Why is the more popular stablecoins become, the more anxious the Federal Reserve gets?

Original Article Title: Contrarian Take: How Stablecoins' Disruption of Money Creation Stands in its way to Mass Adoption
Original Article Authors: @DeFi_Cheetah, @VelocityCap_ Investor
Original Article Translation: zhouzhou, BlockBeats

Editor's Note: Stablecoins combine technological innovation with the financial system, bringing payment efficiency while challenging central banks' currency control. They are similar to "full-reserve banks," not creating credit currency but potentially affecting liquidity and interest rates. Future development may move towards a fractional reserve system or integration with CBDC, reshaping the global financial landscape.

The following is the original content (slightly reorganized for better readability):

The rise of blockchain finance has sparked intense debate about the future of money, with many topics that were once confined to academia and central bank policy circles. Stablecoins—a type of digital asset designed to maintain parity with national fiat currencies—have become a mainstream bridge between traditional finance and decentralized finance. While many are optimistic about the adoption prospects of stablecoins, from the U.S. perspective, promoting stablecoins may not be the best choice as it would disrupt the U.S. dollar's money creation mechanism.

Brief Summary: Stablecoins are effectively competing with the deposit base in the U.S. banking system. Therefore, they undermine the money creation mechanism through a "fractional reserve system" and also impact the effectiveness of the Federal Reserve's monetary policy implementation (whether through open market operations or other ways of controlling the money supply) as they reduce the total deposit amount in the banking system.

It is particularly noteworthy that compared to the money multiplier effect of banks using long-term bonds as collateral, stablecoins have very limited money creation ability because stablecoins are mainly collateralized by short-term government bonds (assets that are insensitive to interest rate changes). Therefore, widespread use of stablecoins in the U.S. may weaken the "monetary transmission mechanism."

Even though stablecoins may increase demand for government bonds, lowering the U.S. government's refinancing costs, their impact on money creation remains.

Only when the U.S. dollar returns to the banking system in the form of "bank deposits" as collateral can money creation remain unchanged. However, in reality, this practice is not cost-effective for stablecoin issuers as they would miss out on "risk-free government bond yields."

Banks also cannot treat stablecoins as fiat currency deposits because stablecoins are issued by private institutions, bringing additional counterparty risks.

The U.S. government is also unlikely to redirect the funds entering the stablecoin system through the purchase of Treasury bonds back to the banking system. Since these funds were sold at different interest rates, the government would have to pay the difference between the Treasury bond interest rate and the bank deposit interest rate, increasing the federal fiscal burden.

More importantly, the "self-custody" feature of stablecoins is incompatible with the custody mechanism of bank deposits. Almost all digital assets, except on-chain assets, require custody. Therefore, the expansion of stablecoins within the United States directly threatens the normal operation of the money creation mechanism.

The only way to make stablecoins compatible with money creation is to have the stablecoin issuer operate as a bank. However, this is highly challenging in itself, involving multiple complex issues such as regulatory compliance, financial interest groups, and more.

Of course, from the perspective of the U.S. government's global view, promoting stablecoins is more beneficial than harmful: it helps expand the dominance of the U.S. dollar, strengthens the U.S. dollar's position as the global reserve currency, makes cross-border payments more efficient, and greatly assists non-U.S. users in need of stable currency. However, vigorously promoting stablecoins within the United States, without breaking the domestic money creation mechanism, would be quite difficult.

To further explain the core content of this article in detail, the operational logic of stablecoins has been analyzed from multiple perspectives:

Reserve Requirements and the Money Multiplier Effect: The reserve support mechanism of stablecoins is fundamentally different from traditional commercial banks.

Regulatory Constraints and Economic Stability: Exploring how stablecoins challenge the existing monetary policy framework, market liquidity, and financial stability.

Future Outlook: Anticipating possible regulatory models, the partial reserve model, and the development path of central bank digital currencies.

Partial Reserve System vs. Fully Reserve-backed Stablecoin

Classical Money Multiplier Principle

In mainstream monetary theory, the core mechanism of money creation is the "partial reserve system." A simplified model can illustrate how commercial banks expand base money (usually denoted as M0) into broader forms of money, such as M1 and M2.

If R is the statutory or bank-set reserve ratio, then the standard money multiplier is about:
m = 1 / R

For example, if a bank must hold 10% of deposits as reserve, the money multiplier m is about 10. This means that for every $1 injected into the system (e.g., through open market operations), up to $10 in new deposits could ultimately be created within the banking system.

·M0 (Monetary Base): Circulating Cash + Commercial Bank Reserves at the Central Bank

·M1: Circulating Cash + Demand Deposits + Other Deposits That Can Be Used for Check-Writing

·M2: M1 + Time Deposits, Money Market Accounts, etc.

In the United States, M1 ≈ 6 × M0. This expansion mechanism has supported the development of the modern credit system, serving as a core foundation for mortgage loans, corporate financing, and other productive capital operations.

Stablecoins as "Narrow Banks"

Stablecoins issued on public blockchains (such as USDC, USDT) typically pledge 1:1 support with fiat currency reserves, U.S. Treasury bonds, or other highly liquid assets. Therefore, these issuers do not "lend out" customer deposits like traditional commercial banks. Instead, they provide on-chain liquidity by issuing digital tokens that can be fully redeemed for "real dollars."

From an economic perspective, these types of stablecoins resemble narrow banks: financial institutions that support their "quasi-deposit liabilities" with 100% high-quality liquid assets.

From a purely theoretical standpoint, the money multiplier of these stablecoins is close to 1: unlike commercial banks, stablecoin issuers do not create "additional money" when they receive a $100 million deposit and hold an equivalent amount of Treasury bonds. However, if these stablecoins gain widespread acceptance in the market, they can still function as money.

We will delve further into this in the following parts: even though they do not have a multiplier effect themselves, the underlying funds released by stablecoins (such as funds from U.S. Treasury auctions being used by stablecoin companies to purchase Treasury bonds) may be reused by the government for spending, thus having an overall monetary expansion effect.

Impact of Monetary Policy

Fed Master Account and Systemic Risk

For stablecoin issuers, obtaining a Federal Reserve master account is crucial because financial institutions with this account enjoy several advantages:

· Direct Access to Central Bank Money: Balances in the master account are considered the highest level of liquidity assets (part of M0).

· Access to the Fedwire System: Enables near-instant settlement for large-value transactions.

· Access to ongoing Fed tools support: including mechanisms like the Discount Window and Interest on Excess Reserves (IOER).

However, providing stablecoin issuers with direct access to these facilities still faces two major "excuses" or hurdles:

·Operational Risk: Integrating real-time blockchain ledger with central bank infrastructure may introduce new technological vulnerabilities.

·Limited Monetary Policy Control: If a significant amount of funds flow into a 100% reserve-backed stablecoin system, it could permanently alter the Fed-reliant "fractional reserve" credit control mechanism.

Therefore, traditional central banks may resist granting stablecoin issuers the same policy treatment as commercial banks, fearing a loss of intervention capacity in credit and liquidity during financial crises.

The "Net New Money Effect" of Stablecoins

When stablecoin issuers hold a large amount of U.S. Treasury or other government debt assets, a subtle yet crucial effect known as the "double-spend effect" occurs:

·The U.S. government finances spending using public funds (i.e., stablecoin issuer's bond-purchase funds);

·Simultaneously, these stablecoins can still circulate in the market as currency.

Thus, even if not as robust as the fractional reserve mechanism, this setup may effectively "double" the available circulating supply of disposable USD to the fullest extent.

From a macroeconomic perspective, stablecoins essentially open up a new channel where government borrowing can flow directly into the daily transaction system, enhancing the real liquidity of the money supply in the economy.

Fractional Reserve, Hybrid Models, and the Future of Stablecoins

Will Stablecoin Issuers Move towards a "Bank-like" Model?

Some speculate that in the future, stablecoin issuers may be allowed to use part of their reserves for lending, mimicking commercial banks' "fractional reserve" mechanism to create money.

To achieve this, a rigorous regulatory framework akin to the banking system must be introduced, including:

·Bank Charters

·Federal Deposit Insurance (FDIC)

·Capital Adequacy Ratio Standards (e.g., Basel Accords)

While some legislative proposals, including the "GENIUS Act," outline a path for stablecoin issuers to become "bank-like," these proposals often still emphasize 1:1 reserve requirements, indicating a low likelihood of a short-term shift to a fractional reserve model.

Central Bank Digital Currency (CBDC)

Another more radical option is for central banks to directly issue Central Bank Digital Currency (CBDC), i.e., digital liabilities issued directly by the central bank to the public and businesses.

The advantages of CBDC are:

· Programmability (similar to stablecoins)

· Sovereign credit endorsement (issued by the state)

However, for commercial banks, this poses a direct threat: if the public can open digital accounts with the central bank, it may lead to a massive outflow of deposits from private banks, weakening the banks' lending capacity, and even triggering a "digital bank run".

Potential Impact on the Global Liquidity Cycle

Today, large stablecoin issuers (such as Circle, Tether) hold hundreds of billions of dollars in short-term U.S. Treasury bonds, and their fund flows have had a real impact on the U.S. money markets.

· If users redeem stablecoins on a large scale, the issuer may be forced to quickly sell off T-bills, thus driving up yields and causing instability in the short-term funding market.

· Conversely, if there is a surge in stablecoin demand, a large-scale purchase of T-bills may push down their yield.

This dual-directional "liquidity shock" indicates that once the market size of stablecoins reaches the level of large money market funds, they will truly penetrate the traditional monetary policy and financial system operation mechanisms, becoming key participants in the "shadow money" system.

Conclusion

Stablecoins are at the intersection of technological innovation, regulatory frameworks, and traditional monetary theory. They make "money" more programmable and accessible, providing a new paradigm for payments and settlements. However, at the same time, they challenge the delicate balance of the modern financial system, especially the fractional reserve system and the central bank's control over the currency.

In short, stablecoins will not directly replace commercial banks, but their existence continues to put pressure on the traditional banking system, forcing the latter to innovate more rapidly.

As the stablecoin market continues to grow, central banks and financial regulators will have to face the following challenges:

· How to coordinate global liquidity changes

· How to improve regulatory structures and cross-sector collaboration

· How to introduce higher transparency and efficiency without harming the money multiplier effect

The future path of stablecoins may include:

· Stricter compliance regulations

· Partial reserve hybrid models

· Integration with CBDC systems

These choices will not only impact the development trajectory of digital payments but may also reshape the direction of global monetary policy.

At the end of the day, stablecoins reveal a core contradiction: the tension between an efficient, programmable full-reserve system and a leverage-based credit mechanism that can drive economic growth. Finding the optimal balance between "transaction efficiency" and "monetary creativeness" will be a key topic in the future evolution of the monetary and financial system.

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