a16z: Stablecoins are on the rise, what new opportunities do entrepreneurs have?

Author: Sam Broner

Compilation: Deep Tide TechFlow

Traditional finance is gradually incorporating stablecoins into its system, and the trading volume of stablecoins continues to grow. Stablecoins, due to their speed, nearly zero cost, and programmable features, have become the best tool for building global fintech.

However, the transition from traditional technology to emerging technology not only signifies a fundamental change in business models but also comes with the emergence of entirely new risks. After all, the self-custody model based on digitized registered assets is fundamentally different from the traditional banking system that has evolved over centuries.

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

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

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

"Monetary unity" refers to the fact that in an economy, all forms of money are interchangeable at a 1:1 ratio and can be used for payment, pricing, and contract fulfillment, regardless of who issues it or where it is stored. Monetary unity means that even if multiple institutions or technologies issue instruments of similar currency, the entire system remains a unified monetary system. In other words, whether it's a deposit with Chase, a deposit with Wells Fargo, a balance with Venmo, or a stablecoin, they should always be exactly equivalent at a 1:1 ratio. This uniformity has been maintained, despite differences in the way 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 fungible nature of the dollar.

The global banking industry, central banks, economists, and regulators all advocate for monetary unity, as it greatly simplifies transactions, contracts, governance, planning, pricing, accounting, security, and everyday economic activities. Today, both businesses and individuals have become accustomed to the unity of currency.

However, stablecoins have not yet fully integrated into the existing financial infrastructure, and thus cannot achieve "currency 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 not be able to complete the exchange at a 1:1 ratio due to slippage caused by insufficient liquidity depth, resulting in an amount less than $5 million. If stablecoins are to completely transform the financial system, this situation is unacceptable.

A universally applicable "par value exchange system" can help stablecoins become part of a unified currency system. If this goal cannot be achieved, the potential value of stablecoins will be significantly discounted.

Currently, stablecoin issuers like Circle and Tether primarily offer direct swap services for stablecoins such as USDC and USDT for institutional clients or users who have passed the verification process. These services usually have a minimum transaction threshold. For example, Circle provides Circle Mint (formerly known as Circle Account) to enterprise users in order to mint and redeem USDC; Tether allows verified users to redeem directly, usually above a certain amount (e.g. $100,000). The decentralized MakerDAO acts as a verifiable redemption/exchange mechanism by allowing users to exchange DAI for other stablecoins (such as USDC) at a fixed exchange rate through the Peg Stability Module (PSM).

Although these solutions work to some extent, they are not universally available and require integrators to connect separately with each issuing institution. If direct integration is not possible, users can only convert between stablecoins or exchange stablecoins for fiat currency through market execution, and cannot settle at face value.

Without direct integration, a business or application might promise to maintain a very small exchange spread— for example, always exchanging 1 USDC for 1 DAI and keeping the spread within 1 basis point— but this promise still depends on liquidity, balance sheet capacity, and operational capabilities.

In theory, central bank digital currency (CBDC) could unify the monetary system, but the numerous accompanying issues (such as privacy concerns, financial surveillance, limited money supply, and slowed innovation) make it almost certain that a superior model that imitates the existing financial system will prevail.

Therefore, the challenge for builders and institutional adopters is how to construct systems that enable 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 unity provides entrepreneurs with significant development opportunities.

Widespread availability of minting and redeeming

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

Stablecoin Clearing Center

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 if the protocol can be expanded on this basis to ensure par-value settlements between issuing parties and fiat currencies, it will significantly enhance the functionality of stablecoins.

Trustworthy and Neutral Collateral Layer

Transfer the fungibility of stablecoins to a widely adopted collateral layer (such as tokenized bank deposits or wrapped government bonds). This way, stablecoin issuers can innovate in branding, market strategies, and incentive mechanisms, while users can unwrap 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 exchange rates. Build a multi-currency exchange to minimize slippage while hiding complexity, allowing stablecoin users to enjoy predictable fees even during large-scale usage.

Dollar Stablecoin: 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 dollar is enormous. For citizens living with high inflation or strict capital controls, the USD stablecoin is a lifeline – it protects savings and provides direct access to global business networks. For businesses, the U.S. dollar, as an international unit of denomination, simplifies and increases the value and efficiency of international transactions. However, the reality is that cross-border remittance fees are as high as 13%, 900 million people around the world live in high-inflation economies without access to stable currencies, and 1.4 billion are underbanked. The success of the US dollar stablecoin reflects not only the demand for the US dollar, but also the desire for a "better currency".

For various reasons such as politics and nationalism, countries typically maintain their own currency systems, as this gives decision-makers 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 the impact, enhance competitiveness, or stimulate consumption by adjusting interest rates or issuing currency.

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

Free capital flow;

Fixed or strictly managed exchange rate;

Independent monetary policy (autonomously setting domestic interest rates).

Decentralized peer-to-peer trading will be influenced by the three policies of the "impossible triangle:"

The transaction bypasses capital controls, fully opening the leverage for capital flow;

"Dollarization" may weaken the effectiveness of policies managing exchange rates or domestic interest rates by anchoring citizens' economic activities to an internationally priced unit (the US dollar).

Decentralized peer-to-peer transfers have impacted all policies within the "impossible triangle." Such transfers bypass capital controls, fully opening the "leverage" of capital flow. Dollarization can weaken the influence of managing exchange rates or domestic interest rate policies by linking citizens to international pricing units. Countries rely on narrow channels of intermediary banking systems to guide citizens towards local currencies, thereby implementing these policies.

Although stablecoins pegged to the US dollar may pose challenges to local monetary policy, they remain attractive in many countries. The reason lies in the low-cost and programmable nature of the dollar, which brings more opportunities for trade, investment, and remittances. Most international business is priced in dollars, and access to dollars can make international trade faster and more convenient, thus more frequent. Furthermore, governments can still tax inflow and outflow channels and supervise local custodians.

Currently, various regulations, systems, and tools have been implemented at the levels of correspondent banking and international payments to prevent money laundering, tax evasion, and fraud. Although stablecoins rely on public, transparent, and programmable ledgers, which facilitate the creation 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 the sake of 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 smoothly integrate stablecoins into the local financial system, the key lies in enhancing foreign exchange liquidity, anti-money laundering (AML) supervision, and other macroprudential buffers while embracing better technology. Here are some potential technological solutions:

Local acceptance of US dollar stablecoins

Integrate USD stablecoins into local banks, fintech companies, and payment systems to support small, optional, and potentially taxable exchange methods. This can enhance local liquidity without completely undermining the status of the local currency.

Local stablecoins serve as channels for deposits and withdrawals.

Launch a local currency stablecoin that has deep liquidity and is deeply integrated with the local financial infrastructure. During the launch of extensive integration, a clearing center or neutral collateral layer may be required (refer to the first part of the previous text). Once the local stablecoin is integrated, it will become the best 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 by holding reserves of yield instruments and adopting high leverage strategies.

Challenging MoneyGram's competitors

Build a compliant, physical retail cash deposit/withdrawal network and encourage agents to settle in stablecoins through a reward mechanism. Although MoneyGram recently announced a similar product, there are still plenty of opportunities for other participants with mature 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 cash flow.

Through these bidirectional improvements in technology and regulation, USD stablecoins can not only meet the demands of the global market 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 collateralization with government bonds, but because they offer nearly instant, almost free trading experiences and possess infinite programmability. Fiat-backed stablecoins were the first to be widely adopted because they are the easiest to understand, manage, and regulate. The core drivers of user demand lie in the practicality and trustworthiness of stablecoins (such as 24/7 settlement, composability, and global demand), rather than the nature of their collateral assets.

However, fiat-backed stablecoins may face challenges due to their success: what will 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 are backed by short-term U.S. Treasuries—currently widely recognized by regulators as one of the compliant assets—it means that stablecoin issuers will hold about one-third of the short-term Treasury market. This shift is similar to the role of Money Market Funds in the current financial system—concentrating holdings of highly liquid, low-risk assets, but its impact on the Treasury market could be even greater.

Short-term Treasuries are considered one of the safest and most liquid assets in the world, and they are denominated in U.S. dollars, simplifying exchange rate risk management. However, if stablecoin issuance reaches $2 trillion, this could lead to a decline in Treasury yields and reduce active liquidity in the repo market. Each new stablecoin actually equates to an additional demand for Treasuries. This will allow the U.S. Treasury to refinance at a lower cost, while also potentially causing T-bills to become more scarce and expensive for other financial institutions. Not only will this squeeze the revenues of stablecoin issuers, but it will also make it harder for other financial institutions to obtain collateral to manage 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 bonds from $7 trillion to $14 trillion. However, even so, the continued growth of the stablecoin industry will still reshape the supply and demand dynamics.

The rise of stablecoins and their profound impact on the government bond market reveals 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 that regulators and market participants must face together.

Narrow Banking Model

Fundamentally, fiat reserve stablecoins are similar to Narrow Banking: they hold 100% of reserves, exist in cash equivalents, and do not lend. This model is inherently low-risk, which is one of the reasons why fiat reserve stablecoins were able to gain early regulatory acceptance. Narrow banking is a trusted and easily verifiable system that provides a clear value proposition for token holders while avoiding the full regulatory burden that traditional fractional reserve banks would have to bear. However, if the size of the stablecoin grows tenfold to $2 trillion, then these funds are fully backed by reserves and short-term Treasuries, which 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 remaining deposits are used to issue loans to businesses, homebuyers, and entrepreneurs. Under the supervision of regulators, banks manage credit risks and loan terms to ensure that depositors can withdraw cash when needed.

However, regulators do not want narrow banks to absorb deposit funds, as funds under the narrow bank model have a lower currency multiplier effect (i.e., a single dollar-backed credit expansion multiple is lower). Ultimately, the economy runs on credit: regulators, businesses, and everyday consumers all benefit from a more dynamic and interdependent economy. If even a small fraction of the $17 trillion U.S. deposit base were to move to fiat reserve stablecoins, banks could lose their cheapest source of funding. This will force banks to face two unfavorable options: either reduce credit creation (e.g., mortgage loans, car loans, and SME credit lines) or cover deposit losses through wholesale financing (e.g., short-term loans from the Federal Home Loan Bank), which is not only more costly but also has shorter maturities.

Despite the aforementioned issues with the narrow banking model, stablecoins have higher monetary liquidity. A stablecoin can be sent, spent, borrowed, or collateralized—and can be used multiple times per minute, controlled by either humans or software, operating around the clock. This high efficiency in liquidity makes stablecoins a superior form of currency.

In addition, stablecoins do not have to be backed by Treasuries. An alternative is Tokenized Deposits, which allow the value proposition of stablecoins to be reflected directly on bank balance sheets while circulating in the economy at the speed of modern blockchains. In this model, deposits remain partially in the reserve banking system, and each stable value token actually continues to support the issuer's lending business. Under this model, the money multiplier effect is restored – not only through the speed of money flow, but also through traditional credit creation; Users can still enjoy round-the-clock settlement, composability, and on-chain programmability.

The rise of stablecoins has provided new possibilities for the financial system, but it also poses the challenge of balancing credit creation and system stability. Future solutions will need to find the best combination between economic efficiency and traditional financial functions.

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

Tokenized Deposit Model: Retaining deposits in a fractional reserve system through Tokenized Deposits.

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

Embedded automatic liquidity mechanism: Reintroducing idle reserves into the credit market through on-chain repo agreements, tri-party facilities, collateral debt position (CDP) pools, and other methods.

The goal is to maintain an interdependent and continually growing economic environment that makes reasonable commercial loans more accessible. Innovative stablecoin designs can achieve this objective by supporting traditional credit creation while enhancing monetary liquidity, decentralized mortgage lending, and direct private loans.

Although the current regulatory environment makes tokenized deposits unfeasible, the clarity of regulations surrounding fiat-backed stablecoins is opening doors for stablecoins that are collateralized by bank deposits.

Deposit-Backed Stablecoins 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 users choose to mint deposit-backed stablecoins, 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 valued in USD, 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 government bond market, and increase currency liquidity.

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 the bank retains the earnings from the underlying assets and maintains relationships with customers. Additionally, stablecoins provide banks with a payment opportunity that does not require intermediary involvement.

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 access funds quickly and securely.

Expand collateral types and tokenize them

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

Put collateral on-chain to enhance liquidity

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

Adopting a Collateralized Debt Position (CDPs) model

Drawing on MakerDAO's DAI and other CDP-based stablecoins, this type of stablecoin utilizes a variety 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 are required to undergo strict third-party audits and transparent disclosures to verify the stability of their collateralization model.

Despite facing huge challenges, each challenge brings great opportunities. Entrepreneurs and policymakers who can understand the nuances of stablecoins will have the chance to shape a smarter, safer, and superior financial future.