Stablecoins have recently surged into the spotlight, with growing interest from readers, investors, and financial commentators. Many are asking: How do stablecoins affect banks? What implications do they have for the global financial system? Initially, I responded to these inquiries individually. But as the volume of questions increased, it became clear that a broader, more structured explanation was needed.
In this article, we’ll explore what stablecoins are, how they work, their economic impact, and why governments — particularly the U.S. — are embracing them despite the risks. We’ll also examine whether stablecoins truly support dollar dominance, and why China may not need them today — but is still preparing for the future.
What Are Stablecoins?
Stablecoins are a type of cryptocurrency designed to maintain a stable value by being pegged to an underlying asset, typically a fiat currency like the U.S. dollar. Unlike volatile digital assets such as Bitcoin or Ethereum, stablecoins aim to combine the benefits of blockchain technology — speed, transparency, and borderless transferability — with the price stability of traditional money.
The most well-known example is USDT (Tether), which maintains a 1:1 parity with the U.S. dollar. This means users can theoretically exchange one USDT for one USD at any time, making it a reliable medium for transactions, remittances, and value storage in the digital economy.
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Why Were Stablecoins Created?
Cryptocurrencies like Bitcoin emerged from a desire to create decentralized, trustless financial systems outside government control. However, their extreme price volatility makes them impractical for everyday transactions. If the value of your digital money can swing 20% in a day, it’s hard to use it to buy groceries or pay rent.
This limitation gave rise to stablecoins — digital currencies that offer the efficiency and accessibility of crypto without the wild price swings. They fulfill three core needs:
- Transaction efficiency: Fast, low-cost cross-border payments.
- Decentralized access: Operate on open blockchains without intermediaries.
- Price stability: Pegged to real-world assets to preserve purchasing power.
These features make stablecoins especially useful in regions with unreliable banking infrastructure or high inflation.
How Do Stablecoins Maintain Their Value?
Most stablecoins claim to be backed by reserves — either cash, short-term bonds, or other liquid assets — held by the issuing company. For example, every USDT issued should correspond to one dollar held in reserve.
However, this model relies heavily on issuer credibility. There is no central regulator guaranteeing these reserves. Even powerful nations have failed to uphold monetary promises — consider the collapse of the Bretton Woods system in 1971, when the U.S. abandoned the gold standard.
Without strict oversight, there’s always a risk that stablecoin issuers might engage in fractional backing — issuing more tokens than they have reserves to cover. This creates systemic fragility similar to traditional banking runs, but without deposit insurance or regulatory safeguards.
How Do Stablecoin Issuers Make Money?
It might seem puzzling: if users can freely convert dollars into stablecoins and back again with no fees, how do companies profit?
There are two primary revenue models:
1. The "Float" Business Model (Legitimate)
When users convert fiat into stablecoins, the issuer temporarily holds those funds before redemption. During this period, the company can invest the capital in low-risk instruments like Treasury bills or commercial paper. As issuance scales up, even small interest margins generate significant returns.
This mirrors the business model of early third-party payment platforms in China, which earned interest on user deposits before regulations required them to hold funds in segregated accounts.
2. Over-Issuance Risk (Problematic)
If a company issues more stablecoins than its reserves can support — say, printing $10 billion worth of tokens backed by only $8 billion — it’s effectively creating unsecured money. While profitable in the short term, this practice increases counterparty risk and could trigger panic during market stress.
History shows that unchecked monetary expansion often ends badly — whether in national economies or private digital ones.
FAQ: Common Questions About Stablecoins
Q: Can stablecoins replace traditional banking?
A: Not fully — but they can disrupt specific functions like cross-border payments and remittances where banks are slow and expensive.
Q: Are all stablecoins backed 1:1 by real assets?
A: Not necessarily. While major players like USDC claim full reserves, audits are not always transparent. Always research the issuer’s reserve disclosures.
Q: What happens if a stablecoin loses its peg?
A: A broken peg can lead to loss of confidence and rapid sell-offs. The 2023 collapse of UST (TerraUSD) showed how quickly a supposedly "stable" coin can unravel.
Q: Are stablecoins regulated?
A: Regulation varies by jurisdiction. The U.S. is moving toward stricter oversight, while some countries restrict or ban them entirely.
Q: Is holding stablecoins safe?
A: Safer than volatile cryptos — but not risk-free. Risks include issuer insolvency, regulatory crackdowns, and smart contract vulnerabilities.
Impact on the Financial System
Stablecoins pose several challenges to traditional finance:
- Erosion of bank deposits: As users move funds into stablecoins for higher utility or yield, banks may lose low-cost funding sources — especially retail checking accounts.
- Regulatory arbitrage: By operating outside traditional banking rules (e.g., capital requirements, KYC/AML), stablecoin issuers gain cost advantages — but introduce systemic risk.
- Shadow banking concerns: Without liquidity buffers or stress testing, large-scale redemptions could trigger cascading failures.
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Why Is the U.S. Embracing Stablecoins?
Despite the risks, U.S. policymakers are increasingly supportive — and for good reason.
America faces a growing debt crisis. With over $30 trillion in national debt and rising Treasury yields, financing obligations is becoming harder. By encouraging stablecoin issuers to back their tokens with U.S. Treasuries, the government effectively creates a new source of demand for short-term bonds.
In essence, every dollar converted into a regulated stablecoin could end up invested in American debt — providing liquidity and helping keep borrowing costs down.
But this comes at a cost: moral hazard. If too much debt is financed through opaque digital channels, long-term financial stability could be compromised.
Can Stablecoins Sustain Dollar Hegemony?
Some argue that stablecoins will extend U.S. financial dominance into the digital realm — that by controlling blockchain-based dollar equivalents, America secures its monetary influence in future virtual economies.
But currency strength ultimately depends on real economic output, not technological first-mover advantage. The dollar became global because it was used to trade essential goods — oil, weapons, tech, food.
If another nation begins producing high-value goods that others depend on — and offers a reliable digital payment alternative — the dollar’s role could diminish rapidly.
Stablecoins don’t create economic power; they reflect it.
Why Doesn’t China Need Stablecoins Now?
China already has what many countries lack:
- A high-speed domestic payment system (via CNAPS) enabling near-instant transfers.
- Low-cost digital transactions through regulated platforms like Alipay and WeChat Pay.
- Full control over capital flows due to RMB’s non-convertible status.
Moreover, the digital yuan (e-CNY) serves many of the same functions as a stablecoin — but under full state oversight. It offers traceability, programmability, and financial inclusion without sacrificing regulatory control.
That said, Hong Kong’s move to regulate stablecoins suggests Beijing sees value in experimenting with decentralized models — possibly as preparation for future RMB internationalization.
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Final Thoughts
Stablecoins represent a powerful fusion of innovation and risk. They offer faster, cheaper alternatives to traditional finance — but without adequate regulation, they could become sources of instability rather than progress.
While they may provide short-term benefits — such as supporting U.S. debt markets or enabling cross-border commerce — their long-term sustainability depends on transparency, accountability, and alignment with broader financial safety goals.
For now, they’re not replacing banks or currencies — but they’re certainly changing how we think about money.