Author: Sam Broner a16z
Compiled by: Shenchao TechFlow
Traditional finance is gradually incorporating stablecoins into its system, while the trading volume of stablecoins continues to grow. Due to their speed, almost zero cost, and programmable characteristics, stablecoins have become the best tools for building global fintech.
However, the transition from traditional technology to emerging technology not only signifies a fundamental change in business models but also comes with the emergence of entirely new risks. After all, a self-custody model based on digitized, named assets is fundamentally different from the traditional banking system that has evolved over centuries.
So, what broader monetary structure and policy issues need to be addressed by entrepreneurs, regulators, and traditional financial institutions during this transformation?
This article will delve into three core challenges and their potential solutions, providing direction for entrepreneurs and builders in traditional financial institutions: the issue of monetary unity; the application of dollar stablecoins in non-dollar economies; and the potential impact of government bond backing on superior currencies.
1. 'Monetary unity' and the construction of a unified monetary system
'Monetary unity' refers to the ability for various forms of currency within an economy, regardless of who issues or stores the currency, to be exchanged at a 1:1 ratio and used for payments, pricing, and contract fulfillment. Monetary unity means that, even with multiple organizations or technologies issuing similar monetary instruments, the entire system remains a unified monetary system. In other words, whether it is deposits from Chase, deposits from Wells Fargo, Venmo balances, or stablecoins, they should always be perfectly equivalent at a 1:1 ratio. This unity is maintained despite differences in asset management practices and regulatory status among various institutions. The history of the U.S. banking industry, to some extent, is a history of creating and improving systems to ensure the fungibility of the dollar.
The global banking industry, central banks, economists, and regulators all advocate for monetary unity, as it greatly simplifies transactions, contracts, governance, planning, pricing, accounting, security, and everyday economic activities. Today, businesses and individuals have become accustomed to monetary unity.
Currently, stablecoins have not fully integrated into the existing financial infrastructure, preventing the realization of 'monetary unity.' For instance, if Microsoft, a bank, a construction company, or a homebuyer attempts to exchange $5 million worth of stablecoins through an automated market maker (AMM), due to insufficient liquidity depth leading to slippage, users will not be able to exchange at a 1:1 ratio, ultimately receiving less than $5 million. Such scenarios are unacceptable if stablecoins are to radically transform the financial system.
A universally applicable 'face value exchange system' could help stablecoins become part of a unified monetary system. If this goal cannot be achieved, the potential value of stablecoins will be significantly diminished.
Currently, stablecoin issuers like Circle and Tether primarily provide direct exchange services for institutional clients or users who have gone through a verification process for stablecoins (like USDC and USDT). These services typically have minimum trading thresholds. For instance, Circle provides Circle Mint (formerly known as Circle Account) for corporate users to mint and redeem USDC; Tether allows verified users to redeem directly, usually with a threshold above a certain amount (e.g., $100,000). The decentralized MakerDAO allows users to exchange DAI for other stablecoins (like USDC) at a fixed rate through the Peg Stability Module (PSM), thereby serving as a verifiable redemption/exchange mechanism.
Although these solutions work to some extent, they are not universally available and require integrators to connect with each issuing institution individually. If direct integration is not possible, users can only convert between stablecoins or redeem stablecoins for fiat through market execution, without the ability to settle at face value.
Without direct integration, businesses or applications may promise to maintain very narrow exchange spreads—for example, always exchanging 1 USDC for 1 DAI and keeping the spread within one basis point—but such promises still depend on liquidity, balance sheet space, and operational capacity.
In theory, central bank digital currencies (CBDCs) could unify the monetary system, but the numerous accompanying issues (such as privacy concerns, financial surveillance, limited money supply, and slowed innovation) make it almost certain that a superior model imitating the existing financial system will prevail.
Therefore, the challenge for builders and institutional adopters is to construct systems that allow stablecoins to serve as 'real currency,' like bank deposits, fintech balances, and cash, despite their heterogeneity in collateral, regulation, and user experience. The goal of integrating stablecoins into monetary unity presents tremendous growth opportunities for entrepreneurs.
Widespread availability of minting and redemption
Stablecoin issuers should work closely with banks, fintech companies, and other existing infrastructures to achieve seamless and face-value deposit and withdrawal channels. This will provide stablecoins with face-value fungibility through existing systems, making them indistinguishable from traditional currencies.
Stablecoin clearinghouse
Establish decentralized cooperative organizations—similar to ACH or Visa in the stablecoin space—to ensure instant, frictionless, and transparent fee conversions. The Peg Stability Module is a promising model, but expanding the protocol to ensure face value settlement between participating issuers and fiat currency would significantly enhance the functionality of stablecoins.
Credibly neutral collateral layer
Transfer the fungibility of stablecoins to a widely adopted collateral layer (such as tokenized bank deposits or wrapped government bonds). This allows stablecoin issuers to innovate in branding, marketing strategies, and incentive mechanisms, while users can unpack and convert stablecoins as needed.
Superior exchanges, intent matching, cross-chain bridges, and account abstraction
Utilize improved existing or known technologies to automatically find and execute deposits, withdrawals, or exchange operations at optimal exchange rates. Build multi-currency exchanges to minimize slippage while hiding complexity, allowing stablecoin users to enjoy predictable fees even during large-scale usage.
USD stablecoins: A double-edged sword of monetary policy and capital regulation
2. Global demand for USD stablecoins
In many countries, the structural demand for dollars is immense. For citizens living under high inflation or strict capital controls, USD stablecoins are a lifeline—they protect savings while providing direct access to the global business network. For enterprises, the dollar serves as an international pricing unit, simplifying and enhancing the value and efficiency of international transactions. However, the reality is that cross-border remittance fees can reach as high as 13%, with 900 million people living in high-inflation economies unable to use stable currencies, and 1.4 billion people lacking access to banking services. The success of USD stablecoins not only reflects the demand for dollars but also embodies a desire for a 'superior currency.'
For various political and nationalistic reasons, countries often maintain their monetary systems, as this grants policymakers the ability to adjust the economy based on local realities. When disasters affect production, key exports decline, or consumer confidence falters, central banks can alleviate shocks, enhance competitiveness, or stimulate consumption by adjusting interest rates or issuing currency.
However, the widespread adoption of USD stablecoins may weaken the ability of local policymakers to regulate local economies. This impact can be traced back to the 'impossible trinity' theory in economics, which states that a country can only choose two out of the following three economic policies at any given time:
1. Free capital flow;
2. Fixed or tightly managed exchange rates;
3. Independent monetary policy (autonomously set domestic interest rates).
Decentralized peer-to-peer transactions affect all policies in the 'impossible trinity': transactions bypass capital controls, fully opening the lever of capital flow; 'dollarization' may weaken the effectiveness of policies managing exchange rates or domestic interest rates by anchoring citizens' economic activities to an international pricing unit (the dollar).
Decentralized peer-to-peer transfers affect all policies in the 'impossible trinity.' Such transfers bypass capital controls, forcing the 'lever' of capital flow to fully open. Dollarization can weaken the impact of policies managing exchange rates or domestic interest rates by linking citizens to an international pricing unit. Countries rely on narrow channels within correspondent banking systems to guide citizens toward local currencies to enforce these policies.
Although USD stablecoins may pose challenges to local monetary policy, they remain attractive in many countries. This is because low-cost and programmable dollars bring more trade, investment, and remittance opportunities. Most international commerce is dollar-denominated, and access to dollars can make international trade faster and more convenient, thereby increasing its frequency. Additionally, governments can still tax inflows and outflows and oversee local custodians.
Currently, various regulations, systems, and tools have been implemented at the level of correspondent banking systems and international payments to prevent money laundering, tax evasion, and fraud. Although stablecoins rely on open, transparent, and programmable ledgers, which facilitate the development of security tools, these tools need to be genuinely developed. This presents an opportunity for entrepreneurs to connect stablecoins with existing international payment compliance infrastructure to uphold and enforce relevant policies.
Unless we assume that sovereign nations will give up valuable policy tools for efficiency (which is highly unlikely) and completely ignore fraud and other financial crimes (which is nearly impossible), entrepreneurs still have the opportunity to develop systems that improve the integration of stablecoins with local economies.
To smoothly integrate stablecoins into local financial systems, the key is to enhance foreign exchange liquidity, anti-money laundering (AML) oversight, and other macroprudential buffers while embracing better technology. Here are some potential technical solutions:
Local acceptance of USD stablecoins
Integrate USD stablecoins into local banks, fintech companies, and payment systems to support small, optional, and possibly taxable exchange methods. This can enhance local liquidity without completely undermining the status of local currency.
Local stablecoins as deposit and withdrawal channels
Launch local currency stablecoins with deep liquidity and thorough integration into local financial infrastructure. During the initiation of extensive integration, a clearinghouse or neutral collateral layer may be needed (referencing the earlier section), and once local stablecoins are integrated, they will become the best choice for foreign exchange trading and the default option for high-performance payment networks.
On-chain foreign exchange market
Create a matching and price aggregation system across stablecoins and fiat currencies. Market participants may need to support existing foreign exchange trading models by holding reserves with yield instruments and employing high-leverage strategies.
Challenge competitors of MoneyGram
Build a compliant, physical retail cash deposit/withdrawal network and encourage agents to settle in stablecoins through incentive mechanisms. Although MoneyGram recently announced similar products, there remains ample opportunity for other participants with established distribution networks.
Improved compliance
Upgrade existing compliance solutions to support the stablecoin payment network. Utilize the programmability of stablecoins to provide richer and faster insights into fund flows.
Through these bidirectional improvements in technology and regulation, USD stablecoins can not only meet the demands of global markets but also achieve deep integration with existing financial systems during localization, while ensuring compliance and economic stability.
3. Potential impact of government bonds as collateral for stablecoins
The popularity of stablecoins is not due to their backing by government bonds but because they provide an almost instantaneous, nearly free trading experience with unlimited programmability. The widespread adoption of fiat-backed stablecoins has occurred first because they are the easiest to understand, manage, and regulate. The core drivers of user demand are the practicality and trustworthiness of stablecoins (such as 24/7 settlement, composability, global demand), rather than the nature of their collateral.
However, fiat-backed stablecoins may face challenges due to their success: if the issuance scale of stablecoins grows tenfold in the coming years—from the current $262 billion to $2 trillion—and regulators require stablecoins to be backed by short-term U.S. government bonds (T-bills), what will happen? This scenario is not impossible, and its impact on the collateral market and credit creation could be profound.
Hold short-term government bonds (T-bills)
If $2 trillion in stablecoins is backed by short-term U.S. government bonds—currently widely recognized by regulators as compliant assets—it means that stablecoin issuers would hold about one-third of the $7.6 trillion short-term government bond market. This shift is analogous to the role of money market funds in the current financial system—concentrating liquid, low-risk assets, but its impact on the government bond market could be even greater.
Short-term government bonds are considered one of the safest and most liquid assets globally, and they are priced in dollars, simplifying exchange rate risk management. However, if the issuance scale of stablecoins reaches $2 trillion, this could lead to a decrease in government bond yields and reduce the active liquidity in the repo market. Each new stablecoin effectively represents additional demand for government bonds. This would allow the U.S. Treasury to refinance at a lower cost, but could also make T-bills scarcer and more expensive for other financial institutions. This would not only squeeze the income of stablecoin issuers but also make it harder for other financial institutions to obtain collateral for managing liquidity.
One possible solution is for the U.S. Treasury to issue more short-term debt, such as expanding the market size of short-term government bonds from $7 trillion to $14 trillion. However, even so, the ongoing growth of the stablecoin industry will still reshape supply and demand dynamics.
The rise of stablecoins and their profound impact on the government bond market reveals the complex interaction between financial innovation and traditional assets. In the future, how to balance the growth of stablecoins with the stability of financial markets will be a key issue that regulators and market participants must face together.
Narrow banking model
Fundamentally, fiat-backed stablecoins are akin to narrow banks: they hold 100% reserves in cash equivalents and do not lend. This model is inherently lower risk and is one of the reasons why fiat-backed stablecoins received early regulatory approval. Narrow banks are a trusted and easily verifiable system that can provide a clear value proposition for token holders while avoiding the comprehensive regulatory burdens faced by traditional fractional reserve banks. However, if the scale of stablecoins grows tenfold to reach $2 trillion, such funds, entirely backed by reserves and short-term government bonds, will have profound implications for credit creation.
Economists express concerns about the narrow banking model because it limits the ability of capital to provide credit to the economy. Traditional banks (i.e., fractional reserve banks) typically retain only a small fraction of customer deposits as cash or cash equivalents, while the rest is used to issue loans to businesses, home buyers, and entrepreneurs. Under the supervision of regulators, banks manage credit risk and loan terms to ensure that depositors can withdraw cash when needed.
However, regulators do not want narrow banks to absorb deposit funds, as the funding under the narrow bank model has a lower money multiplier effect (i.e., the credit expansion multiple supported by a single dollar is lower). Ultimately, the economy relies on credit to operate: regulators, businesses, and everyday consumers all benefit from a more active and interdependent economy. If even a small portion of the $17 trillion deposit base in the U.S. were to migrate to fiat-backed stablecoins, banks could lose their cheapest source of funds. This would force banks to face two unfavorable choices: either reduce credit creation (e.g., decrease mortgages, auto loans, and small business credit lines), or make up for deposit losses through wholesale financing (e.g., short-term loans from federal home loan banks), which are not only more expensive but also shorter in duration.
Despite the aforementioned issues with the narrow banking model, stablecoins offer higher monetary liquidity. A stablecoin can be sent, spent, loaned, or collateralized—and can be used multiple times per minute, controlled by humans or software, operating around the clock. This high efficiency of liquidity makes stablecoins a superior form of currency.
Moreover, stablecoins do not necessarily have to be backed by government bonds. An alternative is tokenized deposits, which allow the value proposition of stablecoins to be directly reflected on the bank's balance sheet while circulating in the economy at the speed of modern blockchain. In this model, deposits remain within a fractional reserve banking system, and each stable value token continues to support the lending business of the issuing institution. This model restores the money multiplier effect—not only through the velocity of money but also through traditional credit creation; while users can still enjoy 24/7 settlement, composability, and on-chain programmability.
The rise of stablecoins presents new possibilities for the financial system, but also poses the challenge of balancing credit creation with system stability. Future solutions will need to find the best intersection between economic efficiency and traditional financial functions.
To enable stablecoins to retain the advantages of the fractional reserve banking system while promoting economic dynamics, design improvements can be made in the following three areas:
· Tokenized deposit model: Retain deposits within a fractional reserve system through tokenized deposits.
· Diversifying collateral: Expand collateral from short-term government bonds (T-bills) to other high-quality, liquid assets.
· Embed automatic liquidity mechanisms: By reintroducing idle reserves into the credit market through on-chain repo agreements, tri-party facilities, collateralized debt position pools, etc.
The goal is to maintain a mutually dependent, continuously growing economic environment, making reasonable business loans more easily accessible. By supporting traditional credit creation while enhancing monetary liquidity, decentralized lending, and direct private lending, innovative stablecoin designs can achieve this goal.
Although the current regulatory environment makes tokenized deposits infeasible, the regulatory clarity surrounding fiat-backed stablecoins is opening the door for stablecoins backed by bank deposits.
Deposit-backed stablecoins can allow banks to continue providing credit to existing customers while enhancing capital efficiency and bringing the programmability, low cost, and high-speed trading advantages of stablecoins. The operation of this stablecoin is very simple: when a user chooses to mint a deposit-backed stablecoin, the bank deducts the corresponding amount from the user's deposit balance and transfers the deposit obligation to a consolidated stablecoin account. Subsequently, these stablecoins, as ownership tokens of dollar-denominated assets, can be sent to a public address designated by the user.
In addition to deposit-backed stablecoins, other solutions can also improve capital efficiency, reduce friction in the government bond market, and increase monetary liquidity.
1. Help banks embrace stablecoins
Banks can enhance their net interest margin (NIM) by adopting or even issuing stablecoins. Users can withdraw funds from deposits while banks retain the earnings of the underlying assets and maintain relationships with customers. Moreover, stablecoins provide banks with payment opportunities without the need for intermediaries.
2. Help individuals and businesses embrace DeFi
As more users directly manage funds and wealth through stablecoins and tokenized assets, entrepreneurs should help these users obtain funds quickly and securely.
3. Expand the types of collateral and tokenize them
Broaden the acceptable range of collateral assets beyond short-term government bonds, such as municipal bonds, high-grade corporate paper, mortgage-backed securities, or other real-world assets (RWAs). This not only reduces dependence on a single market but also provides credit to borrowers outside the U.S. government while ensuring the high quality and liquidity of collateral to maintain the stability and user trust in stablecoins.
4. Put collateral on-chain to enhance liquidity
Tokenize these collaterals, including real estate, commodities, stocks, and government bonds, to create a richer collateral ecosystem.
5. Adopt a collateralized debt position (CDPs) model
By drawing on MakerDAO's DAI and other CDP-based stablecoins, these stablecoins utilize a diversified array of on-chain assets as collateral, not only dispersing risk but also reproducing the monetary expansion functions provided by banks on-chain. Additionally, these stablecoins should be subject to rigorous third-party audits and transparent disclosures to verify the stability of their collateral models.
While facing significant challenges, each challenge presents great opportunities. Those entrepreneurs and policymakers who can understand the nuances of stablecoins will have the chance to shape a smarter, safer, and superior financial future.
