Original Article Title: How stablecoins become money: Liquidity, sovereignty, and credit
Original Article Author: Sam Broner
Original Article Translation: Deep Tide TechFlow
Traditional finance is gradually incorporating stablecoins into its system, and the trading volume of stablecoins is also continuously growing. Due to their speed, almost zero cost, and programmable nature, stablecoins have become the best tool for building global financial technology. However, the transition from traditional technology to emerging technology not only signifies a fundamental change in business models but also brings about new risks. After all, the self-custody model based on digital anonymous assets is fundamentally different from the traditional banking system that has evolved over hundreds of years.
So, in this transformation process, what broader currency structure and policy issues do entrepreneurs, regulators, and traditional financial institutions need to address? This article will delve into three core challenges and their potential solutions, providing guidance for entrepreneurs and builders of traditional financial institutions: the issue of currency unity; the application of the US dollar stablecoin in non-dollar economies; and the potential impact of a better currency supported by government debt.
"Currency unity" refers to the ability for various forms of currency within an economy to be exchanged at a 1:1 ratio regardless of who issued the currency or where it is held, and to be used for payments, pricing, and contract performance. Currency unity means that even if there are multiple institutions or technologies issuing similar currency-like tools, the entire system remains a unified currency system. In other words, whether it's a Chase deposit, a Wells Fargo deposit, Venmo balance, or a stablecoin, they should always be fully equivalent at a 1:1 ratio. This unity is maintained despite differences among institutions in asset management practices and regulatory status. The history of the US banking industry is to some extent a history of creating and improving systems to ensure the interchangeability of the US dollar.
The global banking industry, central banks, economists, and regulatory bodies all advocate for currency unity because it greatly simplifies transactions, contracts, governance, planning, pricing, accounting, security, and daily economic activities. Today, businesses and individuals have become accustomed to currency unity.
However, stablecoins have not yet fully integrated into the existing financial infrastructure, thus preventing the achievement of "currency unity." For example, if Microsoft, a bank, a construction company, or a homebuyer tries to exchange $5 million worth of stablecoin through an Automated Market Maker (AMM), the user will be unable to complete the exchange at a 1:1 ratio due to insufficient liquidity depth-related slippage, ultimately receiving an amount less than $5 million. If stablecoins are to truly transform the financial system, this situation is unacceptable.
A universally applicable "par value exchange system" can help stabilize coins become part of a unified monetary system. If this goal cannot be achieved, the potential value of stablecoins will be greatly discounted.
Currently, stablecoin issuing institutions like Circle and Tether mainly offer stablecoins (such as USDC and USDT) directly to institutional clients or validated users through a redemption service. These services usually have a minimum transaction threshold. For example, Circle provides Circle Mint (formerly Circle Account) for enterprise users to mint and redeem USDC; Tether allows validated users to redeem directly, usually with a minimum threshold amount (e.g., $100,000). The decentralized MakerDAO allows users to exchange DAI for other stablecoins (such as USDC) at a fixed rate through the Peg Stability Module (PSM), acting as a verifiable redemption/exchange mechanism.
While these solutions are effective to some extent, they are not universally accessible and require integrators to interface with each issuing institution separately. If direct integration is not possible, users can only convert between stablecoins or redeem stablecoins for fiat through market execution, rather than settling at par value.
In cases where direct integration is not possible, enterprises or applications may commit to maintaining a minimal exchange spread—for example, always exchanging 1 USDC for 1 DAI and keeping the spread within 1 basis point—but this commitment still depends on liquidity, balance sheet space, and operational capability.
In theory, central bank digital currencies (CBDCs) could unify the monetary system. However, the many accompanying issues (such as privacy concerns, financial surveillance, restricted money supply, and slowed innovation) make it almost certain that a model that mimics the existing financial system will prevail.
Therefore, the challenge for builders and institutional adopters is how to construct a system that enables stablecoins to function as "true money," similar to bank deposits, fintech balances, and cash, despite their heterogeneity in collateral, regulation, and user experience. Including stablecoins in the goal of monetary uniformity provides entrepreneurs with significant development opportunities.
Stablecoin issuers should closely collaborate with banks, fintech companies, and other existing infrastructure to achieve seamless and par value on- and off-ramps. This will provide stablecoins with par value fungibility through existing systems, making them indistinguishable from traditional currencies.
Establish a decentralized consortium—similar to the 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 settlement at face value between the issuing party and the fiat would significantly enhance stablecoins' functionality.
Transfer the fungibility of stablecoins to a widely adopted collateral layer (such as tokenized bank deposits or wrapped government bonds). This way, stablecoin issuers can innovate on branding, market strategy, and incentive mechanisms, while users can unpack and convert stablecoins as needed.
Utilize an improved version of existing or known technology to automatically find and execute deposits, withdrawals, or exchanges at the best rate. Build a multi-currency trading platform to minimize slippage to the fullest extent while hiding complexity, allowing stablecoin users to enjoy predictable fees even at scale.
In many countries, there is a substantial structural demand for the US dollar. For citizens living in high inflation or under strict capital controls, US dollar stablecoins serve as a lifeline—they can protect savings and provide direct access to the global commercial network. For businesses, 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 costs can reach up to 13%, with 900 million people globally residing in high-inflation economies unable to use stable currency, and 1.4 billion unbanked individuals. The success of the US dollar stablecoin not only reflects the demand for the dollar but also signifies the desire for a "better currency."
For various reasons such as politics and nationalism, countries often maintain their own monetary systems as it empowers policymakers to adjust the economy based on local conditions. When disasters affect production, key exports decline, or consumer confidence wavers, central banks can mitigate shocks, enhance competitiveness, or stimulate consumption through interest rate adjustments or currency issuance.
However, widespread adoption of the US dollar stablecoin may undermine local policymakers' ability to regulate the local economy. This impact can be traced back to the "impossible trilemma" theory in economics. This theory points out that a country can only choose two of the following three economic policies at any given time:
· Free capital mobility;
· Fixed or tightly managed exchange rates;
· Independent monetary policy (setting domestic interest rates autonomously).
The following are the impacts of the three policies of the "Impossible Trinity" on decentralized peer-to-peer transactions:
· Transactions bypass capital controls, fully opening the leverage of capital mobility;
· "Dollarization" may weaken the effects of managed exchange rates or domestic interest rates policies by anchoring citizens' economic activities to an international pricing unit (the dollar).
Decentralized peer-to-peer transfers have impacted all policies of the "Impossible Trinity." Such transfers bypass capital controls, forcing the leverage of capital mobility to be fully opened. Dollarization, by anchoring citizens to an international pricing unit, can weaken the impact of managed exchange rates or domestic interest rate policies. Countries rely on a narrow channel of the agent banking system to guide citizens to local currency to implement these policies.
Although a USD stablecoin may pose a challenge to local currency policies, it remains attractive in many countries. This is because the low-cost and programmable nature of the USD brings more trade, investment, and remittance opportunities. Most international businesses are denominated in USD, and accessing the USD can make international trade faster, more convenient, and therefore more frequent. In addition, governments can still tax inflows and outflows and oversee local custodial entities.
Currently, various regulations, systems, and tools have been implemented in the agent banking system and international payment layers to prevent money laundering, tax evasion, and fraudulent activities. While stablecoins rely on a publicly transparent and programmable ledger, which provides convenience for building secure tools, these tools need to be truly developed. This provides 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 (highly unlikely) and completely ignore fraud and other financial crimes (almost impossible), entrepreneurs still have the opportunity to develop systems to improve the integration of stablecoins with the local economy.
To smoothly integrate stablecoins into the local financial system, it is crucial to embrace better technology while enhancing foreign exchange liquidity, anti-money laundering (AML) supervision, and other macro-prudential safeguards. Here are some potential technical solutions:
· Local acceptance of USD stablecoins
Integrate USD stablecoins into local banks, fintech companies, and payment systems, supporting small-scale, optional, and possibly taxable exchange methods. This can improve local liquidity without completely undermining the status of the local currency.
· Local Stablecoin as Deposit and Withdrawal Channel
Introduce local currency stablecoins with deep liquidity and deep integration with the local financial infrastructure. Upon wide integration rollout, a clearinghouse or neutral collateral layer (refer to the first part above) may be needed, and once integrated, local stablecoins will become the preferred option for foreign exchange transactions and the default option for high-performance payment networks.
· On-chain Forex Market
Create a matching and price aggregation system for cross-stablecoin and fiat currency. Market participants may need to support the existing forex trading model through holding reserves in interest-bearing instruments and adopting a high leverage strategy.
· MoneyGram Challenger
Build a compliant, brick-and-mortar retail cash deposit/withdrawal network and incentivize agents to settle in stablecoins through a reward mechanism. Despite MoneyGram's recent announcement of a similar product, there is still ample opportunity for other participants with a mature distribution network.
· Enhanced Compliance
Upgrade existing compliance solutions to support stablecoin payment networks. Leveraging the programmability of stablecoins, provide richer and faster insights into fund flows.
Through these dual improvements in technology and regulation, the US dollar stablecoin can not only meet the needs of the global market but also achieve deep integration with the existing financial system in the localization process, ensuring compliance and economic stability.
The popularity of stablecoins is not because they are backed by treasury bonds, but because they offer an almost instant, almost free transaction experience and possess unlimited programmability. Fiat-backed stablecoins were initially widely adopted 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 assets.
However, fiat-backed stablecoins may face challenges due to their success: what would happen if the stablecoin issuance scales up tenfold in the coming years—from the current $262 billion to $2 trillion—and regulatory agencies require stablecoins to be backed by short-term US Treasury bills? This scenario is not impossible, and its impact on the collateral market and credit creation could be profound.
If a $2 trillion stablecoin is backed by short-term U.S. Treasury bills—currently widely recognized by regulators as a compliant asset—it means that the stablecoin issuer would hold about a third of the $7.6 trillion short-term Treasury bill market. This shift is akin to the role of Money Market Funds in the current financial system—concentrated holdings of highly liquid, low-risk assets, but its impact on the Treasury bill market may be more significant.
Short-term Treasury bills are considered one of the safest and most liquid assets globally, and they are dollar-denominated, simplifying exchange rate risk management. However, if stablecoin issuance reaches $2 trillion, this could lead to a decrease in Treasury bill yields and reduce the active liquidity in the repo market. With each new stablecoin minted, it effectively translates to additional demand for Treasury bills. This would enable 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 stablecoin issuer's revenue but also make it more difficult for other financial institutions to obtain collateral for liquidity management.
One possible solution is for the U.S. Treasury to issue more short-term debt, such as doubling the market size of short-term Treasury bills from $7 trillion to $14 trillion. However, even then, the continued growth of the stablecoin industry would reshape the supply-demand dynamics. The rise of stablecoins and their profound impact on the Treasury bill market reveal the complex interaction between financial innovation and traditional assets. In the future, balancing stablecoin growth with financial market stability will be a key issue faced by regulators and market participants alike.
Fundamentally, a fiat-backed stablecoin is similar to a Narrow Bank: they hold 100% reserves, exist in the form of cash equivalents, and do not engage in lending. This model is inherently low-risk and is one of the reasons fiat-backed stablecoins obtained early regulatory approval. Narrow Banking is a trustworthy and easily verifiable system that can provide token holders with a clear value proposition while avoiding the comprehensive regulatory burden faced by traditional fractional reserve banks. However, if stablecoin issuance were to grow tenfold, reaching $2 trillion, and these funds were fully backed by reserves and short-term Treasury bills, it would have far-reaching implications for credit creation.
Economists express concerns about the Narrow Banking model as it limits the capital available to provide credit to the economy. Traditional banks (i.e., fractional reserve banks) typically only hold a small amount of customer deposits as cash or cash equivalents, with the rest of the deposits being used to extend loans to businesses, homebuyers, and entrepreneurs. Under regulatory oversight, banks manage credit risk and loan maturities to ensure depositors can withdraw cash when needed.
However, regulators do not want narrow banks to absorb deposit funding because under the narrow bank model, funds have a lower money multiplier effect (i.e., a lower credit expansion multiplier for each dollar). Ultimately, the economy relies on credit to function: regulators, businesses, and everyday consumers all benefit from a more active, more interdependent economy. If even a small portion of the $17 trillion U.S. deposit base were to move to a fiat-reserve stablecoin, banks could lose their cheapest source of funding. This would force banks to face two unfavorable choices: either reduce credit creation (e.g., reduce mortgage loans, auto loans, and small business credit lines) or make up for the loss of deposits through wholesale funding (such as the Federal Home Loan Bank's short-term loans), which is not only more expensive but also shorter-term.
Despite the mentioned issues with the narrow bank model, stablecoins offer higher currency liquidity. A stablecoin can be sent, spent, borrowed against, or used as collateral—and can be used multiple times per minute, controlled by humans or software, and operational 24/7. This high liquidity makes stablecoins a superior form of currency.
Furthermore, stablecoins do not have to be backed by government debt. An alternative solution is Tokenized Deposits, allowing 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 still remain within the fractional reserve banking system, and each stable value token continues to underpin the lending business of the issuing institution. In this model, the money multiplier effect is restored—not only through the velocity of money but also through traditional credit creation—and users can still benefit from 24/7 settlement, composability, and on-chain programmability.
The rise of stablecoins has provided the financial system with new possibilities but has also posed a balancing act between credit creation and systemic stability. Future solutions will need to find the optimal balance between economic efficiency and traditional financial functions.
To ensure that stablecoins can both retain the advantages of the fractional reserve banking system and drive economic dynamism, design improvements can be made in the following three areas:
· Tokenized Deposit Model: Retain deposits in the fractional reserve system through Tokenized Deposits.
· Diversification of Collateral: Expand collateral from short-term Treasury bills to other high-quality, liquid assets.
· Embedding Automatic Liquidity Mechanisms: Reintroduce idle reserves into the credit market through on-chain repo agreements, tri-party facilities, collateralized debt pools, and other means.
The goal is to maintain an interdependent, ever-growing economic environment that makes reasonable business loans more readily available. By supporting traditional credit creation while enhancing liquidity, decentralized collateralized lending, and direct peer-to-peer lending, innovative stablecoin design can achieve this goal.
Although the current regulatory environment currently makes tokenized deposits impractical, regulatory clarity around fiat-backed stablecoins is opening doors for bank deposit-backed stablecoins.
Deposit-backed stablecoins allow banks to continue providing credit to existing customers while improving capital efficiency and bringing the programmability, low cost, and high-speed transaction advantages of stablecoins. The operation of this stablecoin is straightforward: 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 comprehensive stablecoin account. Subsequently, these stablecoins, as dollar-denominated asset ownership tokens, can be sent to a user's specified public address.
In addition to deposit-backed stablecoins, other solutions can also enhance capital efficiency, reduce friction in the government bond market, and increase liquidity.
Banks can enhance net interest margin (NIM) by adopting or even issuing stablecoins. Users can withdraw funds from deposits while banks retain the yield on the underlying assets and the customer relationship. Furthermore, stablecoins provide banks with an opportunity for payment involvement without intermediaries.
As more users manage funds and wealth directly through stablecoins and tokenized assets, entrepreneurs should help these users access funds quickly and securely.
Expand the acceptable collateral asset range beyond short-term government bonds to include municipal bonds, high-grade corporate paper, mortgage-backed securities (MBS), or other collateralized real-world assets (RWAs). This not only reduces reliance on a single market but also provides credit to borrowers outside the US government, while ensuring high-quality and liquid collateral to maintain stablecoin stability and user trust.
Tokenize these collateral assets, including real estate, commodities, stocks, and government bonds, to create a more diverse collateral ecosystem.
Building on MakerDAO's DAI and other CDP-based stablecoins, these stablecoins utilize diverse on-chain assets as collateral, not only diversifying risk but also replicating on-chain the money expansion function traditionally provided by banks. Additionally, these stablecoins require strict third-party audits and transparent disclosures to verify the stability of their collateralization model.
While facing significant challenges, each challenge brings enormous opportunities. Entrepreneurs and policymakers who can understand the subtle differences among stablecoins will have the opportunity to shape a smarter, more secure, and superior financial future.
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