The trillion-dollar opportunity for stablecoins to rise, how do entrepreneurs and traditional finance participate?

Author: Sam Broner a16z

Compiled by: TechFlow

Traditional finance is gradually integrating stablecoins into its system, and the transaction volume of stablecoins is also continuing to grow. Stablecoins have become the best tool for building global fintech because of their fast, almost zero cost and programmable nature.

However, the transition from traditional technology to emerging technology not only means fundamental changes in business models, but also comes with the emergence of new risks. After all, the self-custody model based on digitally-described assets is fundamentally different from the traditional banking system that has evolved for 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 explore in-depth three core challenges and their possible solutions, providing directions for entrepreneurs and builders of traditional financial institutions: the issue of currency unity; the application of US dollar stablecoins in non-US dollar economies; and the potential impact of better currencies supported by government bonds.

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

"Money Unity" means that in an economy, all forms of currencies can be swapped in a 1:1 ratio regardless of who is issued or stored in the currency and can be used for payments, pricing and contract performance. Monetary unity means that even if multiple institutions or technologies issue currencies, the entire system is still a unified monetary system. In other words, whether it is Chase's deposit, Wells Fargo's deposit, Venmo's balance, or stablecoins, they should always be fully equivalent in a 1:1 ratio. This unity is maintained despite differences in asset management methods and regulatory status among institutions. The history of the U.S. banking industry is to some extent the history of creating and improving systems to ensure the substitutability of the dollar.

Banking, central banks, economists and regulators around the world all advocate monetary unity because it greatly simplifies transactions, contracts, governance, planning, pricing, accounting, security, and daily economic activities. Today, businesses and individuals have become accustomed to the unity of money.

However, stablecoins are not fully integrated into the existing financial infrastructure at present, so "monetary unity" cannot be achieved. For example, if Microsoft, a bank, a construction company or a home buyer attempts to exchange $5 million in stablecoins through an automated market maker (AMM), users will not be able to complete the exchange in a 1:1 ratio due to slippage caused by insufficient liquidity depth, and the final amount will be less than $5 million. This situation is unacceptable if stablecoins are to completely transform the financial system.

A universally applicable "pattern exchange system" can help stablecoins become part of a unified monetary system. If this is not achieved, the potential value of the stablecoin will be greatly reduced.

Currently, stablecoin issuing agencies like Circle and Tether mainly provide direct redemption services for institutional customers or users who pass the verification process. These services usually have minimum transaction thresholds. For example, Circle provides Circle Mint (formerly known as Circle Account) for enterprise users to cast and redeem USDC; Tether allows verified users to redeem directly, with the threshold usually above a certain amount (such as $100,000). Decentralized MakerDAO uses Peg Stability Module (PSM) to allow users to exchange DAI for other stablecoins (such as USDC) at a fixed exchange rate, thus acting as a verifiable redemption/redeem mechanism.

Although these solutions work to some extent, they are not universally available and require integrators to be connected separately with each issuer. If it is not possible to integrate directly, users can only convert between stablecoins through market execution or convert stablecoins into fiat currency, and cannot settle at face value.

Without direct integration, an enterprise or application may promise to maintain a very small redemption spread—for example, always redeem 1 USDC for 1 DAI and keep the spread within 1 basis point—but this commitment still depends on liquidity, balance sheet space, and operational capabilities.

In theory, central bank digital currency (CBDC) can unify the monetary system, but its accompanying problems (such as privacy concerns, financial monitoring, restricted money supply, and slowing innovation) make better models imitating the existing financial system almost certainly win.

Therefore, the challenge for builders and institutional adopters is how to build systems that enable stablecoins to become “real currency” like bank deposits, fintech balances and cash, despite their heterogeneity in collateral, regulation and user experience. The goal of incorporating stablecoins into monetary unity provides entrepreneurs with huge development opportunities.

Wide availability of casting and redemption

Stablecoin issuers should work closely with banks, fintech companies and other existing infrastructure to achieve seamless deposit and withdrawal channels at face value. This will provide stablecoins with a face value substitutability through existing systems, making them no different from traditional currencies.

Stablecoin Clearing Center

Establish a decentralized cooperative organization—like ACH or Visa in the stablecoin space to ensure instant, frictionless and cost-transparent conversions. Peg Stability Module is a promising model, but if the protocol can be expanded on this basis to ensure par value settlement between participating issuers and fiat currencies, it will significantly improve the functionality of the stablecoin.

Trusted neutral collateral layer

Transfer the substitutability of stablecoins to a widely adopted collateral layer (such as tokenized bank deposits or packaging Treasury bonds). In this way, stablecoin issuers can innovate in brand, market strategies and incentive mechanisms, while users can unpack and convert stablecoins as needed.

Better exchanges, intent matching, cross-chain bridges and account abstractions

Deposit, withdrawal or exchange operations are automatically found and performed at the best exchange rate using improved versions of existing or known technologies. Build multi-currency exchanges to minimize slippage while hiding complexity so that stablecoin users can enjoy foreseeable fees even when used at large scale.

US dollar stablecoins: a double-edged sword of monetary policy and capital regulation

2. Global demand for US dollar stablecoins

In many countries, the structural demand for the US dollar is extremely large. For citizens living under high inflation or strict capital controls, the dollar stablecoin is a lifeline—it not only protects savings but also provides direct access to global business networks. For enterprises, as an international denomination unit, the US dollar can simplify and improve the value and efficiency of international transactions. However, the reality is that cross-border remittance costs are as high as 13%, 900 million people worldwide live in high-inflation economies but cannot use stable currencies, and 1.4 billion people are under-served by banks. The success of the US dollar stablecoin not only reflects the demand for the US dollar, but also reflects the desire for a "more currency".

For many reasons such as politics and nationalism, countries usually maintain their own monetary systems, because this gives policymakers the ability to adjust their economy based on local conditions. When disasters affect production, key exports decline or consumer confidence shake, central banks can ease the impact, enhance competitiveness or stimulate consumption by adjusting interest rates or issuing currencies.

However, widespread adoption of dollar stablecoins may undermine local policymakers’ ability to regulate local economies. This influence can be traced back to the "impossible triangle" theory in economics. The theory points out that a country can only choose two of the following three economic policies at any time:

1. Free flow of capital;

2. Fixed or strictly managed exchange rates;

3. Independent monetary policy (independently set domestic interest rates).

Decentralized peer-to-peer trading will have an impact on the three policies of the "Impossible Triangle": transactions bypass capital controls, allowing the leverage of capital flows to be fully opened; "dollarization" may weaken the policy effect of managing exchange rates or domestic interest rates by anchoring citizens' economic activities to international denomination units (USD).

Decentralized peer-to-peer transfers have had an impact on all policies in the Impossible Triangle. Such transfers bypass capital controls, forcing the "leverage" of capital flows to be fully opened. Dollarization can weaken the impact of managing exchange rates or domestic interest rate policies by linking citizens to international denomination units. Countries rely on narrow channels of agency banking systems to direct citizens to local currencies, thereby implementing these policies.

Although the dollar stablecoin may pose a challenge to local monetary policy, it remains attractive in many countries. The reason is that low-cost and programmable dollar brings more trade, investment and remittance opportunities. Most international businesses are denominated in US dollars. Access to US dollars can make international trade faster and more convenient, thus more frequent. In addition, governments can still tax deposits and withdrawal channels and supervise local trusteeship agencies.

At present, various regulations, systems and tools have been implemented at the agency banking system and international payments level to prevent money laundering, tax evasion and fraud. While stablecoins rely on open, transparent and programmable ledgers, which facilitates building security tools, these tools need to be truly developed. This provides entrepreneurs with the opportunity to connect stablecoins to existing international payment compliance infrastructure to maintain and enforce relevant policies.

Unless we assume that sovereign states will abandon valuable policy tools for efficiency (very unlikely) and completely ignore fraud and other financial crimes (nearly impossible), entrepreneurs still have the opportunity to develop systems to improve the way stablecoins integrate with their local economy.

In order to enable stablecoins to be successfully integrated into the local financial system, the key is to enhance foreign exchange liquidity, anti-money laundering (AML) supervision and other macro-prudential buffering while embracing better technology. Here are some potential technical solutions:

Local acceptance of US dollar stablecoins

Integrate dollar stablecoins into local banks, fintech companies and payment systems to support small, optional and potentially taxable exchange methods. This will not only improve local liquidity, but will not completely weaken the status of local currency.

Local stablecoins serve as deposit and withdrawal channels

Launch a local currency stablecoin with deep liquidity and deep integration with local financial infrastructure. When launching extensive integration, a clearing center or a neutral collateral layer may be required (see the first part of the previous article), once local stablecoins are integrated, they will become the best choice for Forex 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 Forex trading models by holding reserves of earnings instruments and adopting high leverage strategies.

Challenge MoneyGram 's competitors

Build a compliant, physical retail cash deposit/withdrawal network, and encourage agents to settle in stablecoins through reward mechanisms. Despite MoneyGram's recent announcement of similar products, there are plenty of opportunities left to other participants with a mature distribution network.

Improved compliance

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

Through these two-way 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 process of localization, while ensuring compliance and economic stability.

3. The potential impact of treasury bonds as stablecoins

Stablecoins are popularized not because they are collateralized by Treasury bonds, but because they provide an almost instant, almost free transaction experience and are unlimited programmability. The reason why fiat-based reserve stablecoins are first widely adopted is because they are easiest to understand, manage and regulate. The core driving force of user needs lies in the practicality and trust of stablecoins (such as all-weather settlement, composability, global demand), rather than the nature of their collateral assets.

However, fiat-backed reserve stablecoins may face challenges due to their success: What will happen if stablecoins are issued tenfold in the coming years — from the current $262 billion to $2 trillion — and regulators require stablecoins to be supported by short-term U.S. Treasury bonds (T-bills)? This scenario is not impossible, and its impact on collateral markets and credit creation may be far-reaching.

Short-term Treasury bonds (T-bills) held

If the $2 trillion stablecoin is backed by short-term U.S. Treasury bonds — currently widely recognized by regulators as one of the compliant assets — this means that stablecoin issuers will hold about one-third of the $7.6 trillion short-term Treasury market. This shift is similar to the role of Money Market Funds in the current financial system - concentrated holdings of highly liquid and low-risk assets, but their impact on the Treasury bond market may be greater.

Short-term Treasury bonds are considered one of the safest and most liquid assets in the world, and they are denominated in US dollars, simplifying exchange rate risk management. However, if the stablecoin issuance scale reaches $2 trillion, this could lead to a decline in Treasury yields and reduce active liquidity in the repo market. Every new stablecoin is actually equivalent to an additional demand for treasury bonds. This will allow the U.S. Treasury Department to refinance at a lower cost, while also potentially making T-bills more scarce and expensive for other financial institutions. This will not only compress the income of stablecoin issuers, but will also make it more difficult for other financial institutions to obtain collateral for managing liquidity.

One possible solution is the U.S. Treasury Department issuing more short-term debt, such as expanding the market size of short-term Treasury bonds from $7 trillion to $14 trillion. However, even so, the continued growth of the stablecoin industry will reshape the supply and demand dynamics.

The rise of stablecoins and their far-reaching impact on the treasury bond market reveal 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 become a key issue faced by regulators and market participants.

Narrow banking model

Fundamentally, fiat reserve stablecoins are similar to Narrow Banking: They hold 100% of their reserves, exist in cash equivalents, and do not lend. This model is inherently low in risk and is one of the reasons why fiat currency reserve stablecoins can gain early regulatory approval. Narrow Banking is a trustworthy and easy to verify system that provides token holders with a clear value proposition while avoiding the overall regulatory burden that traditional partial reserve banks need to bear. However, if the stablecoin size grows 10 times to $2 trillion, then these funds are entirely supported by reserves and short-term Treasury bonds, which will have a profound impact on credit creation.

Economists are worried about the narrow banking model because it limits the ability of capital to use to provide credit to the economy. Traditional banks (i.e., partial reserve banks) usually retain only a small amount of customer deposits as cash or cash equivalents, while the rest are used to lend to businesses, home buyers and entrepreneurs. Under the supervision of regulators, banks ensure that depositors can withdraw cash when needed by managing credit risks and loan term.

However, regulators do not want narrow banks to absorb deposit funds, because funds in narrow banking models have a lower monetary multiplier effect (i.e., a lower credit expansion multiple supported by a single dollar). Ultimately, the economy depends on credit operation: regulators, businesses, and everyday consumers benefit from a more active, interdependent economy. If even a small portion of the US $17 trillion deposit base migrates to fiat currency reserve stablecoins, banks may lose their cheapest sources of funds. This will force banks to face two adverse options: either reduce credit creation (such as reducing mortgages, auto loans and SME credit lines) or make up for deposit losses through wholesale financing (such as short-term loans from federal housing loan banks), but this is not only more costly, but also has a shorter term.

Despite the above problems with the narrow banking model, stablecoins have higher monetary liquidity. A stablecoin can be sent, consumed, borrowed or collateralized — and can be used multiple times a minute, controlled by humans or software, and run 24/7. This efficient liquidity makes stablecoins a better form of currency.

In addition, stablecoins are not necessarily supported by government debt. An alternative is tokenized deposits, which allows stablecoins’ value propositions to be directly reflected on the bank’s balance sheet while circulating in the economy at the speed of modern blockchains. In this model, deposits remain within the partial reserve banking system, and each stable value token actually continues to support the issuing agency's loan business. In this mode, the currency multiplier effect is restored - not only through the speed of currency flow, but also through traditional credit creation; while users can still enjoy 24/7 settlement, composability, and on-chain programmability.

The rise of stablecoins provides new possibilities for the financial system, but also raises the problem of balancing credit creation and system stability. Future solutions will require the best integration between economic efficiency and traditional financial functions.

In order to allow stablecoins to retain the advantages of some reserve banking system and promote economic dynamics, design improvements can be made in the following three aspects:

· Tokenized deposit model : Keep deposits in part of the reserve system through tokenized deposits.

· Collateral diversification : expand collateral from short-term T-bills to other high-quality, liquid assets.

· Embedded automatic liquidity mechanism : reintroduce idle reserves into the credit market through on-chain repo agreements, tri-party facilities, mortgage bond pools, etc.

The goal is to maintain an interdependent, growing economic environment, making reasonable business loans easier to obtain. Innovative stablecoin design can achieve this by supporting traditional credit creation while simultaneously improving monetary liquidity, decentralized mortgages and direct private loans.

Although the current regulatory environment makes tokenized deposits unfeasible, regulatory clarity around fiat currency reserved stablecoins is opening the door to stablecoins based on bank deposit mortgages.

Deposit-Backed Stablecoins allow banks to continue to provide credit to existing customers while improving capital efficiency and bringing the programmability, low cost and high-speed trading advantages of stablecoins. The operation method of this stablecoin is very simple: when the user chooses to mint a deposit-supported stablecoin, the bank will deduct the corresponding amount from the user's deposit balance and transfer the deposit obligation to a comprehensive stablecoin account. These stablecoins can then be sent to the public address specified by the user as asset ownership tokens denominated in USD.

In addition to deposit-backed stablecoins, other solutions can also improve capital efficiency, reduce friction in the Treasury bond market, and increase currency liquidity.

1. Help banks embrace stablecoins

Banks can increase the net interest margin (NIM) by adopting or even issuing stablecoins. While users can withdraw funds from deposits, banks can still retain the returns of underlying assets and their relationship with customers. In addition, stablecoins provide banks with a payment opportunity without intermediary participation.

2. Help individuals and businesses embrace DeFi

As more and more users manage funds and wealth directly through stablecoins and tokenized assets, entrepreneurs should help these users get funds quickly and safely.

3. Expand collateral types and tokenize them

Expand the scope of acceptable mortgage assets beyond short-term Treasury bonds, such as Municipal Bonds, High-Grade Corporate Paper, Mortgage-backed securities (MBS), or other mortgaged real-life 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 stability and user trust in stablecoins.

4. Put collateral on chains to improve liquidity

Tokenize these collaterals, including real estate, commodities, stocks and Treasury bonds, create a richer collateral ecosystem.

5. Adopt the mortgaged debt warehouse (CDPs) model

Drawing on CDP-based stablecoins such as MakerDAO's DAI, these stablecoins use diversified on-chain assets as collateral, not only diversify risks, but also reproduce the currency expansion functions provided by banks on the chain. At the same time, these stablecoins are required to undergo strict third-party audits and transparent disclosures to verify the stability of their collateral model.

Although faced with huge challenges, each challenge brings great opportunities. Entrepreneurs and policy makers who understand the nuances of stablecoins will have the opportunity to shape a smarter, safer, and superior financial future.