a16z: The Three Major Challenges for Stablecoins to Become Currency—Liquidity, Sovereignty, and Credit

Original Title: 《How stablecoins become money: Liquidity, sovereignty, and credit》

*Author: *Sam Broner

Compiled by: Shenchao TechFlow

Traditional finance is gradually incorporating stablecoins into its system, and the trading volume of stablecoins is also continuously increasing. Stablecoins have become the best tool for building global fintech due to their speed, almost zero cost, and programmability. The transition from traditional technology to new technology means that we will adopt fundamentally different business models — but this transformation will also bring about entirely new risks. After all, a self-custody model based on digital assets is a disruptive change to the banking system that has relied on registered deposits for centuries.

So, in this transformation process, what broader monetary structure and policy issues need to be addressed by entrepreneurs, regulators, and traditional financial institutions?

This article delves into three major challenges and potential solutions, from which both startups and builders in the traditional finance sector can find current focal points: the uniformity of currency; the application of dollar stablecoins in non-dollar economies; and the potential impact of a superior currency backed by government bonds.

1. "The Unity of Currency" and the Construction of a Unified Currency System

"Singleness of Money" refers to the ability of various forms of currency within an economy to be exchanged at a fixed ratio (1:1) for payment, pricing, and contract fulfillment, regardless of who issues the currency or where it is stored. The singleness of money indicates that even with multiple institutions or technologies issuing similar currency instruments, there exists a unified monetary system within the economy. In practice, whether it is 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 in their asset management practices and their regulatory status differs significantly, though often overlooked.

The history of the American banking industry, to some extent, is the history of ensuring the interchangeability of the dollar and continuously improving the related systems.

Global banks, central banks, economists, and regulatory agencies advocate for the "uniformity of currency" because it greatly simplifies transactions, contracts, governance, planning, pricing, accounting, security, and everyday dealings. Nowadays, businesses and individuals have long taken the uniformity of currency for granted.

However, the "monetary unity" is not the current operating mode of stablecoins, 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 dollars worth of stablecoins on an automated market maker (AMM), the user will be unable to achieve a 1:1 exchange rate due to slippage caused by insufficient liquidity depth, resulting in an amount lower than 5 million dollars. If stablecoins are to completely revolutionize the financial system, this situation is clearly unacceptable.

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

Currently, the way stablecoins operate is that issuing institutions (such as Circle and Tether) provide direct redemption services for their stablecoins (USDC and USDT respectively), which are primarily aimed at institutional clients or users who have gone through a verification process, and usually come with minimum transaction amounts.

For example, Circle provides 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 (such as USDC) at a fixed exchange rate through its Peg Stability Module (PSM), essentially acting as a verifiable redemption/exchange mechanism.

Although these solutions are effective, they are not universally available and require integrators to connect with each issuing institution one by one. Without direct integration, users can only exchange or "cash out" between stablecoins through market execution, and cannot settle at face value.

In the absence of direct integration, certain enterprises or applications may claim to maintain a very narrow exchange range—such as consistently exchanging 1 USDC for 1 DAI at a spread of just 1 basis point—but this promise still depends on liquidity, balance sheet capacity, and operational capabilities.

In theory, central bank digital currencies (CBDCs) could unify the monetary system, but they come with many issues—privacy concerns, financial surveillance, restricted money supply, slowed innovation, etc.—therefore, a superior model that mimics the existing financial system is almost destined to 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. Incorporating stablecoins into the goal of monetary unity provides entrepreneurs with the following construction opportunities:

Widely Available Minting and Redemption Mechanism

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

Stablecoin Clearing Center

Establish a decentralized cooperative organization—similar to a stablecoin version of ACH or Visa—to ensure an instant, frictionless, and transparent exchange experience with no fees. MakerDAO's Peg Stability Module (PSM) has provided a promising model, but if the protocol can be expanded based on this to ensure par-value settlements among participating issuers and with fiat USD, it would be a more revolutionary solution.

Develop a trustworthy and neutral collateral layer

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

Better exchanges, trading intentions, cross-chain bridges, and account abstraction

Utilize superior versions of existing or known technologies to automatically find and execute the best channels for capital inflow and outflow or exchange methods, in order to achieve optimal rates. Build a multi-currency exchange to minimize slippage. At the same time, hide this complexity to provide stablecoin users with a predictable fee experience even under large-scale usage.

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

In many countries, there is a strong structural demand for the US dollar. For citizens living in high inflation or strict capital control environments, dollar stablecoins are a lifeline—they not only protect savings but also provide direct access to the global business network.

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

However, the current cost of cross-border remittances is as high as 13%, with 900 million people living in high-inflation economies unable to access stable currencies, and 1.4 billion people lacking adequate banking services. The success of the dollar stablecoin not only reflects the demand for the dollar but also highlights people's desire for "better money."

Apart from reasons such as politics and nationalism, an important reason for countries to maintain their local currencies is that it gives decision-makers 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 US dollar stablecoins may weaken the ability of local policymakers to regulate the economy. The root of this issue lies in the economic principle known as the "Impossible Trinity," which states that a country can only choose two out of the following three economic policies at any given time:

Free movement of capital;

fixed or strictly managed exchange rate;

Independent monetary policy (freely setting domestic interest rates).

Decentralized peer-to-peer transfers have impacted all policies in the "impossible triangle." Such transfers bypass capital controls, forcing capital flows to be completely open. Dollarization weakens the policy influence of managing exchange rates or domestic interest rates by anchoring citizens to international pricing units. Countries guide citizens to local currencies through narrow channels corresponding to the banking system, thus implementing these policies.

Nevertheless, the dollar stablecoin remains attractive to foreigners, as cheaper and 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 and simpler international trade becomes, and the more common it is. Furthermore, governments can still tax the channels of fund inflows and outflows (on/off ramps) and supervise local custodians.

On the banking and international payment level, a series of regulations, systems, and tools already exist to prevent money laundering, tax evasion, and fraud. Although stablecoins operate on open 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 implementing relevant policies.

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

While embracing superior technology, it is essential to improve existing safeguards, such as foreign exchange liquidity, anti-money laundering (AML) regulations, and other macroprudential buffer mechanisms, so that stablecoins can smoothly integrate into the local financial system. These technological solutions can achieve the following objectives:

Localization of Dollar Stablecoin Acceptance

Integrate USD stablecoins into local banks, fintech companies, and payment systems to support small, optional, and possibly taxable conversions. This approach enhances local liquidity without completely undermining the status of the local currency.

Local stablecoins as a channel for capital inflow and outflow

Issue stablecoins that are pegged to local currencies and deeply integrated with local financial infrastructure. This type of stablecoin can serve not only as an efficient tool for foreign exchange trading but also as a default high-performance payment channel. To achieve widespread integration, it may be necessary to establish a clearing center or a neutral collateral layer.

On-chain Forex Market

Develop a matching and pricing aggregation system that spans 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.

Challenger to MoneyGram's Competitors

Build a compliant cash deposit and withdrawal network based on physical retail, rewarding agents with stablecoin settlements. Although MoneyGram recently announced a similar product, there remain significant opportunities for other businesses with established distribution networks to compete.

Improving Compliance

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

3. Consider the impact of using government bonds as collateral for stablecoins.

The popularity of stablecoins is not due to the backing of government bonds, but rather their nearly instant, almost 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 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 will happen if the issuance scale of stablecoins grows from the current $262 billion to $2 trillion in a few years, and regulators require stablecoins to 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 Impacts of Holding Government Bonds

If $2 trillion in stablecoins were required to be invested in short-term U.S. Treasury bonds (one of the few assets currently recognized by regulators), then stablecoin issuers would hold about one-third of the $7.6 trillion circulating supply of Treasury bonds. This shift is similar to the role of Money Market Funds today—concentrating on holding highly liquid, low-risk assets, but the impact on the Treasury bond 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 US dollars, simplifying currency risk management.

However, if the issuance of stablecoins reaches 2 trillion USD, this may lead to a decrease in government bond yields and reduce active liquidity in the repurchase market. Each newly issued stablecoin represents additional demand for government bonds, which will enable the U.S. Treasury to refinance at a lower cost, while also making government bonds more scarce and expensive for other financial systems.

This situation may reduce the income 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, such as expanding the circulation of short-term Treasury bonds from $7 trillion to $14 trillion. However, 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 cash equivalents) and do not engage in lending. This model carries lower risks, which is one of the reasons fiat-backed stablecoins were able to gain early regulatory approval.

Narrow banking is a reliable and easily verifiable system that provides clear value assurance for token holders while avoiding the comprehensive regulatory burdens faced by fractional reserve banking.

However, if the scale of stablecoins grows 10 times to reach 2 trillion USD, its characteristics fully supported by reserves and government bonds will have a ripple effect on credit creation.

Economists are concerned that the narrow banking model restricts the ability of capital 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 withdraw funds when needed by managing credit risk and loan terms.

This is why regulators do not want narrow banks to absorb deposits—the funds in a narrow banking model have a lower money multiplier (i.e., a single dollar supports a lower multiple of credit expansion). 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 could lose their cheapest source of funding.

Faced with the loss of deposits, banks will have to choose between two less-than-ideal options: either reduce credit creation (such as cutting back on mortgages, auto loans, and small business credit lines); or replace the lost deposits through wholesale financing (such as advances from the Federal Home Loan Banks), which are more expensive and have shorter terms.

However, stablecoins as "better money" support a higher velocity of currency circulation. A single stablecoin can be sent, spent, lent, or borrowed within a minute—that is to say, it can be used frequently! All of this can be controlled by humans or software, 24 hours a day, 7 days a week without interruption.

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 remain within the fractional reserve banking system, and each stable value token is effectively still supporting the lending operations of the issuing institution.

The currency multiplier effect has been restored—not just through the velocity of circulation, but also through traditional credit creation—while users can still enjoy 24/7 settlement, composability, and on-chain programmability.

When designing stablecoins, the balance between economy and innovation can be achieved in the following ways:

Tokenized Deposit Model: Keeping deposits within a fractional reserve system;

Diversified Collateral: In addition to short-term government bonds, extend to other high-quality, highly liquid assets;

Embedded Auto Liquidity Pipeline: Utilize mechanisms such as on-chain buybacks, third-party facilities, and CDP (Collateralized Debt Position) pools to reinject idle reserves back into the credit market.

These designs do not compromise with traditional banks but provide more options to maintain economic vitality.

The ultimate goal is to maintain a mutually dependent and continuously growing economy, making reasonable business loans easily accessible. Innovative stablecoin designs can achieve this by supporting traditional credit creation while increasing the velocity of money, decentralized collateralized lending, and direct private lending.

Although the current regulatory environment makes tokenized deposits unfeasible, the regulations surrounding fiat-backed stablecoins are gradually becoming clearer, opening the door for stablecoins that are collateralized by bank deposits.

Deposit-backed Stablecoins allow banks to enhance capital efficiency while providing credit services, along with the programmability, cost advantages, and fast 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 holdings of these assets, which users can send to a public address of their choice.

In addition to deposit-backed stablecoins, the following innovative measures will also help improve capital efficiency, reduce friction in the government bond market, and accelerate the circulation of currency:

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

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.

Expand the types of collateral and achieve tokenization

Expand the range of acceptable collateral assets beyond short-term government bonds (T-bills) to include municipal bonds, high-rated corporate notes, mortgage-backed securities (MBS), or secured real-world assets (RWAs). This not only reduces dependence 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.

Put collateral on-chain to enhance liquidity

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

Using Collateralized Debt Position (CDP) Model

Referencing MakerDAO's DAI and other CDP-based stablecoins, these stablecoins utilize a diversified pool of on-chain assets as collateral to mitigate risks while replicating the monetary expansion functions provided by banks on-chain. Additionally, these stablecoins should be subject to rigorous third-party audits and transparent disclosures to verify the stability of their collateral models.

The stablecoin sector faces significant challenges, but each challenge also presents enormous opportunities. Entrepreneurs and policymakers who can deeply understand the complexities of stablecoins have the chance to shape a smarter, safer, and superior financial future.

Acknowledgements

Special thanks to Tim Sullivan for his unwavering support. I would also like to thank Aiden Slavin, Miles Jennings, Scott Kominers, Christian Catalini, and Luca Prosperi for their insightful feedback and suggestions, which made this article possible.

About the Author

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

Source: Deep Tide TechFlow