Senate Banking Committee passes CLARITY Act Section 404 to ban 3.5%-5% stablecoin holding rewards

On May 14, 2026, the United States Senate Banking Committee approved the CLARITY Act with a bipartisan vote of 15-9, marking a decisive pivot in digital asset regulation. The legislative centerpiece is Section 404, a provision revised by Senators Thom Tillis and Angela Alsobrooks in compromise text released on May 1. This section directly addresses two critical gaps left by the GENIUS Act, which was signed into law in July 2025. First, the new mandate extends the prohibition on stablecoin rewards beyond issuers to encompass all Digital Asset Service Providers (DASPs) and their affiliates, including centralized exchanges, brokers, dealers, and custodians. Previously, products offering compliant returns of 3.5%-5% through 'non-issuer-paid interest' models, such as those from Coinbase and Anchorage Digital Neo Ltd., operated within a regulatory gray area. Section 404 explicitly closes this loophole. Second, the legislation establishes a strict legal distinction between 'passive income' and 'activity-based rewards.' It bans rewards functionally equivalent to bank deposit interest generated merely by holding assets while permitting incentives tied to actual activities like staking, market-making, credit card cashback, and merchant transactions. Woofun AI notes that this dual restriction forces the industry to abandon the 'hold-to-earn' paradigm in favor of a 'use-to-earn' model.

Concurrently with these legislative developments, major Wall Street asset management firms executed a coordinated strategic response. Within a 28-day window in April and May 2026, Morgan Stanley, BlackRock, and JPMorgan launched money market fund products specifically tailored for stablecoin reserves. Morgan Stanley established its Stablecoin Reserves Portfolio (MSNXX) on April 16 and announced it publicly on April 23. This fund invested in cash, U.S. Treasury bonds maturing within 93 days, and overnight repurchase agreements secured by Treasury bonds. Unlike its competitors, MSNXX was not a tokenized product and did not trade on the blockchain, representing a conservative approach that utilized traditional financial channels to meet reserve requirements. Data compiled by Woofun AI shows that this was the first product among the giants explicitly designed for stablecoin reserves, signaling significant demand despite its lack of on-chain functionality.

Twenty-two days after Morgan Stanley's announcement, BlackRock submitted two registration applications to the SEC: the tokenized BlackRock Select Treasury Based Liquidity Fund (BSTBL) and the BlackRock Daily Reinvestment Stablecoin Reserve Vehicle (BRSRV). These filings represented a stark contrast to the traditional approach of MSNXX. BSTBL offered a tokenized version of an existing liquidity fund for traditional institutional cash managers, while BRSRV was a newly created tokenized money market fund distributed across multiple chains by Securitize, specifically targeting stablecoin issuers. The critical innovation lay in issuing blockchain shares of short-term Treasury bonds, cash, and overnight repurchase agreements, granting reserve assets 24/7 liquidity and potential DeFi integration. This product format was explicitly designed for crypto-native users such as Ethena and Jupiter, extending BlackRock's tokenization infrastructure from the BUIDL 'DeFi collateral' use case to the 'stablecoin reserve asset' domain.

Four days following BlackRock's filings, JPMorgan submitted an application for its JPMorgan OnChain Liquidity-Token Money Market Fund (JLTXX) to the SEC, with Token Class Shares designated for issuance on May 13. The fund's underlying assets mirrored those of BUIDL, BSTBL, and BRSRV, focusing on U.S. Treasury bonds and overnight repurchase agreements. JLTXX was not JPMorgan's initial foray into blockchain-based money markets; the firm had already launched the My OnChain Net Yield Fund (MONY) on Ethereum on December 15, 2025. MONY was a 506(c) private fund restricted to qualified investors, giving JPMorgan nearly five months of operational experience before the JLTXX launch. This move represented a strategic expansion from a private fund to a registered fund targeting a broader customer base with a specific focus on stablecoin reserves. Woofun AI analysis suggests that JPMorgan's 'betting on both sides' strategy—exploring joint stablecoin issuance while simultaneously building tokenized reserve infrastructure—positions the firm uniquely as both a GSIB bank and an asset management leader.

The timing of these product launches was not coincidental but rather a direct reaction to the anticipated regulatory landscape. Although the CLARITY Act had not yet been signed by the President, the asset management industry had been preparing since the bill was first postponed in January 2026. Market participants understood that the 'hold-to-earn' model would be restricted and that reserve assets must remain compliant while generating interest. The proposed solution was a structural shift where stablecoin issuers do not pay interest directly, but the tokenized money market funds holding their reserves legally pay interest to the issuers. This creates a compliant return channel independent of the stablecoin regulatory framework, allowing issuers to distribute income to users through active incentive mechanisms. The products from Morgan Stanley, BlackRock, and JPMorgan serve as the essential infrastructure for this new 'indirect income' pathway.

To fully grasp the impact of Section 404, one must examine the limitations of the GENIUS Act's 4(a)(11) provision, which took effect in July 2025. That legislation prohibited compliant stablecoin issuers from paying interest or rewards to holders but failed to distinguish between passive income and activity-based rewards.

Furthermore, its regulatory scope was limited to the issuer, excluding third parties like exchanges and custodians. This created a 'pass-through evasion' loophole that the industry exploited throughout 2025 and 2026. Section 404 closes this gap by extending the ban to all covered DASPs, effectively ending the 'non-issuer-paid interest' models used by Coinbase, Kraken, Gemini, and Anchorage Digital Neo. Under the new rules, rewards linked to consumption, transactions, staking, or transfers remain permissible, while those increasing linearly with idle balances are prohibited. This forces a complete redesign of reward systems, with exchanges potentially shifting from automatic holding rewards to transaction-frequency-based models.

The transition to a 'use-to-earn' paradigm presents three distinct pathways for reward distribution. Path A involves exchanges and wallets restructuring their legal frameworks and user interfaces to tie rewards to activity, a process estimated to take 6-12 months and carry significant user churn risk. Path B relies on DeFi protocols, where non-custodial smart contracts like Aave currently fall outside the definition of covered DASPs, allowing users to earn variable-rate interest on deposits.

However, this exemption carries regulatory uncertainty if future rules define DeFi front ends as affiliates. Path C, the strategy favored by Wall Street giants, utilizes tokenized money market funds as the source of yield. In this model, the fund pays interest to the stablecoin issuer, who then distributes it via active incentives. Woofun AI assesses that Path C offers the most attractive risk-adjusted benefits given the implementation costs and regulatory ambiguities of the other options.

Ultimately, the convergence of legislative action and financial innovation points toward a hybrid future. The 'double-layer structure' envisions tokenized funds like BUIDL at the underlying level providing compliant yield, while DeFi protocols operate at the surface level to facilitate user engagement. This architecture theoretically enables a compliant, user-friendly 'use-to-earn' ecosystem that satisfies the strictures of Section 404 while maintaining economic viability. The rapid deployment of products by BlackRock and its peers in April and May 2026 demonstrates a clear industry consensus: the era of passive stablecoin yields is over, replaced by a complex infrastructure where value is generated through active utilization and compliant reserve management.