Traditional finance is gradually incorporating stablecoins into its system, and the transaction volume of stablecoins is also growing. Stablecoins have become the best tool for building global financial technology because of their fast, almost zero cost and easy programming characteristics. The transition from traditional technology to new technology means that we will adopt a fundamentally different business model-but this transformation will also bring new risks. After all, the self-custody model based on digital assets is a disruptive change to the banking system that has been used for hundreds of years, compared with the banking system that relies on registered deposits.
So, what are the broader monetary structure and policy issues that entrepreneurs, regulators, and traditional financial institutions need to address during this transformation?
This article delves into three challenges and potential solutions that both startups and builders in traditional finance can find current focus: the unification of currency; the use of dollar stablecoins in non-dollar economies; and the possible impact of a better currency backed by Treasury bonds.
1. "Currency Unity" and the Construction of a Unified Monetary System
The “Singleness of Money” refers to the fact that within an economy, all forms of money are interchangeable at a fixed ratio (1:1) and used for payments, pricing, and contract fulfillment, regardless of who issues the money or where it is stored. The singleness of money states that even if there are multiple institutions or technologies issuing currency-like instruments, there is still a unified monetary system within the economy. In fact, whether it is the dollars in your JPMorgan account, the dollars in your Wells Fargo account, or the balance on Venmo, they should always be equal to the stablecoin - and always maintain a 1:1 ratio. This principle holds true even if there are differences in how these institutions manage assets and their regulatory status has significant but often overlooked differences.
The history of American banking is, in part, the history of ensuring the fungibility of the dollar and continually improving the systems involved.
Global banks, central banks, economists and regulators have long taken the “uniformity of money” for granted, as it greatly simplifies transactions, contracts, governance, planning, pricing, accounting, security and everyday transactions.
However, “monetary uniformity” is not how stablecoins work today, as they are not yet fully integrated with existing infrastructure. For example, if Microsoft, a bank, a construction company, or a homebuyer tries to redeem $5 million in stablecoins on an automated market maker (AMM), the user will not be able to achieve a 1:1 exchange ratio due to slippage caused by insufficient liquidity depth, and will ultimately receive less than $5 million. This is clearly unacceptable if stablecoins are to revolutionize the financial system.
A universal par redemption system would help stablecoins become part of a unified monetary system. If stablecoins cannot be part of a unified monetary system, their potential functionality and value will be greatly reduced.
Currently, the way stablecoins work is that issuers (such as Circle and Tether) provide direct redemption services for their stablecoins (USDC and USDT respectively). These services are mainly for institutional clients or users who have passed the verification process, and are usually accompanied by minimum transaction amounts.
For example, Circle provides Circle Mint (formerly Circle Account) for corporate users to mint and redeem USDC; Tether allows verified users to make direct redemptions, usually after reaching a certain threshold (such as US$100,000).
The decentralized MakerDAO, through its Peg Stability Module (PSM), allows users to exchange DAI for other stablecoins (such as USDC) at a fixed exchange rate, essentially acting as a verifiable redemption/exchange mechanism.
While these solutions work, they are not universally available and require integrators to connect with each issuer one by one. Without direct integration, users can only exchange or "get off" between stablecoins through market execution, rather than settlement at par.
In the absence of direct integration, some businesses or applications may claim to be able to maintain an extremely narrow conversion range - such as always converting 1 USDC to 1 DAI with a spread of 1 basis point - but this promise still depends on liquidity, balance sheet space, and operational capabilities.
In theory, central bank digital currencies (CBDCs) could unify the monetary system, but they come with so many problems—privacy concerns, financial surveillance, constrained money supply, slowed innovation, etc.—that better models that mimic the existing financial system are almost destined to win out.
For builders and institutional adopters, the challenge is how to build systems that enable stablecoins to be “pure money” like bank deposits, fintech balances, and cash, despite differences in collateral, regulation, and user experience. The goal of incorporating stablecoins into the uniformity of money offers entrepreneurs the following building opportunities:
1. Widely available minting and redemption mechanisms
Stablecoin issuers need to work closely with banks, fintech companies and other existing infrastructure to create seamless on/off ramps. Achieving par-value interchangeability of stablecoins through existing systems can make stablecoins indistinguishable from traditional currencies, thereby accelerating their global adoption.
2. Stablecoin clearing center
Establish a decentralized cooperative organization - similar to the ACH or Visa of stablecoins - to ensure an instant, frictionless exchange experience with transparent fees. MakerDAO's Peg Stability Module (PSM) has provided a promising model, but if the protocol can be expanded based on this to ensure the settlement of par value between participating issuers and with the fiat dollar, it will be a more revolutionary solution.
3. Develop a trusted and neutral collateral layer
Moving the fungibility of stablecoins to a widely accepted collateral layer (such as tokenized bank deposits or wrapped Treasuries) allows stablecoin issuers to innovate in branding, marketing, and incentives, while users can easily unwrap and convert as needed.
4. Better exchanges, transaction intent, cross-chain bridges, and account abstraction
Leverage better versions of existing or known technologies to automatically find and execute the best inbound and outbound channels or conversion methods to achieve the best rates. Build multi-currency exchanges to minimize slippage. At the same time, hide these complexities and provide stablecoin users with a predictable fee experience even at large-scale use.
2. Global demand for US dollar stablecoins: a lifeline under high inflation and capital controls
In many countries, there is a strong structural need for the U.S. dollar. For citizens living in an environment of high inflation or strict capital controls, a U.S. dollar stablecoin is a lifeline—not only protecting savings but also providing a direct connection to the global commercial network.
For businesses, the US dollar is an international unit of account, making international transactions more convenient and transparent. People need a fast, widely accepted and stable currency to spend and save.
However, the current cross-border remittance fees are as high as 13%, 900 million people in the world live in high-inflation economies without access to stable currencies, and 1.4 billion people are underserved by banks. The success of the US dollar stablecoin not only reflects the demand for the US dollar, but also highlights people’s desire for a “better currency”.
Aside from political and nationalist reasons, one important reason countries maintain local currencies is that it gives policymakers the ability to adjust their economies to local economic realities. When disasters affect production, key exports decline, or consumer confidence falters, central banks can adjust interest rates or issue currency to cushion the shock, boost competitiveness, or stimulate consumption.
The widespread adoption of US dollar stablecoins may weaken the ability of local policymakers to regulate the economy. The root of this problem lies in the "Blockchain Trilemma" principle in economics, which states that a country can only choose two of the following three economic policies at any time:
1. Free movement of capital;
2. Fixed or strictly managed exchange rates;
3. Independent monetary policy (freedom to set domestic interest rates).
Decentralized peer-to-peer transfers affect all policies in the “Blockchain Trilemma”. Such transfers bypass capital controls and force capital flows to be fully open. Dollarization weakens the influence of policies that manage exchange rates or domestic interest rates by anchoring citizens to international units of account. Countries implement these policies by channeling citizens to local currencies through narrow channels corresponding to the banking system.
Still, dollar stablecoins are attractive to foreign countries because cheaper, programmable dollars can attract trade, investment, and remittances. Most international business is denominated in dollars, so the easier it is to get dollars, the faster, simpler, and more common international trade will be. In addition, governments can still tax on/off ramps and monitor local custodians.
At the banking and international payment level, a range of regulations, systems and tools already exist to prevent money laundering, tax evasion and fraud. Although stablecoins run on public and programmable ledgers, making it easier to build security tools, these tools still need to be developed. This provides entrepreneurs with an opportunity to connect stablecoins to the existing international payment compliance infrastructure to support and enforce relevant policies.
Unless we assume that sovereigns will give up valuable policy tools for the sake of efficiency (extremely unlikely) and turn a blind eye to fraud and other financial crime (also unlikely), entrepreneurs will have an opportunity to build systems that help stablecoins better integrate into local economies.
While embracing better technologies, existing safeguards such as foreign exchange liquidity, anti-money laundering (AML) supervision and other macroprudential buffers must be improved so that stablecoins can be smoothly integrated into the local financial system. These technological solutions can achieve the following goals:
1. Local acceptance of USD stablecoins
Integrating USD stablecoins into local banks, fintechs, and payment systems to support small, optional, and potentially taxable conversions would improve local liquidity without completely undermining the local currency.
2. Local stablecoins as a channel for capital inflow and outflow
Issue a stablecoin pegged to the local currency and deeply integrated with the local financial infrastructure. Such a stablecoin can not only serve as an efficient tool for foreign exchange transactions, but also become the default high-performance payment channel. In order to achieve widespread integration, it may be necessary to establish a clearinghouse or a neutral collateral layer.
3. On-chain foreign exchange market
Develop matching and price aggregation systems across stablecoins and fiat currencies. Market participants may need to support existing foreign exchange trading strategies by holding yield-generating reserve assets and using high leverage.
4. Challenging MoneyGram’s competitors
Build a compliant, physical retail-based cash deposit and withdrawal network that rewards agents for settlement in stablecoins. Although MoneyGram recently announced a similar product, there is still a lot of opportunity for other companies with mature distribution networks to compete.
5. Improved compliance
Upgrade existing compliance solutions to support stablecoin payment networks. Leverage the greater programmability of stablecoins to provide richer and faster insights into capital flows, further improving transparency and security.
3. Consider the impact of using government bonds as stablecoin collateral
Stablecoins are popular not because they are backed by national debt, but because of their near-instant, nearly free transaction characteristics and unlimited programmability. Fiat-backed stablecoins were the first to be widely adopted because they are easy to understand, manage and regulate. However, the core drivers of user demand are their practicality and trust (such as 24/7 settlement, composability and global demand), rather than the specific form of their collateral.
Fiat-backed stablecoins may face challenges as a result of their success: What happens if the issuance of stablecoins grows from the current $262 billion to $2 trillion in a few years, and regulators require that stablecoins must be backed by short-term U.S. Treasury bonds (T-bills)? This scenario is not impossible, and its impact on mortgage markets and credit creation could be huge.
Potential impact of Treasury holdings
If $2 trillion in stablecoins were required to invest in short-term U.S. Treasuries (one of the few assets currently approved by regulators), then stablecoin issuers would hold about a third of the $7.6 trillion in Treasury bonds in circulation. This shift is similar to the role of money market funds today—concentrated holdings of liquid, low-risk assets—but the impact on the Treasury market could be more far-reaching.
Short-term Treasury bills are seen as ideal collateral because they are widely considered to be one of the world's lowest-risk and most liquid assets, and they are denominated in U.S. dollars, simplifying currency risk management.
However, if stablecoin issuance reaches $2 trillion, this could lead to lower Treasury yields and reduce active liquidity in the repo market. Each new stablecoin is equivalent to additional demand for Treasury bonds, which will enable the U.S. Treasury to refinance at a lower cost, while also making Treasury bonds more scarce and expensive for the rest of the financial system.
This situation could cut into revenue for stablecoin issuers while making it harder for other financial institutions to obtain the collateral needed to maintain liquidity.
One potential solution is for the U.S. Treasury to issue more short-term debt, such as expanding the circulation of short-term Treasury bills from $7 trillion to $14 trillion. But even so, the rapid growth of the stablecoin industry will reshape the supply and demand dynamics, bringing new market challenges and changes.
Narrow banking model
In essence, fiat-reserve stablecoins are very similar to narrow banks: they hold 100% of reserves (cash or equivalent) and do not lend. This model is less risky, which is one of the reasons why fiat-reserve stablecoins were able to gain early regulatory approval.
Narrow Banking is a trustworthy and easily verifiable system that provides clear value guarantees to token holders while avoiding the full regulatory burden faced by Fractional Reserve Banking.
However, if stablecoins grow tenfold to $2 trillion, their full reserve and Treasury backing will have a knock-on effect on credit creation.
Economists' concern about the narrow banking model is that it limits the ability of capital to be used to provide credit to the economy. Traditional banks (i.e. fractional reserve banks) keep only a small portion of customer deposits as cash or cash equivalents, while lending the majority of deposits to businesses, homebuyers and entrepreneurs. Under the supervision of regulators, banks ensure that depositors can access their funds when needed by managing credit risk and loan terms.
This is why regulators don’t want narrow banks to take deposits — funding in a narrow bank model has a lower money multiplier (i.e., a lower multiple of credit expansion supported by a single dollar). Fundamentally, the economy depends on the flow of credit: regulators, businesses, and ordinary consumers all benefit from a more vibrant, interdependent economy. If even a small portion of the $17 trillion U.S. deposit base migrated to fiat-backed stablecoins, banks could lose their cheapest source of funding.
Faced with a loss of deposits, banks face two less-than-ideal options: either cut back on credit creation (e.g., by reducing mortgages, auto loans, and small business lines of credit); or replace the lost deposits with wholesale funding (e.g., advances from the Federal Home Loan Banks), which is more expensive and has shorter maturities.
However, stablecoins, as “better money”, support a higher velocity of money. A single stablecoin can be sent, spent, lent, or borrowed within a minute — that is, it can be used frequently! All of this can be controlled by humans or software, 24 hours a day, 7 days a week.
Stablecoins do not have to be backed by national debt. Tokenized deposits are another solution that allows the value proposition of stablecoins to remain on bank balance sheets while circulating through the economy at the speed of modern blockchains.
Under this model, deposits would continue to remain in the fractional reserve banking system, and each stable value token would actually still back the issuing institution’s lending business.
The money multiplier effect is restored — not just through velocity, but through traditional credit creation — while users still enjoy 24/7 settlement, composability, and on-chain programmability.
When designing stablecoins, a balance between economics and innovation can be achieved by:
1. Tokenized deposit model: keep deposits in a fractional reserve system;
2. Diversified collateral: In addition to short-term government bonds, it is expanded to other high-quality and liquid assets;
3. Embedding automated liquidity pipelines: Using mechanisms such as on-chain repo, tri-party facilities, and CDP (collateralized debt position) pools to inject idle reserves back into the credit market.
These designs do not compromise with traditional banks, but rather provide more options for maintaining economic vitality.
The ultimate goal is to sustain an interdependent and growing economy where reasonable business loans are easily accessible. Innovative stablecoin designs can achieve this by supporting traditional credit creation while increasing money velocity, decentralized collateralized lending, and direct private lending.
Although the current regulatory environment makes tokenized deposits not feasible, the regulation surrounding fiat-backed stablecoins is gradually becoming clearer, opening the door to stablecoins collateralized by bank deposits.
Deposit-backed stablecoins allow banks to improve capital efficiency while providing credit services, while bringing the programmability, cost advantages and fast transaction characteristics of stablecoins. When a user chooses to mint a deposit-backed stablecoin, the bank will deduct the corresponding amount from the user's deposit balance and transfer the deposit obligation to an integrated stablecoin account. These stablecoins will represent USD-denominated holdings of these assets, and users can send them to a public address of their choice.
In addition to deposit-backed stablecoins, the following innovations will help improve capital efficiency, reduce friction in Treasury markets, and accelerate money circulation:
1. Help banks embrace stablecoins
By adopting or even issuing stablecoins, banks can allow users to withdraw funds from deposits while retaining the yield on the underlying assets and maintaining their relationships with customers. Stablecoins also provide banks with payment opportunities without the involvement of middlemen.
2. Help individuals and businesses embrace decentralized finance (DeFi)
As more and more users manage their funds and wealth directly through stablecoins and tokenized assets, entrepreneurs should help these users access funds quickly and securely.
3. Expand the types of collateral and achieve tokenization
Expand the range of acceptable collateral assets beyond short-term Treasury bonds (T-bills), such as municipal bonds, highly rated corporate notes, mortgage-backed securities (MBS), or secured real-world assets (RWAs). This will not only reduce reliance on a single market, but also provide credit to borrowers outside the U.S. government, while ensuring the high quality and liquidity of collateral assets to maintain the stability of stablecoins and user confidence.
4. Put collateral on-chain to improve liquidity
Tokenizing these collateral assets (such as real estate, commodities, stocks, and treasuries) creates a richer collateral ecosystem.
5. Adopt the Collateralized Debt Position (CDP) model
Refer to CDP-based stablecoins such as MakerDAO's DAI, which use diversified on-chain assets as collateral to diversify risks while reproducing the monetary expansion function provided by banks on the chain. In addition, these stablecoins should be required to undergo rigorous third-party audits and transparent disclosures to verify the stability of their collateral models.
The stablecoin space faces enormous challenges, but every challenge also brings huge opportunities. Entrepreneurs and policymakers who can deeply understand the complexity of stablecoins have the opportunity to shape a smarter, safer, and superior financial future.
Acknowledgements
Special thanks to Tim Sullivan for his continued support. Thanks also to Aiden Slavin, Miles Jennings, Scott Kominers, Christian Catalini, and Luca Prosperi for their insightful feedback and suggestions that made this article possible.
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