Stablecoins are having a moment.
You can send money anywhere in the world in a few milliseconds with a single click. You can hold something like U.S. dollars even in environments where access to foreign currency is heavily controlled—effectively hedging your currency risk. And because this all lives on-chain, you can build programmable money and applications directly on top of familiar currencies. Think decentralized exchanges, automated market makers, prediction markets—some of the most representative on-chain apps today rely on stablecoins as their primary rail.
But here’s the thing: it’s tempting to file all of this under “tech innovation.” That’s the easy story. The harder—and more important—story is that widespread stablecoin adoption doesn’t just change software. It quietly moves a meaningful slice of monetary policy from the public sector to private actors.
That shift is happening because tokenization isn’t merely “representing real-world assets on a blockchain.” It’s also the reverse: taking the properties of assets that exist only on-chain (tokens) and transplanting those properties back into traditional markets.
And once you do that, you import risks that well-regulated financial markets usually don’t allow to exist in that form. We all understand bank run risk in the abstract. What we don’t understand nearly as well is: what exactly is the stablecoin equivalent, and how does it behave under stress? We can’t fully map the territory yet—but we can at least triangulate the risk by comparing stablecoins to adjacent financial products we do understand.
That’s what this piece is about: the economic and financial-engineering risks that come with stablecoins going mainstream.
Defying the order of fiat currency
Let’s rewind and remind ourselves how modern money works.
Ever since the Nixon shock back in 1971–after the Bretton Woods system collapsed–major global currencies became fiat currency: money backed by nothing explicit other than the credibility of a central bank.
One defining feature of this system is that money supply control depends heavily on how much money creation is allowed (or induced) through fractional reserve banking—in other words, the money multiplier effect. And the dial we all obsess over—the policy dial—is the base rate. Raise rates, borrowing gets more expensive, people borrow less, money supply contracts. Lower rates, borrowing gets cheaper, people borrow more, money supply expands.
Controlling money supply is one of the most sacred duties of a central bank. For the Federal Reserve (Fed), the dual mandate—maximal employment and stable prices—ultimately runs through that channel.
And here’s the slightly uncomfortable truth baked into fractional reserve banking: most of the money “in” your bank account is not literally sitting there as your money. That’s not a scandal; it’s a prerequisite. Without the multiplier and leverage, modern economies don’t run.
Bitcoin and blockchains were, in many ways, a direct challenge to that premise. Without a wallet’s private key, no one can touch the assets inside. And unless you send it out, once a coin lands in your wallet, it’s yours—forever.
That clashes head-on with what “money” needs to mean in a fiat system. Central banks need to be able to intervene—expand and contract balance sheets. But assets that have been tokenized onto a blockchain don’t naturally allow that kind of elastic, top-down balance sheet operation.
So stablecoins drift into an odd identity: they start to look less like “money itself” and more like a security—effectively a claim on the collateral backing the token. And when a security starts circulating as money, you don’t just get convenience; you create arbitrage opportunities and you can destabilize the monetary system in ways that are… not subtle.
Ironically, by defying the order of fiat currency, stablecoins end up performing one of blockchain’s original roles quite well: exposing the internal contradictions of the fiat system.
A quick history of stablecoins: the return of private money
The first stablecoin to gain broad traction was Tether (USDT), which appeared in 2014 under the name Realcoin. It followed a fiat-collateralized model and claimed each token was worth one U.S. dollar. In a market defined by volatile crypto assets, it exploded as a store of value and as the de facto base currency.
But Tether also became a perpetual controversy machine. The core question was simple: “Is there really enough collateral?” Early on, it claimed 100% cash backing, then quietly changed its terms and admitted that reserves included harder-to-cash assets like commercial paper and loan receivables. Add the preference for attestation over a full audit, and it wasn’t hard to see why critics called it an unregulated shadow bank harvesting money-issuance profits.
USDC arrived in 2018, built by Circle (backed by Goldman Sachs) in partnership with Coinbase, and it went straight for that credibility gap. Same fiat-collateralized model, opposite philosophy: compliance and transparency. Reserves skewed toward cash and short-dated U.S. Treasuries, and monthly reports were published through accounting firm verification. This was stablecoins trying to move into the regulated financial system rather than dancing around it—more “digital dollar through cooperation” than “digital dollar through evasion.”
Still, for crypto purists, “trust these centralized issuers” was always going to feel like a betrayal of decentralization. So decentralized stablecoins emerged—MakerDAO being the canonical example—trying to stabilize value using smart contracts without a central operator.
DAI’s core mechanism was over-collateralization: lock up volatile assets like ETH, mint a dollar-pegged token, and if collateral value drops below a threshold, the system forces liquidation to keep solvency. Transparent? Yes. Decentralized? Mostly. Capital-efficient? Absolutely not.
Then came the ambitious idea: algorithmic stablecoins—no collateral, just rules. The peak version of that experiment was TerraUSD (UST) paired with Luna, built by Terraform Labs. The mechanism looked like algorithmic open market operations: if UST > \$1, burn Luna, mint UST, expand supply, push price down; if UST < \$1, burn UST, mint Luna, contract supply, push price up. The system turned arbitrageur incentives into its stabilizing engine.
Anchor Protocol poured fuel on the fire with ~20% “fixed” yields, attracting enormous liquidity and pushing Terra into the world’s #3 stablecoin by market cap. Then May 2022 happened: a major sell attack hit UST, the peg broke, and panicked holders rushed to exit by swapping UST into Luna. The algorithm did what it was designed to do—minted effectively unlimited Luna—which crashed Luna’s price, making peg recovery even less plausible. The death spiral wasn’t a metaphor; it was the mechanism. The Terra collapse wiped roughly \$40B in days and became a historic demonstration of what happens when uncollateralized private money loses trust: a bank run that moves at internet speed.
Here’s the fun (and unsettling) part: none of this is entirely new.
Go back before the Fed existed—back to the free banking era in 19th-century America. There was no single national currency issued by a central bank. Instead, state-chartered private banks issued their own banknotes backed by gold or state bonds. Structurally, that’s not far from an issuer minting stablecoins backed by Treasuries and cash.
The problem back then was that a “one dollar” banknote wasn’t accepted as “one dollar” everywhere. Value depended on the bank’s credit, the quality of its collateral, and even physical distance from the issuing bank. Notes traded at a discount. If that sounds familiar, it’s because it’s basically the same as a stablecoin de-peg or the tiny valuation drift you’ll see inside a DEX liquidity pool under changing liquidity conditions. People preferred safer notes (think USDC) and avoided weaker ones, and out of that chaos emerged the principle of singleness of money: in a central-bank money system, “a dollar is a dollar” everywhere, interchangeable at face value.
And yes, there were wildcat banks too: under-supervised banks in remote areas that printed far more notes than their gold reserves justified, then made redemption difficult to delay failure. If you squint, it’s hard not to see some stablecoin issuers with opaque audits, fuzzy headquarters, or offshore structures as the digital-age reincarnation of wildcat banks.
The 19th-century private money experiment ended badly—repeated financial panics, repeated bank runs—and that failure helped justify a central bank as lender of last resort, ultimately contributing to the Fed’s creation. But stablecoins, powered by blockchains, are effectively reopening the era of private money without a central bank. That’s technological progress, sure—but from a stability perspective, you can also view it as regression to a pre-lender-of-last-resort world. And that’s where things get dangerous.
GENIUS Act: May or May Not Be So Genius
On July 18, 2025, President Donald Trump signed the GENIUS Act—the first U.S. law aimed at regulating stablecoins—bringing stablecoins into the formal perimeter of financial regulation for the first time.
A major “this is actually meaningful” feature: the Act strictly limits backing assets to high-quality liquid assets like T-bills and reverse repos. In effect, it turns stablecoin issuers into narrow bank-like entities with something close to a 100% reserve model. That’s a real step forward compared to a world where reserves could include murky and risky instruments like commercial paper, creating insolvency risk. Users can start seeing stablecoins less as the credit risk of a private company and more as an asset adjacent to U.S. sovereign credit—a foundation of trust you need if stablecoins are going to become more than just speculative chips and actually function as payment instruments.
But regulation doesn’t eliminate tradeoffs—it reshapes them.
The Act creates a macroeconomic dilemma: shadow monetization. Private issuers absorb enormous quantities of government debt and effectively transform that debt into circulating money, yet the interest income and seigniorage effects accrue to private companies rather than the state. And because issuers are forced into “safe-assets-only” portfolios, their business models can get squeezed—pushing pressure outward into higher user fees over time, or encouraging regulatory arbitrage through other off-perimeter derivatives.
Most importantly, the fatal missing piece remains: lender of last resort. Even if your collateral is “safe,” in an extreme crisis you can still face a liquidity crunch—Treasury market liquidity can seize up temporarily, or a custodian can fail operationally. A stablecoin issuer that can’t access the Fed’s discount window is still exposed to sudden suspension risk. The Act can reduce credit risk, but it doesn’t fully remove liquidity risk.
So let’s talk about the two big beasts: shadow monetization, and liquidity/run dynamics.
Shadow monetization: losing control over money issuance
One of the biggest issues with the prevailing stablecoin model is that it allows private actors to do the functional equivalent of quantitative easing at will. That’s shadow monetization—also called private quantitative easing.
Mechanically, here’s how it happens. Under frameworks like the GENIUS Act, the dominant collateral is U.S. Treasuries. In traditional finance, when the U.S. government issues Treasuries, non-bank institutions like pension funds buy them. Those assets move off the “spendable” surface of the economy; the payment flows to the Treasury. In a macro sense, it’s one way liquidity gets absorbed and money supply gets tightened—cash gets locked into an illiquid asset.
But stablecoin issuers buy Treasuries and then re-issue a liquid token against them. Now, even if the Treasury receives the sale proceeds, system liquidity doesn’t fall in the same way—because the newly minted stablecoins circulate as spendable instruments.
So you end up with two “money-like” layers coexisting: public money (cash) controlled by the state, and private money in the form of stablecoins minted by private issuers.
And stablecoins are distinct from deposits. As Gary B. Gorton famously puts it, banks “produce” short-term debt—deposits—and the credibility of that private money depends on the bank’s credit. Bank money creation is constrained by regulation—capital adequacy ratios like Basel III limit leverage and thus limit money creation. But stablecoins, if collateral is acceptable, can scale without that same leverage constraint. If someone supplies enough cash to buy T-bills, an issuer can mint essentially unlimited stablecoins. The only constraint becomes demand, not regulation.
This is why stablecoins create an open lane for private quantitative easing: what central banks do when they buy government bonds with newly created money can, in a stablecoin world, be replicated by any issuer with enough inbound cash.
Stablecoins aren’t the first place we’ve seen this. Eurodollars are a classic example: U.S. dollars held and lent by banks outside the U.S., outside U.S. reserve requirements and deposit insurance rules. Those banks could expand balance sheets and effectively “print” dollar-like claims beyond the Fed’s direct reach, with dollars circulating globally—funding oil trades, wars, everything. One outcome: it contributed to the Fed eventually moving away from strict M1/M2 targeting.
Another often-cited parallel is Money Market Mutual Fund behavior in crises. In 2008, the Reserve Primary Fund broke the buck after holding large amounts of Lehman’s commercial paper; NAV fell to \$0.97. Once the sacred \$1 peg cracked, panic hit, withdrawals surged, and stress spread across shadow finance—until the U.S. government intervened to stabilize the system.
Now, to be fair: it may be excessive to assume stablecoins must replay these exact dynamics one-to-one. Unlike Money Market Mutual Fund products that skewed toward investment characteristics, stablecoins also satisfy a real need: supplying elasticity where legacy systems don’t.
Which brings us to the next section.
Monetary elasticity: when policy can’t keep up with reality
Gorton argues that the economy always needs safe, money-like assets—things that aren’t “money,” but stay stable in value and can pay for goods and services. That demand doesn’t disappear.
One reason it emerges is that governments—through the Treasury and central banks—often fail to supply enough public money (cash, reserves) to satisfy it. And when that happens, the private sector manufactures “fake safe assets.” That’s the birth of shadow money.
The demand for shadow money is the same demand that, in 2008, drove the creation of repo claims structured around securitized mortgage assets. Today, that demand has migrated: instead of turning MBS into repo, the market is turning T-bills into a new kind of money—stablecoins.
There’s a catch, though: this private “QE” is procyclical. It expands aggressively in booms and contracts violently in busts, amplifying damage.
If you interpret this through Perry Mehrling’s “Money View,” the dual nature of stablecoins becomes clearer. In a money hierarchy, you can think in layers—top (ultimate money), middle (public and bank money), bottom (shadow money). Stablecoins are an attempt to make lower-layer securities circulate like upper-layer money. It’s risky, yes—but it’s also liquidity alchemy: giving immediate purchasing power to assets that would otherwise be illiquid.
And this is where the central stablecoin dilemma emerges: elasticity mismatch.
On the upside: public money supply is slow and inelastic because it requires policy decisions. Markets, meanwhile, run 24/7 and demand instant settlement. Stablecoins can expand quickly when demand appears, supplying liquidity right when the market wants it.
On the downside: that same unconstrained issuance can overshoot—fueling bubbles through private QE—and then, in crises, evaporate through private QT, worsening downturns.
There’s a deeper, darker condition under all of this: the “magic” only works as long as trust holds. The moment trust fractures, liquidity alchemy turns into panic—because the lower-layer asset can’t truly behave like top-layer money under stress. That’s where run risk surfaces.
The trap of 100% backing: liquidity and a prisoner’s dilemma
People love to assume: “If something is 100% backed, it’s safe.” That intuition breaks on one word: liquidity.
Markets price assets by supply and demand. If a very large position needs to be sold immediately, there may not be enough counterparties at the current price—trades fail to clear, or prices gap violently. Liquidity is basically the market’s capacity to absorb size without dislocation. Lower liquidity means higher volatility; higher liquidity means lower volatility.
And liquidity is not stable—it can collapse precisely when you need it most.
In calm times, a 100%-reserve stablecoin looks flawless on paper: assets and liabilities match 1:1. But in crisis, that accounting symmetry gets crushed by market liquidity reality.
A stablecoin run isn’t like a stock crash where everyone eats losses together. A run is a first-mover-advantage, zero-sum game. Imagine rates rise and the stablecoin’s bond collateral drops 1% in price. The “true” value becomes \$0.99, but the issuer still promises \$1 redemptions. The first redeemers get their full dollar. The issuer sells bonds to raise cash and pays them out.
But to raise \$1 in cash by selling \$0.99 bonds, the issuer must sell more than \$1 face value. Every early redeemer effectively drains more value from the vault, pushing losses onto those who remain. As withdrawals accelerate, the remaining backing per token degrades—\$0.98, then \$0.97, and so on.
Worse, large forced selling can trigger fire sale dynamics that crash bond prices further, accelerating the same death spiral you saw elsewhere in financial history. This is precisely why frameworks like the GENIUS Act restrict collateral to high-quality liquid assets in the first place.
At the end of the day, the game theory is brutal: “The first out gets a dollar; the last out gets nothing.” That is a prisoner’s dilemma. Rational actors will run early because not running is dominated. And the root cause is simple: there’s no lender of last resort willing to buy the collapsing collateral at par.
The irony of lender of last resort
Traditional banks aren’t immune to runs either. The difference is that banks have access to the Fed’s discount window.
Think of the discount window as a system-wide pawn shop: when depositors rush in, a bank doesn’t have to dump long-dated bonds or loans into the market at distressed prices. It can pledge those assets at the Fed and borrow cash. When markets are panicking and no one will buy, the Fed becomes the "lender of last resort".
That backstop prevents a temporary liquidity squeeze from cascading into insolvency. Banks can rely on funding liquidity from the central bank instead of begging market liquidity for mercy.
Stablecoin issuers, under today’s regime, don’t get that privilege. In stress, they have one option: sell assets into the market. If even Treasuries trade at a discount due to panic, the issuer can be forced into failure. It’s like having a building where the emergency exit disappears precisely when the fire alarm goes off.
So why not just give stablecoins the backstop?
Because of moral hazard. If issuers know they’ll be rescued, they’ll chase yield, privatizing profit and socializing risk.
There’s also the narrow bank fear: if stablecoins become effectively risk-free under Fed protection, deposits could migrate en masse out of banks into stablecoins, starving the real economy of bank lending and triggering credit contraction.
And yet—history shows that in real crises, principles bend. In 2008 and 2020, when Money Market Fund structures faced run dynamics, the Fed created the MMLF as an emergency facility—a kind of “shadow discount window” for non-banks—to stop systemic collapse.
Stablecoins under the GENIUS Act could create the same political and institutional trap: no formal backstop in normal times, but a high likelihood of backstop-by-panic in crisis—handing the Fed another time bomb of dilemma.
Asset sovereignty vs. credit crunch
Earlier we said blockchain assets collide with the fiat definition of “money,” because private-key-based sovereignty resists balance-sheet intervention.
This sovereignty-maximizing narrow bank structure raises a classic concern: clamp down leverage, and you risk a credit crunch. Is that concern real?
Under a narrow bank model—100% T-bill-backed stablecoins—the biggest macro threat is bank disintermediation leading to credit crunch. To see why, you have to compare what money does inside a bank vs. inside a stablecoin issuer.
The difference is productive capital vs. storage capital.
Deposit \$100 at a commercial bank, and the bank lends out most of it (say \$90) to real economic actors—small businesses, homebuyers, entrepreneurs building factories. Money in the banking system actively fuels productive activity. But withdraw that \$100 and buy stablecoins, and the issuer takes your \$100 and buys T-bills. From the user’s perspective, it’s “safe.” From the macro perspective, that money stops funding private production and instead gets stored as government debt financing.
As deposit flight accelerates, banks lose their cheap funding base. To meet regulatory ratios, they shrink balance sheets—cut new lending, call existing loans, raise loan rates. Meanwhile, billions flow into the Treasury market (crowding out), and the private credit channel dries up. That’s the anatomy of a credit crunch.
A natural pushback is: “But stablecoins are liquid—aren’t they still money?” The missing piece is maturity transformation: the banking “magic” where short-term deposits finance long-term loans, creating liquidity for the economy by bridging liquid funding to illiquid projects.
Stablecoins don’t do that. They take already-liquid cash and lock it into the safest—and least productive—asset class: government bonds. If, hypothetically, half the world’s money migrated into stablecoins, we might end up with the safest financial system in history… and a stagnating economy where risk-taking, innovation, and growth financing become structurally harder.
An economy without credit lending: why DeFi can’t be a bank
There’s a hopeful counterargument: if banks lose deposits, can DeFi step in and fill the lending gap?
It’s a nice thought. But the current DeFi structure can’t replace commercial banks—at least not without shrinking the economy—because of a fundamental difference between trust and collateral.
Bank lending is based on future income. Banks underwrite business plans and credit, and they lend based on the belief that borrowers will earn and repay in the future. Even without strong collateral, banks can create credit (and money) through the lending process—supplying elastic money that expands and contracts with the economy.
DeFi protocols, by contrast, are basically pawn shops. Smart contracts can’t read a founder’s character or evaluate a business vision. They can only verify present assets. So to borrow \$100, you lock up \$150 worth of ETH. That’s an inelastic money system: no collateral, no credit, no new money creation.
If DeFi truly replaced banks, we’d enter a hyper-collateralized economy. Young entrepreneurs with great ideas but no assets couldn’t borrow a cent, because code can’t underwrite their future. Lending becomes the privilege of existing capital holders, and innovation without collateral gets squeezed out.
That dynamic deepens structural inequality—rich-get-loans—and threatens the SME and startup ecosystems that rely on credit as oxygen. Stablecoins plus DeFi can mimic parts of banking “efficiency,” but they can’t replace the credit creation function that drives growth.
Conclusion: can a rebel’s creation wear a suit?
Bitcoin started as a rebel’s creation. It immortalized the chaos of the 2008 crisis in the genesis block and challenged a world where “my money isn’t really mine” under fiat currency and fractional reserve banking. Ethereum and early blockchain projects differed in implementation details, but they largely shared that identity.
Then money flooded into crypto, and the rebel’s creation started getting dressed by whoever showed up. First came the scammers, dressing it in clown clothes. As the market matured and the scammers retreated, traditional finance arrived—trying to dress it in a suit.
It’s confusing, isn’t it? You start by trying to break the suit-wearers’ order, and then you find yourself wearing the suit.
Stablecoins are the symbol of that suited rebel. They grew with traditional finance support; they accelerate dollar penetration; they’ve become major buyers of U.S. Treasuries. And yet they still collide with the system that raised them: anyone can “mint money,” de-peg risk persists even with full backing, and credit crunch risk lurks in the background.
This article broke the problems of today’s stablecoin model into roughly six buckets: parallels with free banking and erosion of singleness of money; shadow monetization; elasticity issues; run risk and the absence of lender of last resort; credit crunch risk from “lazy” liquidity lock-up; and DeFi’s inability to replicate credit creation.
But the point here is not “stablecoins should be banned.” Innovation is inherently disruptive—but in finance, disruption can easily become mutual destruction. The better stance is to look at the structural problems head-on, at the macro level, and find a coexistence path.
As discussed, stablecoins are, in a sense, inevitable given the demand for monetary elasticity. Public money issuance requires policy decisions; it can’t fully replace private money-like instruments. The procyclicality and instability that come with this are costs we may have to accept because you can’t satisfy every conflicting policy objective simultaneously.
Still, blockchain-style asset sovereignty—absolute control via private keys—may be something we should be more cautious about, because it can choke off credit creation, one of the most important forces behind modern growth. That’s one reason central banks worldwide push policies that try to route stablecoin and CBDC funds back into banks as much as possible.
It’s hard to deny the current stablecoin model is transitional. A structure where private companies monopolize seigniorage and asset-management profits while steering money supply is not sustainable. Some experts propose deposit-token models that may better satisfy the competing demands of stability, credit creation, and tokenization.
And we probably need to rethink the role of banks, too. If we want credit creation and stability in a digital world, we likely need institutions that play bank-like roles—even if today’s banking model is too old and too legacy to be truly digital-native. That implies new challengers will have to disrupt the space to drive meaningful change. In that world, what should central banks do? How should they intervene effectively in markets that shift minute by minute? Governments will have to grapple with that.
So: can a rebel’s creation wear a suit? ■
