The Future of Stablecoins from the Perspective of the History of American Banking

Stablecoins, as an innovative payment method, simplify the process of value transfer. They create a market that runs parallel to traditional financial infrastructure, with annual transaction volumes even surpassing major payment networks.

Understanding the limitations and scalability of stablecoin design from the perspective of the history of banking development is a beneficial viewpoint. This helps us understand which practices are feasible, which are not, and the reasons behind them. Like many products in the cryptocurrency space, stablecoins may repeat the developmental history of banking, starting with simple bank deposits and notes, gradually evolving to more complex credit to expand the money supply.

This article will explore the future development of stablecoins from the perspective of the historical development of the American banking industry. It first introduces the recent developments of stablecoins and then compares it with the history of the American banking industry, in order to make an effective comparison between stablecoins and the banking sector. In this process, the article will discuss three recently emerged forms of stablecoins: fiat-backed stablecoins, asset-backed stablecoins, and strategically supported synthetic dollars, to look ahead to future developments.

The Development History of Stablecoins

Since Circle launched USDC in 2018, the development over these years has fully demonstrated in which aspects stablecoins are feasible and in which aspects they are not.

Early users of stablecoins used fiat-backed stablecoins for transfers and savings. Although stablecoins generated by decentralized over-collateralized lending protocols have their uses and reliability, actual demand is not strong. So far, users appear to strongly prefer stablecoins pegged to the US dollar, rather than other fiat currencies or new denominations of stablecoins.

Certain types of stablecoins have completely failed. For example, decentralized, low-collateral stablecoins like Luna-Terra seemed to have greater capital efficiency than fiat-backed or over-collateralized stablecoins, but ultimately ended in disaster. Other types of stablecoins remain to be seen: while yield-bearing stablecoins are intuitively exciting, they face obstacles in user experience and regulation.

With the successful application of stablecoins, other types of dollar-denominated tokens have also emerged. For example, strategies supporting synthetic dollars like Ethena represent a new product category that has not yet been fully defined. Although similar to stablecoins, they have not yet achieved the safety standards and maturity required for fiat-backed stablecoins, and are currently primarily adopted by DeFi users who take on higher risks for higher returns.

We have also witnessed the rapid popularity of fiat-backed stablecoins such as Tether-USDT and Circle-USDC, which are favored for their simplicity and security. Asset-backed stablecoins are relatively lagging behind, even though these assets account for the largest share of deposit investments in the traditional banking system.

Analyzing stablecoins from the perspective of the traditional banking system helps to explain these trends.

History of Development of the American Banking Industry: Bank Deposits and U.S. Currency

To understand how current stablecoins mimic the development of the banking system, it is particularly helpful to understand the history of the American banking industry.

Before the Federal Reserve Act of 1913 was enacted, especially before the National Bank Act of 1863-1864, different forms of currency had different risk levels, and therefore their actual values varied.

The "actual" value of bank notes ( cash ), deposits, and checks can vary greatly, depending on three factors: the issuer, the ease of redemption, and the credibility of the issuer. Especially before the establishment of the Federal Deposit Insurance Corporation ( FDIC ) in 1933, deposits had to be specially underwritten against bank risks.

During this period, one dollar ≠ one dollar.

What is the reason? Because banks are facing ( and still facing ) the contradiction between maintaining deposit investment profits and ensuring deposit safety. In order to achieve deposit investment profits, banks need to release loans and take on investment risks, but to ensure deposit safety, banks need to manage risks and hold positions.

Until the Federal Reserve Act was enacted in 1913, in most cases, one dollar = one dollar.

Today, banks use dollar deposits to purchase government bonds and stocks, issue loans, and engage in simple strategies such as market making or hedging according to the Volcker Rule. The Volcker Rule was introduced in the context of the 2008 financial crisis to limit banks' involvement in high-risk proprietary trading activities, reduce speculative activities of retail banks, and lower the risk of bankruptcy.

Although retail banking customers may believe that all their money is safely placed in deposit accounts, this is not the case. Looking back at the collapse of Silicon Valley Bank in 2023 due to a mismatch of funds, which led to a liquidity crisis, serves as a bloody lesson for the market.

Banks earn profits by lending out deposits of ( to earn a spread. Behind the scenes, banks balance profitability and risk, while most users are unaware of how banks manage their deposits. However, during turbulent times, banks can essentially guarantee the safety of deposits.

Credit is a particularly important part of banking operations and is also a way for banks to increase the money supply and the efficiency of economic capital. Despite federal oversight, consumer protection, widespread adoption, and improvements in risk management, consumers can view deposits as a relatively risk-free unified balance.

Returning to stablecoins, they offer users many experiences similar to bank deposits and notes—convenient and reliable value storage, exchange medium, lending—but in a non-bundled "self-custodied" form. Stablecoins will mimic their fiat currency predecessors, starting from simple bank deposits and notes, but as on-chain decentralized lending protocols mature, asset-backed stablecoins will become increasingly popular.

A Perspective on Stablecoins from the View of Bank Deposits

Against this backdrop, we can evaluate three types of stablecoins from the perspective of retail banking - fiat-backed stablecoins, asset-backed stablecoins, and strategy-backed synthetic dollars.

) fiat-backed stablecoin

The stablecoins backed by fiat currency are similar to the banknotes of the National Bank era in the United States from 1865 to 1913. During this period, banknotes were bearer instruments issued by banks; federal regulations required customers to be able to redeem them for equivalent dollars, for example, special U.S. bonds or other fiat currency "coins". Therefore, although the value of banknotes may vary due to the issuer's reputation, accessibility, and solvency, most people trust banknotes.

Fiat-backed stablecoins follow the same principles. They are tokens that users can directly exchange for easily understood and trustworthy fiat currencies—but there are similar warnings: while paper money is an anonymous note that anyone can redeem, holders may not live near the issuing bank, making it difficult to exchange. Over time, people have accepted the fact that they can find someone to trade with and then exchange their paper money for dollars or coins. Similarly, fiat-backed stablecoin users are also increasingly confident that they can reliably find high-quality stablecoin liquidity providers using Uniswap, Coinbase, or other exchanges.

Today, the combination of regulatory pressure and user preferences seems to be attracting more and more users to fiat-backed stablecoins, which account for over 94% of the total supply of stablecoins. Two companies dominate the issuance of fiat-backed stablecoins, having issued over $150 billion of USD-dominated fiat-backed stablecoins.

But why should users trust the issuers of fiat-backed stablecoins?

After all, fiat-backed stablecoins are centrally issued, and it is easy to imagine the risk of a "bank run" occurring during the redemption of stablecoins. To address these risks, fiat-backed stablecoins undergo audits by well-known accounting firms and obtain local licensing qualifications as well as compliance with regulatory requirements. For example, Circle regularly undergoes audits by Deloitte. These audits aim to ensure that stablecoin issuers have enough fiat currency or short-term treasury bill reserves to pay for any short-term redemptions, and that issuers have sufficient total legal collateral to support the redemption of each stablecoin at a 1:1 ratio.

Verifiable reserve proof and the issuance of decentralized fiat stablecoins are feasible paths, but there has not been much adoption.

Verifiable reserve proofs will enhance auditability, which can currently be achieved through zkTLS### zero-knowledge transport layer security, also known as network proof ( and similar methods, although it still relies on trusted centralized authorities.

Issuing a decentralized fiat-backed stablecoin may be feasible, but there are significant regulatory issues. For example, to issue a decentralized fiat-backed stablecoin, the issuer needs to hold U.S. Treasury bonds on-chain that have a risk profile similar to traditional government bonds. This is not possible today, but it would make it easier for users to trust fiat-backed stablecoins.

) asset-backed stablecoin

Asset-backed stablecoins are the product of on-chain lending protocols, mimicking how banks create new money through credit. Decentralized over-collateralized lending protocols like Sky Protocol(, which originated from MakerDAO), have issued new stablecoins that are supported by highly liquid collateral on-chain.

To understand how it works, imagine a checking account where the funds in the account are part of the new funds created, achieved through a complex system of lending, regulation, and risk management.

In fact, most of the currency in circulation, known as the M2 money supply, is created by banks through credit. Banks create money using mortgages, auto loans, business loans, inventory financing, etc. Similarly, on-chain lending protocols use on-chain assets as collateral to create asset-backed stablecoins.

The system that allows credit to create new money is called the fractional reserve banking system, which truly originated from the Federal Reserve Act of 1913. Since then, the fractional reserve banking system has gradually matured and underwent significant updates in 1933 with the establishment of the Federal Deposit Insurance Corporation, in 1971 when President Nixon ended the gold standard, and in 2020 when the reserve requirement was reduced to zero.

With each transformation, consumers and regulators are increasingly confident in the system of creating new money through credit. First, bank deposits are protected by federal deposit insurance. Second, despite major crises like those in 1929 and 2008, banks and regulators have been steadily improving their practices and processes to reduce risk. For 110 years, the share of credit in the U.S. money supply has been growing larger, and now it accounts for the vast majority.

Traditional financial institutions use three methods to securely issue loans:

1. Margin loans for assets with liquid markets and fast settlement practices (;

2. Conduct a large-scale statistical analysis on a group of loans ) secured by mortgage (;

3. Provide thoughtful and customized underwriting services ) business loans ###.

On-chain decentralized lending protocols still only account for a small portion of stablecoin supply, as they are just getting started and have a long way to go.

The most famous decentralized over-collateralized lending protocol is transparent, well-tested, and conservative. For example, the most renowned collateral lending protocol Sky Protocol( originated from MakerDAO), which issues asset-backed stablecoins for the following assets: on-chain, exogenous, low volatility, and high liquidity( that are easy to sell). Sky Protocol also has strict regulations on collateral ratios as well as effective governance and liquidation protocols. These attributes ensure that even if market conditions change, the collateral can be safely sold, thereby protecting the redemption value of the asset-backed stablecoins.

Users can evaluate the mortgage agreement based on four criteria:

1. Governance Transparency;

2. The proportion, quality, and volatility of assets supporting stablecoins;

3. The security of smart contracts;

4. The ability to maintain the loan-to-collateral ratio in real time.

Like the funds in a demand deposit account, asset-backed stablecoins are new funds created through asset-backed loans, but their lending practices are more transparent, auditable, and easier to understand. Users can audit the collateral of asset-backed stablecoins, which differs from the traditional banking system where one can only entrust their deposits to bank executives for investment decisions.

In addition, the decentralization and transparency achieved by blockchain can alleviate the concerns that securities laws aim to address.