Deep understanding of the complexities of stablecoins by entrepreneurs and policymakers presents an opportunity to shape a smarter, safer, and superior financial future.

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 programmability, stablecoins have become the best tool for building global fintech. The transition from traditional technology to new technology means adopting fundamentally different business models—but this transformation also brings new risks. After all, a self-custodial model based on digital assets represents a disruptive change to the banking system that has existed for centuries, compared to a bank system reliant on registered deposits.

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

This article delves into three major challenges and potential solutions, providing current focal points for both startups and builders in traditional finance: the unity of money; the application of dollar stablecoins in non-dollar economies; and the potential impacts of a superior currency backed by government bonds.

1. "Unity of Money" and the Construction of a Unified Monetary System

"Unity of Money" refers to the ability to exchange various forms of money within an economy at a fixed ratio (1:1) for payment, pricing, and contract fulfillment, regardless of who issues the currency or where it is stored. The unity of money indicates that even with multiple institutions or technologies issuing similar monetary instruments, a unified monetary system still exists within the economy. In practice, whether it’s the dollars in your JPMorgan account, the dollars in your Wells Fargo account, or the balance in Venmo, they should always be equivalent to stablecoins—and always maintain a 1:1 ratio. This principle holds true even if these institutions differ significantly in how they manage assets and their regulatory status, which is often overlooked.

The history of the U.S. banking industry is, to some extent, a history of ensuring the interchangeability of the dollar and continuously improving the relevant systems.

Global banks, central banks, economists, and regulators advocate for the "unity of money" because it greatly simplifies transactions, contracts, governance, planning, pricing, accounting, security, and everyday transactions. Today, businesses and individuals have long taken the unity of money for granted.

However, the "unity of money" is not how stablecoins currently operate, as stablecoins have not yet been fully integrated with existing infrastructure. For example, if Microsoft, a bank, a construction company, or a homebuyer attempts to exchange $5 million worth of stablecoins on an automated market maker (AMM), the user will be unable to achieve a 1:1 exchange ratio due to slippage caused by insufficient liquidity, ultimately receiving less than $5 million. If stablecoins are to fundamentally transform the financial system, this situation is clearly unacceptable.

A universal par value exchange system would help stablecoins become part of a unified monetary system. If stablecoins cannot serve as components of a unified monetary system, their potential function and value will be significantly diminished.

Currently, stablecoins operate by having issuing entities (such as Circle and Tether) provide direct redemption services for their stablecoins (USDC and USDT, respectively), primarily aimed at institutional clients or users who go through a verification process, often accompanied by minimum transaction amounts.

For instance, Circle offers Circle Mint (formerly Circle Account) for enterprise users to mint and redeem USDC; Tether allows verified users to redeem directly, usually requiring a certain threshold (e.g., $100,000).

The decentralized MakerDAO allows users to exchange DAI for other stablecoins (like USDC) at a fixed rate through its Peg Stability Module (PSM), effectively acting as a verifiable redemption/exchange mechanism.

While these solutions are effective, they are not universally available and require integrators to connect with each issuing entity individually. Without direct integration, users can only exchange or "cash out" between stablecoins through market execution, rather than settling at par value.

In the absence of direct integration, some businesses or applications may claim to maintain extremely narrow exchange ranges—such as always exchanging 1 USDC for 1 DAI at a 1 basis point spread—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 they come with numerous issues—privacy concerns, financial surveillance, restricted money supply, and slowed innovation—making it almost certain that a superior model mimicking the existing financial system will prevail.

For builders and institutional adopters, the challenge lies in how to construct systems that allow stablecoins to function as "pure money," like bank deposits, fintech balances, and cash, despite differences in collateral, regulation, and user experience. The goal of integrating stablecoins into the unity of money presents the following opportunities for entrepreneurs:

1. Widely Available Minting and Redemption Mechanisms

Stablecoin issuers need to work closely with banks, fintech companies, and other existing infrastructures to create seamless and par value funding on/off ramps. Achieving par value interchangeability for stablecoins through existing systems can make stablecoins indistinguishable from traditional currencies, thereby accelerating their global adoption.

2. Stablecoin Clearing Centers

Establish decentralized cooperative organizations—similar to a stablecoin version of ACH or Visa—to ensure an instant, frictionless, and transparent fee exchange experience. MakerDAO's Peg Stability Module (PSM) has provided a promising model, but expanding protocols based on this to ensure par value settlement between participating issuers and with fiat dollars would be a more revolutionary solution.

3. Developing a Trusted Neutral Collateral Layer

Transferring the interchangeability of stablecoins to a widely accepted collateral layer (such as tokenized bank deposits or wrapped government bonds) allows stablecoin issuers to innovate in branding, marketing, and incentive mechanisms while enabling users to easily unwrap and convert as needed.

4. Superior Exchanges, Trading Intent, Cross-Chain Bridges, and Account Abstraction

Utilizing better versions of existing or known technologies to automatically find and execute the best funding on/off ramps or exchange methods for optimal rates. Building multi-currency exchanges to minimize slippage while hiding these complexities, providing stablecoin users with a predictable fee experience even under large-scale usage.

2. Global Demand for Dollar Stablecoins: A Lifeline in High Inflation and Capital Controls

In many countries, there is a strong structural demand for dollars. For citizens living in high inflation or strict capital control environments, dollar stablecoins serve as a lifeline—they not only protect savings but also connect directly to the global business network.

For businesses, the dollar is the international unit of account, making international transactions more convenient and transparent. People need a fast, widely accepted, and stable currency for consumption and savings.

However, current cross-border remittance fees can be as high as 13%, with 900 million people living in high-inflation economies unable to access stable currency, and 1.4 billion people lacking adequate banking services. The success of dollar stablecoins not only reflects the demand for dollars but also highlights the desire for "better money."

Aside from political and nationalist reasons, one important reason countries maintain local currencies is that it gives policymakers the ability to adjust the economy based on local economic realities. 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.

The widespread adoption of dollar stablecoins may weaken the ability of local policymakers to regulate the economy. The root of this issue lies in the economic principle of the "Impossible Trinity," 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 (freely setting domestic interest rates).

Decentralized peer-to-peer transfers affect all policies in the "Impossible Trinity." Such transfers bypass capital controls, forcing capital flows to be completely open. Dollarization would weaken the policy influence of managing exchange rates or domestic interest rates by anchoring citizens to an international unit of account. Countries guide citizens to local currencies through narrow channels corresponding to their banking systems to implement these policies.

Nevertheless, dollar stablecoins remain attractive to foreigners, as cheaper, programmable dollars can attract trade, investment, and remittances. Most international business is priced in dollars, so the easier it is to obtain dollars, the faster, simpler, and more widespread international trade becomes. Additionally, governments can still tax the on/off ramps and oversee local custodians.

At the banking and international payment levels, there is already a range of regulations, systems, and tools in place to prevent money laundering, tax evasion, and fraud. Although stablecoins operate on public and programmable ledgers, making the construction of security tools simpler, these tools still need to be developed in practice. This presents an opportunity for entrepreneurs to connect stablecoins with existing international payment compliance infrastructure, thereby supporting and enforcing relevant policies.

Unless we assume that sovereign nations will abandon valuable policy tools for efficiency (which is highly unlikely) and ignore fraud and other financial crimes (also unlikely), entrepreneurs will have the opportunity to build systems that help stablecoins better integrate into local economies.

While embracing superior technology, existing safeguards such as foreign exchange liquidity, anti-money laundering (AML) regulations, and other macroprudential buffers must be improved to ensure stablecoins can smoothly integrate into local financial systems. These technological solutions can achieve the following goals:

1. Local Acceptance of Dollar Stablecoins

Integrating dollar stablecoins into local banks, fintech companies, and payment systems to support small, optional, and potentially taxable conversions. This approach can enhance local liquidity without completely undermining the status of local currencies.

2. Local Stablecoins as Funding On/Off Ramps

Issuing stablecoins pegged to local currencies and deeply integrating them with local financial infrastructure. These stablecoins can serve not only as efficient tools for foreign exchange trading but also as the default high-performance payment channels. Achieving widespread integration may require establishing clearing centers or neutral collateral layers.

3. On-Chain Foreign Exchange Markets

Developing 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 utilizing high leverage.

4. Challenging MoneyGram Competitors

Building a compliant, cash deposit and withdrawal network based on physical retail, rewarding agents with stablecoin settlements. Although MoneyGram recently announced a similar product, there are still ample opportunities for other companies with established distribution networks to compete.

5. Improving Compliance

Upgrade existing compliance solutions to support stablecoin payment networks. Leverage the stronger programmability of stablecoins to provide richer and faster insights into fund flows, further enhancing transparency and security.

3. Considering the Impact of Using Government Bonds as Collateral for Stablecoins

The popularity of stablecoins is not due to their backing by government bonds, but rather their nearly instantaneous, almost free transaction characteristics and limitless programmability. Fiat-backed stablecoins were adopted first because they are easy to understand, manage, and regulate. However, the core driving force behind user demand lies in 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 due to their success: what happens if the issuance scale of stablecoins grows from the current $262 billion to $2 trillion in a few years, 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 significant.

Potential Impact of Holding Government Bonds

If $2 trillion in stablecoins are required to be invested in short-term U.S. Treasury bills (one of the few assets currently recognized by regulators), stablecoin issuers would hold about one-third of the $7.6 trillion in Treasury circulation. This shift is similar to the role of money market funds today—concentrating liquidity in low-risk assets, but the impact on the Treasury market could be even more profound.

Short-term government bonds are considered ideal collateral because they are widely regarded as one of the lowest-risk and most liquid assets in the world, and they are denominated in dollars, simplifying currency risk management.

However, if the issuance scale of stablecoins reaches $2 trillion, this could lead to a decline in Treasury yields and reduce active liquidity in the repo market. Each new stablecoin issued represents additional demand for Treasuries, allowing the U.S. Treasury to refinance at lower costs while making Treasuries scarcer and more expensive for other financial systems.

This situation could cut into the revenues of stablecoin issuers while making it more difficult 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, for example, expanding the circulation of short-term Treasuries from $7 trillion to $14 trillion. Even so, the rapid growth of the stablecoin industry will still reshape supply and demand dynamics, bringing new market challenges and transformations.

Narrow Banking Model

Essentially, fiat-backed stablecoins are very similar to narrow banking: they hold 100% reserves (cash or equivalents) and do not engage in lending. This model carries lower risk, which is one reason why fiat-backed stablecoins gained early regulatory approval.

Narrow banks are a trusted and easily verifiable system that provides clear value assurance to token holders while avoiding the comprehensive regulatory burden faced by fractional reserve banks.

However, if the scale of stablecoins grows tenfold to $2 trillion, their fully reserve-backed and Treasury-backed characteristics will have a ripple effect 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) only keep a small portion of customer deposits as cash or cash equivalents while lending most deposits to businesses, homebuyers, and entrepreneurs. Under regulatory oversight, banks manage credit risk and loan terms to ensure depositors can withdraw funds when needed.

This is why regulators do not want narrow banks to accept deposits—the funds under the narrow banking model have a lower money multiplier (i.e., the credit expansion multiple supported by a single dollar is lower). Fundamentally, the economy relies on the flow of credit: regulators, businesses, and ordinary consumers all benefit from a more active and interdependent economy. If even a small portion of the $17 trillion U.S. deposit base migrates to fiat-backed stablecoins, banks may lose their cheapest source of funding.

Faced with deposit outflows, banks will have two less-than-ideal options: either reduce credit creation (e.g., cut back on mortgages, auto loans, and small business credit lines); or replace lost deposits with wholesale financing (e.g., advances from the Federal Home Loan Bank), which are more expensive and shorter-term.

However, stablecoins as "better money" support a higher velocity of money. A single stablecoin can be sent, spent, lent, or borrowed within a minute—meaning it can be used frequently! All of this can be controlled by humans or software, operating 24/7.

Stablecoins do not necessarily have to be backed by government bonds. Tokenized deposits are another solution that allows the value proposition of stablecoins to remain on the bank's balance sheet while circulating in the economy at the speed of modern blockchain.

In this model, deposits will continue to reside in the fractional reserve banking system, with each stable value token effectively still supporting the lending operations of the issuing institution.

The money multiplier effect can be restored—not just through velocity, but through traditional credit creation—while users can still enjoy 24/7 settlement, composability, and on-chain programmability.

When designing stablecoins, the following approaches can achieve a balance between the economy and innovation:

1. Tokenized Deposit Model: Keep deposits within the fractional reserve system;

2. Diversified Collateral: Expand beyond short-term Treasuries to include other high-quality, liquid assets;

3. Embed Automated Liquidity Pipelines: Utilize on-chain repos, third-party facilities, CDP (Collateralized Debt Position) pools, and other mechanisms to reinject idle reserves into the credit market.

These designs do not compromise traditional banking but provide more options for maintaining economic vitality.

The ultimate goal is to sustain an interdependent and growing economy, making reasonable business loans easily accessible. Innovative stablecoin designs can achieve this by supporting traditional credit creation while enhancing the velocity of money, decentralized collateral lending, and direct private lending.

Although the current regulatory environment makes tokenized deposits unfeasible, the regulatory landscape surrounding fiat-backed stablecoins is gradually clarifying, opening the door for stablecoins backed by bank deposits.

Deposit-backed stablecoins can allow banks to enhance capital efficiency while providing credit services, bringing the programmability, cost advantages, and rapid transaction characteristics of stablecoins. When users choose to mint deposit-backed stablecoins, banks will deduct the corresponding amount from the user's deposit balance and transfer the deposit obligation to a comprehensive stablecoin account. These stablecoins will represent dollar-denominated claims on these assets, which users can send to public addresses of their choice.

In addition to deposit-backed stablecoins, the following innovative measures will also help improve capital efficiency, reduce friction in the Treasury market, and accelerate the velocity of money:

1. Helping 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 relationships with customers. Stablecoins also provide banks with payment opportunities without the need for intermediaries.

2. Helping Individuals and Businesses Embrace Decentralized Finance (DeFi)

As more users manage their funds and wealth directly through stablecoins and tokenized assets, entrepreneurs should help these users access funds quickly and securely.

3. Expanding Collateral Types and Achieving Tokenization

Broaden the range of acceptable collateral assets beyond short-term Treasuries (T-bills) to include municipal bonds, high-rated corporate notes, mortgage-backed securities (MBS), or secured 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 the high quality and liquidity of collateral assets to maintain the stability of stablecoins and user confidence.

4. Tokenizing Collateral to Enhance Liquidity

Tokenize these collateral assets (such as real estate, commodities, stocks, and Treasuries) to create a richer collateral ecosystem.

5. Adopting Collateralized Debt Position (CDP) Model

Referencing CDP-based stablecoins like MakerDAO's DAI, these stablecoins utilize diversified on-chain assets as collateral, spreading risk while replicating the money expansion function provided by banks on-chain. Additionally, 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 significant challenges, but each challenge also presents tremendous opportunities. Those entrepreneurs and policymakers who can deeply understand the complexities of stablecoins have the chance to shape a smarter, safer, and superior financial future.

Acknowledgments

Special thanks to Tim Sullivan for his unwavering 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.

About the Author

Sam Broner is a partner on the a16z crypto investment team. Before joining a16z, he was a software engineer at Microsoft, where he helped create Fluid Framework and Microsoft Copilot Pages. Sam also attended the MIT Sloan School of Management, participated in the Hamilton Project at the Boston Federal Reserve Bank, led the Sloan Blockchain Club, organized Sloan's first AI Summit, and received MIT's Patrick J. McGovern Award for creating an entrepreneurial community. You can follow him on X (formerly Twitter) @SamBroner or visit his personal website sambroner.com for more content.

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