By Allison Morrow, CNN

New York (CNN) — New York’s top prosecutors are raising an alarm on the crypto industry’s first legislative milestone, the GENIUS Act, alleging that the law fails to protect victims of fraud and gives legal cover to companies that are “profiting from fraud.”

In a letter exclusively seen by CNN and signed by New York Attorney General Letitia James and four district attorneys, including Manhattan’s Alvin Bragg, the prosecutors say the law has provided the “imprimatur of legitimacy” for a kind of cryptocurrency known as stablecoins, while allowing firms that issue stablecoins to “avoid significant regulatory requirements that are needed to combat financing terrorism, drug trafficking, money laundering, and especially cryptocurrency fraud.”

The GENIUS Act is a broad bipartisan effort, signed into law in July, to create a regulatory framework for stablecoins, a kind of cryptocurrency that has exploded in popularity in the largely unregulated market for digital assets. The law creates reserve requirements for coin issuers similar to rules that ensure banks hold enough assets to cover their liabilities — meaning firms that issue stablecoins must back their digital offerings one-for-one with liquid assets like US dollars or short-term Treasuries.

But James and Bragg take issue with what the GENIUS Act lacks — namely, language that would compel companies to return stolen funds to victims of fraud.

That absence, they write, “will embolden stablecoin issuers, and even provide legal cover, when they affirmatively decide to keep stolen funds and proceeds under their control rather than returning them to victims.”

Already, they claim, the two most dominant stablecoin issuers — Tether and Circle — have throttled law enforcement efforts to seize and return funds to victims while profiting off the crimes that the prosecutors say remain prominent in stablecoin markets.

Tether, the largest stablecoin issuer by volume, has the ability to freeze suspicious transactions of its USDT coin, the prosecutors write. But they say that it has only done so on an ad-hoc basis, and only when working with federal-level law enforcement.

“The reality for many victims, therefore, is that funds stolen in or converted to USDT will never be frozen, seized, or returned,” the letter states. “They currently decide on a case-by-case basis when they will assist law enforcement in recovering funds for victims, and nothing prevents them from stopping all reissuance entirely.”

Tether said in a statement to CNN that the company “takes fraud, consumer harm, and the misuse of USDT extremely seriously and maintains a zero-tolerance policy toward illicit activity.”

The company, which is based in El Salvador, said that it “does not have a blanket legal obligation to comply with state-level civil or criminal processes in the way a US-regulated financial institution would. That said, Tether voluntarily works closely with US law enforcement at the federal, state, and local levels and routinely assists investigations aimed at protecting victims and preventing further harm.”

Prosecutors allege that Circle, the second-largest stablecoin issuer, which is publicly traded and headquartered in New York, “claims to be an ally in the fight against financial fraud.” But its policies “are significantly worse than those of Tether for victims of fraud,” the letter states.

Even when Circle does agree to freeze funds, the prosecutors say, the company hoards them rather than return them to victims, collecting interest on the underlying assets.

That creates a “crystal clear” financial incentive to reject requests from law enforcement, the prosecutors say. “It is financially preferable to only freeze cryptocurrency deemed to have been stolen, but not return the underlying asset to law enforcement or any fraud victim, because Circle can continue to collect the interest through investment of the underlying funds.”

In a statement to CNN, Dante Disparte, Circle’s chief strategy officer said the company “has always prioritized financial integrity and advancing US and global regulatory standards for stablecoins.” The GENIUS Act, Disparte said, “makes clear that stablecoin issuers must abide by applicable financial integrity rules for combating illicit activity, while enhancing clear consumer protection norms. We have followed prevailing rules as a U.S. regulated financial institution, and we will continue to advance these standards.”

The letter, reviewed by CNN, marks one of the most forceful criticisms of the GENIUS Act from law enforcement officials since President Donald Trump signed it in July. While the bill received broad bipartisan support, critics have said it lacks sufficient protections for consumers and raises serious concerns about crypto volatility spilling into the mainstream financial system. And it comes as another landmark, industry-backed crypto regulation effort works its way through Congress.

Proponents, including major crypto companies that lobbied for its passage, touted the GENIUS Act as a part of the industry’s goal of establishing, in President Donald Trump’s words, “a clear and simple regulatory framework,” for stablecoins, which have become the lifeblood of the crypto ecosystem.

The prosecutors’ letter is addressed to Democratic Sens. Chuck Schumer, Kirsten Gillibrand — the lead Democratic senator supporting the GENIUS Act — and Mark Warner, who serves on the intelligence and banking committees.

Sens. Schumer and Gillibrand didn’t immediately respond to a request for comment. In a statement, a spokesperson for Sen. Warner said “stablecoin issuers have a responsibility to comply with lawful court orders under the GENIUS Act and to cooperate fully with law enforcement to help victims recover stolen funds… Protecting victims is paramount, and Congress is continuing to evaluate whether additional legislative tools are needed to ensure issuers and law enforcement can act quickly to stop criminal activity and return stolen funds to their rightful owners.”

In June, when the legislation cleared the Senate, Gillibrand touted its potential to “enable US businesses and consumers to take advantage of the next generation of financial innovation.”

Stablecoins, as their name suggests, are designed to hold a steady value by mirroring another asset, usually US dollars. One stablecoin should always equal roughly one dollar — a useful function for investors who want to keep their money within the crypto ecosystem without exposing their holdings to the wild swings that bitcoin, ether and other tokens are known for. They’re also seen as a kind of on- and off-ramp between crypto and mainstream financial markets that have historically had little overlap.

Last year, stablecoin transaction volumes soared 72% to $33 trillion, according to Bloomberg News, which cited data compiled by Artemis Analytics. While bitcoin remains the most popular crypto token, its trading volume is eclipsed by dollar-pegged stablecoins.

That relative stability, combined with the anonymity of crypto transactions, has also proven popular among criminals. Stablecoins now account for 63% of the illicit transactions that take place in crypto, according to Chainalysis, a crypto research firm.

And while the crypto industry has been trying to shed its longtime association with scams, cybercrime, drug trafficking and money laundering, the crime problem is far from resolved. Since 2020, Chainalysis estimates illicit activity on the blockchain — crypto’s core infrastructure — has grown by an average of 25% a year. Thieves and scammers have moved an estimated $28 billion into the world’s most prominent crypto exchanges over the past two years, according to a recent report from the International Consortium of Investigative Journalists.

The New York prosecutors said they “regularly investigate criminal enterprises which use stablecoins to commit cryptocurrency fraud and launder stolen proceeds” and attempt to “freeze and seize” stolen funds to return them to victims.

But the GENIUS Act, they say, hamstrings those operations while emboldening stablecoin issuers to resist law enforcement efforts to return stolen funds to victims.

“Unlike any other type of cryptocurrency, Circle and Tether have the ability to freeze stablecoins” and “immediately halt the flow of stolen funds and criminal proceeds,” the letter says.

Instead, they argue, “Tether has provided assistance only in limited circumstances, and Circle has chosen to actively thwart law enforcement and to profit from victims’ losses.” The prosecutors estimate that in 2024 Circle and Tether each made $1 billion in profits from investing their reserve funds, including reserve funds backing stolen and frozen stablecoins. As of November, they say, Circle had more than $114 million in frozen funds.

For crypto critics, the GENIUS Act’s lack of fraud and restitution provisions point to an ongoing problem for the industry, where even basic consumer protections are missing.

“All of that mundane stuff that has sort of been sorted out for traditional finance through decades of trial and error – it’s not there in the GENIUS Act,” Hilary J. Allen, a law professor at American University who specializes in banking and cryptocurrency, told CNN. “It was always open to the crypto industry to operate under the traditional rules… the laws were never incompatible with the technology. The laws were incompatible with the crypto business model.”

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