In-depth exploration of three core challenges and their potential solutions, providing direction for entrepreneurs and builders of traditional financial institutions.

Author: Sam Broner

Translation: Deep Tide TechFlow

Traditional finance is gradually incorporating stablecoins into its system, and the trading volume of stablecoins continues to grow. Due to their speed, almost zero cost, and programmable features, 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 brings about new risks. After all, the self-custody model based on digital bearer assets is fundamentally different from the traditional banking system that has evolved over hundreds of years.

So, what broader monetary structure and policy issues do entrepreneurs, regulators, and traditional financial institutions need to address during this transformation?

This article will delve into three core challenges and their potential solutions, providing direction for entrepreneurs and builders of traditional financial institutions: the issue of monetary uniformity; the application of dollar stablecoins in non-dollar economies; and the potential impact of better currencies backed by government bonds.

1. "Monetary Uniformity" and the Construction of a Unified Monetary System

"Monetary uniformity" refers to the ability to exchange various forms of currency at a 1:1 ratio within an economy, regardless of who issues the currency or where it is stored, and to use it for payments, pricing, and contract fulfillment. Monetary uniformity means that even if multiple institutions or technologies issue similar currency instruments, the entire system remains a unified monetary system. In other words, whether it is deposits at Chase, deposits at Wells Fargo, Venmo balances, or stablecoins, they should always be fully equivalent at a 1:1 ratio. This uniformity is maintained despite differences in how institutions manage assets and their regulatory status. The history of the U.S. banking industry is, to some extent, a history of creating and improving systems to ensure the substitutability of the dollar.

Global banking, central banks, economists, and regulators all advocate for monetary uniformity because it greatly simplifies transactions, contracts, governance, planning, pricing, accounting, security, and everyday economic activities. Today, businesses and individuals have become accustomed to monetary uniformity.

However, stablecoins have not yet fully integrated into the existing financial infrastructure, and thus cannot achieve "monetary uniformity." For example, if Microsoft, a bank, a construction company, or a homebuyer attempts to exchange $5 million worth of stablecoins through an automated market maker (AMM), the user will be unable to complete the exchange at a 1:1 ratio due to slippage caused by insufficient liquidity depth, ultimately receiving less than $5 million. If stablecoins are to fundamentally transform the financial system, this situation is unacceptable.

A universally applicable "par 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 stablecoins (such as USDC and USDT) to institutional clients or users who go through a verification process. These services often have minimum transaction thresholds. For example, Circle offers Circle Mint (formerly Circle Account) for corporate users to mint and redeem USDC; Tether allows verified users to redeem directly, with thresholds typically above a certain amount (e.g., $100,000). The decentralized MakerDAO allows users to exchange DAI for other stablecoins (such as USDC) at a fixed exchange rate through the Peg Stability Module (PSM), thus serving as a verifiable redemption/exchange mechanism.

Although these solutions work to some extent, they are not universally accessible and require integrators to connect individually with each issuer. If direct integration is not possible, users can only convert between stablecoins or exchange stablecoins for fiat currency through market execution, without the ability to settle at par value.

Without direct integration, businesses or applications may promise to maintain a very small exchange price difference—for example, always exchanging 1 USDC for 1 DAI and keeping the price difference within one basis point—but this promise still depends on liquidity, balance sheet space, and operational capacity.

In theory, central bank digital currencies (CBDCs) could unify the monetary system, but the numerous issues they bring (such as privacy concerns, financial surveillance, limited money supply, and slowed innovation) make it almost certain that a better model mimicking the existing financial system will prevail.

Therefore, the challenge for builders and institutional adopters is how to construct a system that allows stablecoins to function as "real money," like bank deposits, fintech balances, and cash, despite their heterogeneity in collateral, regulation, and user experience. Integrating stablecoins into the goal of monetary uniformity presents significant growth opportunities for entrepreneurs.

• Widespread Availability of Minting and Redemption

Stablecoin issuers should closely collaborate with banks, fintech companies, and other existing infrastructures to achieve seamless and par value deposit and withdrawal channels. This will provide stablecoins with par value substitutability through existing systems, making them indistinguishable from traditional currencies.

• Stablecoin Clearinghouse

Establish a decentralized cooperative organization—similar to ACH or Visa in the stablecoin space—to ensure instant, frictionless, and transparently priced conversions. The Peg Stability Module is a promising model, but expanding the protocol to ensure par value settlement between participating issuers and fiat currencies would significantly enhance the functionality of stablecoins.

• Trustworthy Neutral Collateral Layer

Shift the substitutability of stablecoins to a widely adopted collateral layer (such as tokenized bank deposits or wrapped government bonds). This way, stablecoin issuers can innovate in branding, market strategy, and incentive mechanisms, while users can unpack and convert stablecoins as needed.

• Better Exchanges, Intent Matching, Cross-Chain Bridges, and Account Abstraction

Utilize improved existing or known technologies to automatically find and execute deposit, withdrawal, or exchange operations at the best rates. Build multi-currency exchanges to minimize slippage while hiding complexity, allowing stablecoin users to enjoy predictable fees even during large-scale usage.

• Dollar Stablecoins: A Double-Edged Sword for Monetary Policy and Capital Regulation

2. Global Demand for Dollar Stablecoins

In many countries, there is a substantial structural demand for the dollar. For citizens living under high inflation or strict capital controls, dollar stablecoins are a lifeline—they protect savings and provide direct access to the global business network. For businesses, the dollar, as an international pricing unit, simplifies and enhances the value and efficiency of international transactions. However, the reality is that cross-border remittance fees can be 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 dollar stablecoins not only reflects the demand for the dollar but also embodies the desire for "better currency."

For various political and nationalist reasons, countries typically maintain their own monetary systems, as this gives policymakers the ability 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 by adjusting interest rates or issuing currency.

However, the widespread adoption of dollar stablecoins may weaken the ability of local policymakers to regulate the local economy. This impact can be traced back to the "impossible trinity" theory in economics, which states that a country can only choose two of the following three economic policies at any given time:

1. Free capital movement;

2. Fixed or tightly managed exchange rates;

3. Independent monetary policy (autonomously setting domestic interest rates).

Decentralized peer-to-peer transactions affect all three policies of the "impossible trinity":

• Transactions bypass capital controls, fully opening the leverage of capital movement;

• "Dollarization" may weaken the effectiveness of policies managing exchange rates or domestic interest rates by anchoring citizens' economic activities to the international pricing unit (the dollar).

Decentralized peer-to-peer transfers impact all policies in the "impossible trinity." Such transfers bypass capital controls, forcing the "leverage" of capital movement to be fully opened. Dollarization can weaken the impact of policies managing exchange rates or domestic interest rates by linking citizens to the international pricing unit. Countries rely on narrow channels of the agent banking system to guide citizens toward local currency, thereby implementing these policies.

Although dollar stablecoins may pose challenges to local monetary policy, they remain attractive in many countries. This is because low-cost and programmable dollars bring more opportunities for trade, investment, and remittances. Most international business is priced in dollars, and accessing dollars allows for faster and more convenient international trade, leading to more frequent transactions. Additionally, governments can still tax deposit and withdrawal channels and supervise local custodians.

Currently, various regulations, systems, and tools have been implemented at the agent banking and international payment levels to prevent money laundering, tax evasion, and fraud. While stablecoins rely on open, transparent, and programmable ledgers, which facilitate the construction of secure 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 abandon valuable policy tools for efficiency (which is highly unlikely) and completely ignore fraud and other financial crimes (which is almost impossible), entrepreneurs still have the opportunity to develop systems that improve the integration of stablecoins with local economies.

To ensure stablecoins smoothly integrate into local financial systems, the key lies in enhancing 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 Dollar Stablecoins

Integrate dollar stablecoins into local banks, fintech companies, and payment systems, supporting small, optional, and potentially 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 that are deeply integrated with local financial infrastructure. During the initial phase of broad integration, a clearinghouse or neutral collateral layer may be needed (refer to the first part above), and once local stablecoins are integrated, they will become the preferred 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 through reserves held in yield-bearing instruments and high-leverage strategies.

• Challenging MoneyGram's Competitors

Build a compliant, physical retail cash deposit/withdrawal network and encourage agents to settle in stablecoins through incentive mechanisms. Although MoneyGram recently announced a similar product, there are still many opportunities for other participants with established distribution networks.

• Improved Compliance

Upgrade existing compliance solutions to support stablecoin payment networks. Leverage the programmability of stablecoins to provide richer and faster insights into fund flows.

Through these bidirectional improvements in technology and regulation, dollar stablecoins can not only meet the demands of global markets but also achieve deep integration with existing financial systems during the localization process, while ensuring compliance and economic stability.

3. The Potential Impact of Government Bonds as Collateral for Stablecoins

The popularity of stablecoins is not due to their backing by government bonds, but rather because they offer an almost instantaneous, nearly free transaction experience and possess unlimited programmability. Fiat-backed stablecoins were the first to be widely adopted because they are the easiest to understand, manage, and regulate. The core driving force behind user demand lies in the practicality and trustworthiness of stablecoins (such as 24/7 settlement, composability, and global demand), rather than the nature of their collateral.

However, fiat-backed stablecoins may face challenges due to their success: What would happen if the issuance of stablecoins grows tenfold in the coming years—from the current $262 billion to $2 trillion—and regulators require that stablecoins be backed by short-term U.S. Treasury bills (T-bills)? This scenario is not impossible, and its impact on the collateral market and credit creation could be profound.

Holding Short-Term Treasury Bills (T-bills)

If $2 trillion in stablecoins were backed by short-term U.S. Treasury bills—currently widely recognized by regulators as compliant assets—it would mean that stablecoin issuers would hold about one-third of the $7.6 trillion short-term Treasury market. This shift would be similar to the role of money market funds in the current financial system—concentrating liquidity in low-risk assets, but its impact on the Treasury market could be even greater.

Short-term Treasury bills are considered one of the safest and most liquid assets globally, and they are denominated in dollars, simplifying exchange rate risk management. However, if the issuance of stablecoins reaches $2 trillion, this could lead to a decline in Treasury yields and reduce the active liquidity in the repurchase market. Each new stablecoin effectively represents additional demand for Treasury bills. This would enable the U.S. Treasury to refinance at a lower cost, but it could also make T-bills scarcer and more expensive for other financial institutions. This would not only compress the income of stablecoin issuers but also make it more difficult 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 Treasury bills from $7 trillion to $14 trillion. However, even so, the continued growth of the stablecoin industry will still reshape the supply-demand dynamics.

The rise of stablecoins and their profound impact on the Treasury market reveal the complex interactions between financial innovation and traditional assets. In the future, how to balance the growth of stablecoins with the stability of financial markets will become a key issue for regulators and market participants alike.

Narrow Banking Model

Fundamentally, fiat-backed stablecoins are similar to narrow banking: they hold 100% reserves in the form of cash equivalents and do not engage in lending. This model is inherently lower risk and is one of the reasons why fiat-backed stablecoins gained early regulatory approval. Narrow banks are a trustworthy and easily verifiable system that provides token holders with a clear value proposition while avoiding the comprehensive regulatory burden faced by traditional fractional reserve banks. However, if the scale of stablecoins grows tenfold to $2 trillion, then these funds, fully backed by reserves and short-term Treasury bills, will have a profound impact on credit creation.

Economists are concerned 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 keep only a small portion of customer deposits as cash or cash equivalents, while the rest is used to lend to businesses, homebuyers, and entrepreneurs. Under regulatory supervision, 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 because the funds under the narrow banking model have a lower money multiplier effect (i.e., a single dollar supports a lower multiple of credit expansion). Ultimately, the economy relies on credit to function: 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. migrates to fiat-backed stablecoins, banks may lose their cheapest source of funding. 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 compensate for deposit losses through wholesale financing (such as short-term loans from the Federal Home Loan Banks), which is 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, borrowed, or collateralized—and can be used multiple times per minute, controlled by humans or software, and operate 24/7. This efficient 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 bank balance sheets while circulating in the economy at the speed of modern blockchain. In this model, deposits remain within the fractional reserve banking system, and each stable value token continues to support the lending operations 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 it also raises the balancing dilemma between credit creation and system stability. Future solutions will need to find the best combination between economic efficiency and traditional financial functions.

To allow stablecoins to retain the advantages of the fractional reserve banking system while promoting economic dynamism, design improvements can be made in the following three areas:

1. Tokenized Deposit Model: Retain deposits within the fractional reserve system through tokenized deposits.

2. Diversification of Collateral: Expand collateral from short-term Treasury bills (T-bills) to other high-quality, liquid assets.

3. Embed Automatic Liquidity Mechanisms: Reintroduce idle reserves into the credit market through on-chain repo agreements, tri-party facilities, collateralized debt pools (CDP pools), etc.

The goal is to maintain an interdependent, continuously growing economic environment that makes reasonable business loans more accessible. By supporting traditional credit creation while enhancing monetary liquidity, decentralized collateralized lending, and direct private lending, innovative stablecoin designs can achieve this goal.

Although the current regulatory environment makes tokenized deposits unfeasible, the regulatory clarity surrounding fiat-backed stablecoins is opening doors 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 transaction advantages of stablecoins. The operation of this type of 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 comprehensive stablecoin account. Subsequently, these stablecoins, as ownership tokens denominated in dollars, 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 Treasury 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 still retain the earnings from the underlying assets and their relationship with customers. Additionally, stablecoins provide banks with a payment opportunity that does not require 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 access funds quickly and securely.

3. Expand Collateral Types and Tokenize Them

Broaden the range of acceptable collateral assets beyond short-term Treasury bills to include municipal bonds, high-grade corporate paper, mortgage-backed securities (MBS), or other real-world assets (RWAs). This not only reduces reliance on a single market but also provides credit to borrowers outside the U.S. government while ensuring high quality and liquidity of collateral to maintain the stability of stablecoins and user trust.

4. Tokenize Collateral to Improve Liquidity

Tokenize these collateral assets, including real estate, commodities, stocks, and Treasury bills, to create a richer collateral ecosystem.

5. Adopt Collateralized Debt Position (CDP) Models

Drawing on CDP-based stablecoins like MakerDAO's DAI, these stablecoins utilize a diversified set of on-chain assets as collateral, which not only diversifies risk but also replicates the monetary expansion function provided by banks on-chain. At the same time, these stablecoins should be subject to rigorous third-party audits and transparent disclosures to verify the stability of their collateralization models.

While facing significant challenges, each challenge also presents enormous opportunities. Those who can understand the nuances of stablecoins—entrepreneurs and policymakers alike—will have the chance to shape a smarter, safer, and superior financial future.

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