If the financial landscape shifts so that retail savings migrate from traditional fractional-reserve banks to stablecoins backed 100% by government securities, the global economy faces a fundamental change in how money is created. While often viewed simply as a new payment technology, this shift would sharply reduce the private sector’s ability to create credit and force a total rethink of monetary policy.
The mechanics of money: Fractional vs. full backing
To understand the impact, one must compare the underlying mechanics of a bank deposit versus a fully backed stablecoin. In the current fractional-reserve system, banks hold only a mix of cash and securities as partial reserves against their deposits. This allows them to create money endogenously: when a bank issues a loan, it simultaneously creates a new deposit balance, sparking a “money multiplier” effect.
For example, under a 10% reserve requirement, a $100,000 deposit allows a bank to hold $10,000 and lend out the remaining $90,000. Through the multiplier effect, that initial deposit could theoretically support up to $1,000,000 in broad money.
In contrast, a stablecoin issuer that promises 100% backing in government securities operates without this multiplier. If a user moves $100,000 into such a stablecoin, the issuer must hold $100,000 in government securities. These funds are effectively locked; the issuer cannot simultaneously use those same assets to fund new loans without breaking their promise of 1:1 backing. Consequently, the “raw input” that banks previously used to generate credit is removed from the system, leading to lower endogenous money creation.
The credit crunch and the rise of shadow banking
The immediate consequence of this migration is a contraction in the availability of cheap funding for loans. As retail deposits leave the banking system, banks lose their primary source of low-cost capital. To replace these lost funds, banks would be forced to turn to wholesale funding, central bank reserves, or the issuance of new debt and equity. These alternatives are generally more expensive, which raises funding costs and creates a compression in the supply of lending available to consumers and businesses.
As traditional banks pull back, the power to create money would likely shift toward “shadow lenders” and non-bank entities. These non-bank lenders could expand by using repo markets and securitisation to transform government securities into loanable funds. While this fills the gap, it increases regulatory arbitrage, as lenders actively seek out funding environments where regulations are lighter, thereby increasing the complexity of the financial system.
New risks for central banks
This structural change poses significant challenges for central banks and regulators. A primary concern is the weakening of “monetary transmission.” Currently, central banks influence the economy by adjusting interest rates which cascade through bank deposit rates and lending. If deposit-based lending shrinks in favor of stablecoins, interest rate changes may not pass through to the broader economy as cleanly as they do today.
Furthermore, the nature of liquidity risk changes. In the banking system, runs are mitigated by deposit insurance. However, a run on a fully backed stablecoin (where users rush to redeem their tokens for cash) would force the issuer to rapidly liquidate their government securities. If redemptions exceed the market’s capacity to absorb these securities, it could trigger severe liquidity stress in short-term funding markets, potentially requiring the central bank to intervene as a backstop.
The path forward
To manage this transition, policymakers face difficult questions regarding the classification of these assets. They must decide whether stablecoins should be treated as deposits or separate payment instruments, and determine who is responsible for insuring or guaranteeing redemptions.
Ultimately, avoiding a credit freeze or a systemic crisis would likely require significant regulatory coordination. This could include enforcing liquidity buffers, placing limits on maturity transformation by issuers, and potentially establishing active central bank support (such as term lending or buying private credit) to preserve the flow of funds to the real economy.
