Although stablecoins are currently used by millions of people and trillions of dollars in value are traded, the definition of the stablecoin category and its understanding remains vague.

Stablecoins are a store of value and a medium of value exchange, usually (but not necessarily) pegged to the U.S. dollar. Although the development time of stablecoins is only 5 years, its development and evolution path in two dimensions is significant: 1. From under-collateralization to over-collateralization; 2. From centralization to decentralization.

This is very beneficial to help us understand the technical structure of stablecoins and eliminate the market’s misunderstandings about stablecoins.

As a payment innovation, stablecoins simplify the way of value transfer. It has constructed a market parallel to traditional financial infrastructure, and its annual transaction volume has even exceeded that of major payment networks.

Taking history as a guide, we can see the rise and fall. To understand the limitations and scalability of stablecoin design, a valuable perspective lies in examining the history of the banking industry—uncovering what worked, what didn’t, and the reasons behind each outcome. Like many products in the crypto space, stablecoins may replicate the historical trajectory of banking, starting with basic deposits and notes before evolving into increasingly sophisticated credit mechanisms to expand the money supply.

In this article, we present a translated and adapted analysis of A Useful Framework for Understanding Stablecoins: Banking History by a16z partner Sam Broner. It offers a framework for envisioning the future of stablecoins by drawing lessons from the development of the U.S. banking system.

The article begins by outlining recent advancements in stablecoins, followed by a comparison with the evolution of U.S. banking. This comparative approach highlights parallels between the two, enabling a deeper understanding of stablecoins’ potential paths. Along the way, we explore three emerging forms of stablecoins: fiat-backed, asset-backed, and strategy-backed synthetic dollars, offering a forward-looking perspective on the future of this financial innovation.

Key Takeaways

Through the compilation, I was deeply inspired. Looking at its essence, there is no escape from the three pillars of banking and monetary science.

• Although the payment innovation of stablecoins seems to subvert traditional finance, the most important thing to understand is that the essential attributes of currency (value scale) and core functions (medium of exchange) remain unchanged. Therefore, stablecoins can be said to be the carrier or expression of currency.
• Since it is essentially currency, the development patterns of modern currency history over the past several hundred years are of great reference significance. This is also the merit of Sam Broner’s article. He not only saw the issuance of money, but also saw the subsequent use of credit by banks as a tool for money creation. This directly guides the direction for stablecoins that are still in the currency issuance stage.
• If stablecoins backed by legal currency are the public’s choice in the current currency issuance stage, then asset-backed stablecoins will be the choice in the subsequent credit creation money stage. My personal view is that as more and more illiquid RWA come to the chain, their mission is not to circulate, but to mortgage and create credit as underlying assets.
• Let’s turn to strategy-backed synthetic dollars. Due to the inherent design of their technical structure, these stablecoins face inevitable regulatory challenges and user experience hurdles. Currently, they are primarily utilized in DeFi yield products, struggling to overcome the “impossible trinity” of traditional financial investments: returns, liquidity, and risk. However, recent developments, such as interest-bearing stablecoins backed by U.S. Treasury assets and innovative applications like PayFi, are beginning to break through these limitations. PayFi integrates DeFi into payments, transforming every dollar into smart, autonomous capital.
• Ultimately, it’s essential to return to the core purpose: the creation of stablecoins, synthetic dollars, or dedicated currencies aims to further highlight the intrinsic attributes of money through digital currency and blockchain technology. These innovations are designed to strengthen the core functions of money, enhance operational efficiency, reduce costs, tightly manage risks, and fully leverage the role of currency in facilitating value exchange and driving economic and social development.

1. The Evolution of Stablecoins

Since Circle launched USDC in 2018, the development of stablecoins has provided ample evidence of what works and what doesn’t.

Early adopters used fiat-backed stablecoins for transfers and savings. While decentralized, overcollateralized lending protocols produced stablecoins that were functional and reliable, their actual demand remained limited. To date, users appear to strongly favor USD-denominated stablecoins over those pegged to other fiat currencies or novel denominations.

Certain categories of stablecoins have failed outright. Decentralized, undercollateralized stablecoins like Luna-Terra initially appeared more capital-efficient than fiat-backed or overcollateralized alternatives but ended in disaster. Other categories, such as interest-bearing stablecoins, remain under observation due to user experience and regulatory challenges.

Building on the product-market fit of current stablecoins, new USD-denominated token types have emerged. For instance, strategy-backed synthetic dollars like Ethena represent a novel and not yet fully defined category. While resembling stablecoins, they lack the security and maturity of fiat-backed stablecoins, making them more suitable for DeFi users willing to accept higher risks for greater returns.

We’ve also witnessed the rapid adoption of fiat-backed stablecoins like Tether-USDT and Circle-USDC. Their simplicity and security make them appealing. Meanwhile, asset-backed stablecoins lag behind, despite representing the largest share of deposit investments in the traditional banking system.

Analyzing stablecoins through the lens of the traditional banking system provides valuable insights into these trends.

2. U.S. Banking History: Bank Deposits and U.S. Currency

To understand how stablecoins emulate the banking system’s development, it’s particularly useful to examine the history of U.S. banking.

Before the Federal Reserve Act of 1913—and especially prior to the National Bank Acts of 1863-1864—various forms of currency carried different levels of risk, resulting in significant variations in their real value.

The “real” value of banknotes (cash), deposits, and checks often depended on three factors: the issuer, ease of redemption, and the issuer’s credibility. Notably, before the establishment of the Federal Deposit Insurance Corporation (FDIC) in 1933, deposits required specific coverage against bank risk.

During this period, one dollar ≠ one dollar.

Why? Because banks faced (and still face) a trade-off between the profitability of deposit investments and the security of deposits. To make deposit investments profitable, banks needed to extend loans and assume investment risks. Yet, to ensure deposit security, banks had to manage risks and maintain reserves.

Following the enactment of the Federal Reserve Act in 1913, one dollar generally equaled one dollar.

Today, banks invest dollar deposits in Treasury bonds, stocks, and loans, employing simple strategies like market-making or hedging within the limits of the Volcker Rule. The rule, introduced after the 2008 financial crisis, restricts high-risk proprietary trading by banks to reduce speculative activities and minimize bankruptcy risks.

While retail banking customers may believe their money is safe in deposit accounts, reality tells a different story. The 2023 collapse of Silicon Valley Bank due to liquidity mismatches serves as a stark reminder.

Banks earn profits by lending deposits and capturing interest rate spreads. Behind the scenes, banks balance profitability and risk, though customers often remain unaware of how their deposits are managed. Even during periods of turbulence, banks generally maintain deposit safety.

Credit plays a particularly significant role in banking, as it increases monetary supply and improves economic capital efficiency. Thanks to federal oversight, consumer protections, and improved risk management, consumers today view deposits as relatively risk-free, fungible balances.

Returning to stablecoins, they offer many of the same experiences as bank deposits and notes—convenient, reliable value storage, a medium of exchange, and borrowing options—while adopting an “unbundled” and self-custodial model. Stablecoins mimic their fiat predecessors, starting with simple deposit and note functionalities, but asset-backed stablecoins will likely gain prominence as decentralized on-chain lending protocols mature.

3. Understanding Stablecoins Through the Lens of Bank Deposits

With this context, we can evaluate three types of stablecoins—fiat-backed, asset-backed, and strategy-backed synthetic dollars—through the perspective of retail banking.

3.1 Fiat-Backed Stablecoins​​

Fiat-backed stablecoins resemble U.S. banknotes during the National Banking Era (1865-1913). At that time, banknotes were bearer instruments issued by banks, with federal regulations requiring redemption in equivalent dollar value (e.g., specific U.S. Treasury bonds) or other legal tender (“coin”). While the value of banknotes varied depending on the issuer’s reputation, accessibility, and solvency, most people trusted them.

Fiat-backed stablecoins follow similar principles. They are tokens directly redeemable for fiat currencies that are easy to understand and trusted. However, they come with comparable limitations: banknotes were bearer instruments that could be redeemed by anyone, but holders who lived far from the issuing bank faced difficulties in redeeming them. Over time, people accepted the fact that they could trade their banknotes with others who would exchange them for dollars or coins. Similarly, fiat-backed stablecoin users increasingly trust that they can reliably find high-quality stablecoin liquidity providers on platforms like Uniswap, Coinbase, or other exchanges.

Today, a combination of regulatory pressure and user preferences appears to be driving the majority of users toward fiat-backed stablecoins, which account for over 94% of the total stablecoin supply. Circle and Tether dominate fiat-backed stablecoin issuance, collectively issuing over $150 billion worth of USD-pegged stablecoins.

Why Should Users Trust Fiat-Backed Stablecoin Issuers?

Fiat-backed stablecoins are centralized issuances, which inherently come with the potential risk of a “bank run” during redemption. To mitigate these risks, issuers of fiat-backed stablecoins undergo audits by reputable accounting firms, acquire necessary licensing, and comply with regulatory standards. For instance, Circle regularly undergoes audits conducted by Deloitte. These audits aim to verify that stablecoin issuers maintain sufficient reserves of fiat currency or short-term treasury bills to cover short-term redemptions and that each stablecoin issued is backed 1:1 by fiat collateral.

Verifiable Proof of Reserve and Decentralized Issuance of Fiat Stablecoins offer potential pathways to address these risks, but adoption remains limited. Verifiable proof of reserves enhances auditability and can be implemented through mechanisms such as zkTLS (Zero-Knowledge Transport Layer Security) and similar technologies, albeit still reliant on trusted centralized authorities.

Decentralized issuance of fiat-backed stablecoins could also foster trust but presents significant regulatory challenges. For example, issuing decentralized fiat-backed stablecoins would require on-chain holdings of U.S. Treasury securities with similar risk profiles as traditional Treasuries. While this remains infeasible today, it could make fiat-backed stablecoins more trustworthy.

3.2 Asset-Backed Stablecoins

Asset-backed stablecoins are products of on-chain lending protocols, replicating how banks create new money through credit. Decentralized over-collateralized lending protocols, such as Sky Protocol (formerly MakerDAO), issue new stablecoins backed by highly liquid, on-chain collateral.

To understand this mechanism, imagine a checking account where the funds represent part of newly created money, facilitated by complex lending, regulatory, and risk management systems. In traditional finance, most of the circulating money supply (M2 money supply) is created by banks through credit issuance. Similarly, on-chain lending protocols leverage on-chain assets as collateral to generate asset-backed stablecoins.

This system is akin to fractional reserve banking, which originated with the Federal Reserve Act of 1913. Over time, fractional reserve banking evolved, with significant updates in 1933 (creation of the FDIC), 1971 (end of the gold standard under President Nixon), and 2020 (reserve requirements reduced to zero).

Each iteration increased trust in the system of creating new money through credit. Firstly, bank deposits are protected by federal deposit insurance. Secondly, despite significant crises such as those in 1929 and 2008, banks and regulators have steadily improved practices to reduce risk. Over the past 110 years, credit has grown to dominate the U.S. money supply.

Traditional financial institutions employ three methods to safely issue loans:

1. Against assets with liquid markets and swift liquidation practices (e.g., margin loans).
2. Through statistical analysis of pooled loans (e.g., mortgages).
3. With carefully tailored underwriting services (e.g., commercial loans).

On-chain decentralized lending protocols represent only a small portion of stablecoin supply due to their nascent stage and the long path ahead.

The most notable decentralized over-collateralized lending protocols are transparent, well-tested, and conservative. For instance, Sky Protocol issues asset-backed stablecoins collateralized by: On-chain, exogenous assets with low volatility and high liquidity. Sky Protocol enforces strict collateralization ratios and governance and liquidation mechanisms to ensure that collateral can be safely sold, even under adverse market conditions, protecting the redemption value of asset-backed stablecoins.

Users can evaluate collateralized lending protocols based on four criteria:

1. Governance transparency.
2. The proportion, quality, and volatility of the assets backing the stablecoin.
3. The security of the underlying smart contracts.
4. The ability to maintain collateral ratios in real-time.

Like funds in a checking account, asset-backed stablecoins represent newly created money supported by asset-backed loans. However, these loans are more transparent, auditable, and comprehensible than traditional banking practices. Users can audit the collateral for asset-backed stablecoins, unlike in traditional banking systems where deposits are entrusted to bank executives for investment decisions.

Moreover, blockchain-enabled decentralization and transparency mitigate risks addressed by securities laws. This is particularly important for stablecoins, as truly decentralized asset-backed stablecoins may fall outside the scope of securities regulations—especially when backed solely by digital-native collateral rather than “real-world assets.” Such collateral can be secured through autonomous protocols rather than centralized intermediaries.

As more economic activity transitions on-chain, two trends are expected: First, a greater variety of assets will be utilized as collateral in on-chain lending protocols; Second, asset-backed stablecoins will account for a larger share of the on-chain money supply. Other forms of loans could eventually be issued safely on-chain, further expanding the on-chain money supply.

Just as the growth of traditional banking credit, regulatory easing of reserve requirements, and maturity of credit practices required time, so too will the maturation of on-chain lending protocols. Soon, it is reasonable to expect that more people will use asset-backed stablecoins as easily and confidently as fiat-backed stablecoins.

3.3 Strategy-Backed Synthetic Dollars

Recently, some projects have launched tokens pegged at $1, representing a combination of collateral and investment strategies. These tokens are often mistaken for stablecoins, but strategy-backed synthetic dollars (SBSD) should not be categorized as such for several reasons:

SBSDs expose users directly to the trading risks of actively managed assets. They are typically centralized, undercollateralized tokens with characteristics of financial derivatives. More accurately, SBSDs are akin to dollar-denominated shares in open-ended hedge funds—a structure that is hard to audit and may expose users to risks from centralized exchanges (CEX) and asset price volatility, particularly during major market swings or prolonged downturns.

These attributes make SBSDs unsuitable as reliable stores of value or mediums of exchange, the primary purposes of stablecoins. While SBSDs can be constructed in various ways, with differing levels of risk and stability, they represent dollar-denominated financial products that investors might consider adding to their portfolios.

SBSDs can be built on diverse strategies—for example, basis trading or participating in yield-generating protocols like restaking protocols for active validator services (AVSs). These projects manage risk and return, often allowing users to earn yield on cash positions. By managing risk through yield—such as evaluating AVSs to mitigate risks, identifying higher-yield opportunities, or monitoring inversions in basis trades—projects can create yield-generating SBSDs.

Before using any SBSD, users should thoroughly understand its risks and mechanisms, as they would with any new financial tool. DeFi users should also consider the potential repercussions of using SBSDs in DeFi strategies, as decoupling can cause severe cascading effects. When an asset decouples or sharply devalues relative to its reference asset, derivatives that rely on price stability and consistent yields can suddenly become unstable. However, when strategies include centralized, closed-source, or unauditable components, underwriting the risks of any given strategy may be difficult or impossible.

While banks also implement simple and actively managed strategies for deposits, these represent only a small portion of overall capital allocation. Scaling such strategies to support stablecoins broadly is challenging, as they require active management, making them difficult to decentralize or audit reliably. SBSDs pose greater risks to users than bank deposits. If users’ deposits are placed into such instruments, they have valid reasons to be skeptical.

Indeed, users have remained cautious about SBSDs. While they appeal to risk-tolerant users, few actively trade them. Furthermore, the U.S. Securities and Exchange Commission (SEC) has taken enforcement actions against issuers of “stablecoins” that function similarly to shares in investment funds.

4. Conclusion

The era of stablecoins has arrived. Globally, over $160 billion in stablecoins are used for transactions. These fall into two primary categories: fiat-backed stablecoins and asset-backed stablecoins. Other dollar-denominated tokens, such as strategy-backed synthetic dollars, are gaining recognition but do not meet the definition of stablecoins as stores of value and mediums of exchange.

The history of banking offers valuable insight into understanding stablecoins as an asset class—stablecoins must first consolidate around a clear, comprehensible, and easily redeemable form of money, much like how Federal Reserve notes gained public trust in the 19th and early 20th centuries.

Over time, we can expect an increase in the issuance of asset-backed stablecoins by decentralized, over-collateralized lending protocols, akin to how banks expanded the M2 money supply through deposit credit. Finally, we should anticipate that DeFi will continue to grow, creating more SBSDs for investors while enhancing the quality and quantity of asset-backed stablecoins.

While this analysis provides valuable context, our focus should remain on the present. Stablecoins are already the cheapest remittance option, presenting a genuine opportunity to reshape the payments industry. This creates opportunities for established businesses and, more importantly, for startups to innovate on an entirely new frictionless and cost-free payment platform.

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