

That risk, he explained, is why the process is intentionally slow and filled with friction. But it also brings attention to the absence of standardized operational rules across the industry—something regulators have yet to fully address.

“At least if the money is still there, there’s something we can do about it,” Donnelly said, adding that once funds move across chains or into other assets, recovery becomes far more difficult.

Consumer Risk Extends Beyond the Recovery Debate

While the recovery gap has drawn political attention, Donnelly suggested that the issue is often overstated compared with broader consumer-protection concerns.

He described the holding of stolen funds as a symptom of an under-regulated environment and said increased oversight would likely reduce the problem over time, particularly as licensed issuers become more responsive to law-enforcement requests.

The more significant risk, he argued, is the shift toward self-custody and wallet-based stablecoin systems, which effectively turn users into their own banks.

As individuals begin storing more value in personal wallets, they may lose the security protections traditionally provided by banks, creating new attack vectors for hackers and fraudsters.

The crypto industry, he added, is still relatively young, and much of the security infrastructure that protects consumers in traditional finance is only beginning to develop.

Stablecoins as a New Financial “Swim Lane”

Beyond security and recovery, Donnelly said stablecoins could create an entirely new category of financial services, sitting alongside traditional banks and fintech companies.

He described the current regulatory environment as enabling a “third swim lane” in finance—stablecoin-native payment rails that could support cross-border transfers and micro-transactions more efficiently than legacy systems, particularly in the United States where payment fees remain high.

This shift, he said, is already putting banking-like functionality into the hands of consumers, raising new questions about oversight, licensing, and responsibility.

Donnelly suggested that stablecoin issuers themselves may eventually seek bank-like status, as doing so would expand their revenue opportunities and allow them to compete more directly with traditional financial institutions.

Regulation Likely to Evolve in Stages

Despite the controversy surrounding the GENIUS Act, Donnelly believes the legislation should be viewed as a starting point rather than a final framework.

He argued that any stablecoin law will likely require multiple iterations as regulators respond to new risks, similar to the way anti-money-laundering rules have evolved in traditional finance.

He also warned that overly strict regulation at an early stage could drive companies offshore, reducing the effectiveness of U.S. oversight and limiting innovation.

By contrast, a more flexible approach could encourage issuers to operate within the U.S. regulatory perimeter, making it easier for authorities to supervise the industry over time.

Political Timelines Could Shape the Outcome

The future of stablecoin legislation may depend heavily on U.S. election cycles. Donnelly said delays in passing a framework could push the industry back into regulatory uncertainty for years.

If the current momentum stalls, he warned, the market could return to a “stalemate” environment where traditional financial players stay on the sidelines and unregulated actors continue to dominate.

In his view, stablecoins represent a key bridge between crypto and mainstream finance, and the industry is highly motivated to secure the first comprehensive regulatory framework.

He then went on to describe stablecoins as a “Trojan horse” that could push digital assets into widespread adoption, making the success or failure of current legislation a pivotal moment for the sector.