The impact of blockchain and stablecoins on monetary creation
Even though many academics, researchers and economists have written about monetary creation and its mechanisms, it is still one of the most misunderstood aspects of finance and the economy.
Models such as fractional reserve banking, which posits that banks lend out a portion of their deposits, still hold some credence even though they have been proven false by empirical evidence such as that provided by Richard Werner in his 2014 paper “How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking” as well as the Bank of England’s paper “Money creation in the modern economy”.
Most of the circulating money supply is created via private banks issuing credit, whether it is in the form of loans to businesses, mortgages, loans to governments or consumer credit. The entire financial system relies on a steady roll-over of credit into infinity at the global level, technically called a “refinancing of debt”, where the steady issuance of new credits is used to repay older ones, and whenever the system “grips” (whenever bank lending falls), the system nears collapse (technically called a “credit crunch”, often happening in uncertain economic times, when banks are risk averse). Contrary to popular belief, levels of indebtedness at the global level can’t really come down in any significant way. If every single indebted business, consumer or government wanted to reimburse their debt in full, there would be no money left in the economy.
But in the last decade or so, money creation has witnessed a complete revolution via the emergence of blockchain. In the case of crypto-assets such as Bitcoin or Ethereum, their mode of issuance has nothing to do with credit. Bitcoin and Ethereum “tokens” or “coins” are created via hard coded algorithmic rules virtually ex-nihilo, or rather, based on certain conditions set in code, such as a proof of providing computing power to secure the network (in the case of Bitcoin, called proof-of-work) or the proof of locking a certain amount of Ethereum for the same reason (called proof-of-stake). Some years ago, policy makers, financial advisors and economists could argue that these “coins” were nothing more than pure speculation, much like the tulip mania of the 17th century, or poker chips. Many “experts” argued that crypto-assets didn’t have any inherent value in and of themselves, and thus didn’t qualify as “moneys”. Recent developments have completely changed this picture, with the growing institutional adoption of Bitcoin, Ethereum and many more crypto-assets, whether through publicly traded ETFs, private company treasuries or government “strategic reserves”.
But this is only the tip of the iceberg. On top of the modes of emission of Bitcoin and Ethereum, there are a variety of other monetary creation or “minting” mechanisms within the crypto-assets ecosystem, such as airdrops, pre-mined coins, liquidity-mining and yield-farming incentives, ICO/IEO/IDO distributions, and most consequentially for macroeconomics, stablecoin issuance, whether fiat-redeemable (USDT/USDC) or crypto-collateralized (in the case of DAI), which expands and contracts quasi-money outside the banking system through redemptions, over-collateralized loans, and automated market-maker mechanics. And that’s not even mentioning the world of meme coins and NFTs.
These systems have largely been ignored, due to the marginal size of the crypto-assets market compared to the total monetary mass in circulation, which currently stands at around $95 trillion across just the four major currency areas, and over $100 trillion globally. Thus the mainstream assumption so far, is that even a $250–300 billion stablecoin float is only a few-tenths of a percent of broad money (for reference, U.S. M2 alone is about $22 trillion).
But this is a miscalculation, especially in light of the breakneck speed at which the US has been adopting legislation which is favourable to crypto-dollarization, most notably stablecoins and tokenized cash instruments. As these rails plug into broker-dealers, money-market funds, payment processors, and eventually bank balance sheets, the relevant metric is not just their stock but also their flow, velocity, and convertibility. In May of this year, stablecoin transactions have surpassed VISA transactions for the first time. Stablecoins function like a 24/7, programmable eurodollar: they intermediate T-bills and bank deposits, settle globally in minutes, and can be rehypothecated across exchanges, DeFi, and fintech apps. This creates a high-beta, cross-border shadow-money layer whose marginal expansion or contraction could transmit into more risk-taking, dollar liquidity, and demand for short-term sovereign debt far more quickly than their headline market cap implies, which also means their macro impact will arrive sooner and stronger than most traditional measures of “size” would suggest.
Understand what this means. When banks issue loans, in a non-speculative and sound financial system, they do so on the basis of a social promise of a human or human governed entity to reimburse that same loan, ideally through productive economic activity. If banks were only lending to consumers so they could go on holiday to the Bahamas, the economy would be quick to collapse. But fortunately, many loans turn into investments and into productive activities such as producing goods/services, building new houses, developing infrastructure, funding research that will yield to various technological and technical breakthroughs in the future, etc. So long as the goods/services grow at roughly the same pace as money supply, the economy remains healthy. Whenever there is a disconnect between the two, it spells trouble. And this is precisely the case in today’s world, where debt-to-GDP ratio of many countries have skyrocketed, latest of which the French one, as well as private consumer debt. The legacy money creation system was never stable to begin with, giving rise to short boom and bust cycles of roughly 12 years, on top of a debt “supercycle” which takes nearly a century to play out, and which, according to legendary investor Ray Dalio, is coming to a close very soon (think 1929 style depression and “monetary reset”). While modern monetary magic tricks have so far managed to kick the can down the road (via quantitative easing, low interest rates and creative ways of lubricating the financial system via the strategic injection of liquidity), there is no telling when a “black swan” event will finally permanently grip the financial machine.
On top of this fragility, crypto-assets based money issuance throws an extra wrench into the system. On the positive side, the development of crypto-based money issuance can diversify monetary creation away from the private banks’ oligopoly over monetary creation. Time and again, whenever the banking system grips, governments and central banks trip over themselves to rescue them from financial pandemonium, easing all regulation “temporarily” (as long as “necessary”) to ensure that an angry mob of citizens that cannot access their money in the bank doesn’t force them out of office. No ruling political party wants to be associated with letting a banking crisis spiral into permanent loss of deposits for citizens. Even if most modern economies guarantee deposits up to around €100k, these are all hypotheticals, and just like insurance companies typically go bust in case of major systemic catastrophes (like the “once-in-a-century” flood that turns actuarial tables to confetti), deposit-guarantee schemes are only as credible as the sovereign backstopping them and the speed of the crisis plumbing. Sure, economists will say that ultimately, central banks can press a button and “print” as much money as necessary to pay back depositors, but that’s a gross miscalculation given how money is created/destroyed. Whatever money is created needs to match money that is scheduled to be “destroyed” when a loan is repaid. Thus a failed bank’s loan book has to be taken up by someone, otherwise, suddenly, billions and billions of currency units would circulate eternally in the economy without ever being repaid, which would create mass inflation. The real reason why no one wants to see a private bank fail, is because someone has to pick up all of the outstanding credit, all of the liabilities, of that bank, not just secure the deposits. And no one would happily take on untangling the nightmarish spaghetti bowl of interbank exposures, rehypothecated collateral, off-balance-sheet vehicles, derivatives, and securitized loan tranches that stitch that institution into the wider system, because tugging one thread risks unraveling the whole fabric. Private banks played a very good game of making themselves not just “too big to fail”, but “too complex to fail” as well, whether big or small. It’s much easier to just inject a few billions into a failing bank then to dip one’s nose into a bank’s assets and liabilities potpourri.
In that sense, crypto-based issuance is a double-edged sword: it can decentralize single points of failure and keep payments running when banks seize up, but it also introduces new run dynamics, collateral reflexivity, and governance risks that are not anchored in productive credit creation. The net effect is that money creation is no longer a closed loop inside (more or less) regulated banks but a coupled system spanning on-chain and off-chain balance sheets, where shocks transmit at the speed of software. Whether this ultimately stabilizes or destabilizes the cycle will depend on the prudential architecture we build around it (transparent reserves, segregation of assets, credible redemption rights, circuit breakers, and clarity on supervisory perimeters) rather than on comforting fictions about size or on the outdated idea that “money” is whatever banks say it is.
So far, the strategy of policy makers has been to either ignore the impact of crypto-assets or to try to regulate them out of existence, to prevent them from affecting the larger financial system. Both of these approaches have failed. That train has left the station. Now comes the hard part: to start reflecting whether the existing financial plumbing can be kept “as is” or whether these recent developments call for a major overhaul of the system.
This has always been a problem. Most people prefer the comforting illusory stability of a dated system as opposed to jumping into the unknown, under an experimental system, via trial and error. No King, to my knowledge, has willingly stepped down and “reformed” monarchy to the point where democracy emerged. So too, no regulator or banker seems ready to call into question the very foundation of the financial system, resting on money creation through credit, in the face of a growing adoption of crypto-assets. Rather, they are attempting to integrate these developments inside an otherwise unchanged financial system, as could be seen by the recent initiative of 9 EU banks issuing a stablecoin as well as the SWIFT payments network adopting blockchain. These developments are akin to a King putting together a “mock parliament” to satisfy the desire for systemic change from his population. It’s cosmetic at best and won’t address the elephant in the room: money creation powers are shifting, and fast. It’s no longer about speeding up payments so that they can also happen on weekends, or to facilitate cross-border payments. That’s completely missing the point of what crypto really brings to the table. In a couple of years, DeFi might go from marginal to mainstream, thanks to progress in both security, UX friendly design and speed. People will have a choice: go to the bank for a loan, or use some crypto-asset as collateral, and mint fully liquid stablecoins. And that’s not even considering the possibility that consumers will empty their bank accounts and pour money into yield-baring stablecoins in DeFi protocols like AAVE. While bankers will try to ban interest on stablecoins inside CEXs (centralized exchanges), there is little they can do to stop interest through lending via DeFi. Non-custodial wallets are so far outside the scope of regulation, and for good reason: how would anyone even regulate them? If regulators try, all of this space will move full open-source, published by anonymous coders, freely downloadable by anyone. Good luck stopping people from downloading open-source software freely available through the Internet. Unless the world embraces China’s Internet control systems.
While many critics would question whether consumers will ever massively adopt a young and still experimental technology, I would point to the very origin of the emergence and interest in blockchain and Bitcoin as an argument in favor of growing adoption of crypto-assets. If the financial system, the economy and the banking system were all super stable, yielding predictable returns, with an economy growing at 5% and faster than debt, with low inflation, low banking fees, improving banking services, etc, I would see no reason why anyone would take an interest in blockchain technology. Truth is: Bitcoin and blockchain emerged specifically as a reaction to the 2008 crisis, where bank bailouts were financed via tax payers money, under a “socializing risk privatizing profit” rationale. Financial services, as always, score lowest on the European consumer scoreboard’s consumer sentiment. The current system is failing consumers. If it wasn’t, people wouldn’t bother tinkering with risky, young, gimmicky technology like blockchain, where every year brings a plethora of scams, rug pulls and hacks robbing thousands of people of their investments (FTX, Terra Luna…). People have better things to do than learn how to manage their money themselves. It is only when existing systems have failed them that they grudgingly take it upon themselves to find better ways to safeguard their hard-earned wealth.
In the meantime, the European Central Bank is attempting a long shot with the digital euro, as a kneejerk reaction to the emergence of stablecoins. That’s been in the pipeline for years, and might not see the light before 2029. So far, what can be said about the digital euro is that it will be too late and too restrictive (balance caps, non-interest-bearing wallets, limited programmability, not strong enough privacy, full KYC to open an account, only for EU citizens), mostly due to private bank lobbying, seeing that the digital euro doesn’t result in citizens massively draining their private bank accounts and put all their money in a risk free and fee-less digital euro account. That being said, the digital euro has an important role to play in years to come, in light of the Relative Theory of Money, but it’s a role that is not currently foreseen by the ECB, and will take some time to play out. I’ve actually asked Christine Lagarde about the Relative Theory of Money myself four years ago, but didn’t get any response. I was way too early. The ECB is simply not ready for this yet.
Stablecoin adoption spurred by the “pro-crypto” US administration will force a profound rethink of the very architecture of finance, something I’ve been reflecting on for nearly a decade, ever since I came across blockchain technology. How will monetary creation outside of the private banking system impact our economies? Will it spur inflation? Will it cause a banking crisis? What happens when technology enabling easy payments via stablecoins or other crypto-assets is massively adopted by consumers and businesses? Especially if consumers massively opt for non-custodial wallets?
These questions bleed into many more issues besides monetary creation. They impact payments systems, taxation, capital control, trading and investing and more. Yet none of these aspects of finance has evolved much in response to the emergence of blockchain and crypto-assets. At best, some existing oligopolies such as Mastercard and Visa have scrambled to integrate crypto-assets into their products, but the appeal of decentralization and non-custodial control over one’s funds may call into question their added value besides legal clarity and third-party liability. These hurdles may be overcome at some point, as various decentralized solutions emerge, such as via oracles, decentralized escrow, insurance and more.
What is certain, is that TradFi (traditional finance) has not adapted to the reality of crypto-assets, and will face important trials in the coming years. In 2026, if the typical 4 year crypto-assets cycle holds, we will face another major bear market at which time many will once again declare Bitcoin and the overall crypto-market as “dead”. The years after, however, will prove to be critical if we are to experience a smooth transition from one system to another, as the next crypto cycle begins.
If you’re interested in the future of blockchain technology and the evolution of the financial system, you can read my paper on the societal implications of Blockchain technology, for a sneak peak on what the future could look like.
