Author: Zhu Weisha

This article comments using quotes, displayed in order with underscores

Currently, some discussions about stablecoins are only from a single perspective. To deduce the operation and future prospects of stablecoins, a multi-dimensional and multi-perspective examination is necessary. If we hope to promote the development of digital payment systems and achieve healthy growth, we must also pay attention to performance and balance across multiple dimensions.

1. Central Bank Perspective: Preventing Currency Overissuance and High Leverage Amplification

Stablecoin issuers may wish to bear minimal costs while obtaining the maximum scale of stablecoin issuance and application. They might wonder, why can central banks print money, and can’t I? Nowadays, they can also have the function of printing money through stablecoins, but due to a lack of deep understanding and responsibility regarding monetary policy, macroeconomic regulation, and public infrastructure functions, they may lack sufficient self-discipline, potentially leading to uncontrolled issuance, high leverage, and instability. (1) The stability of stablecoins is not self-proclaimed; there needs to be a judgment mechanism. Currently, there are at least two concerns from central banks. First is "excessive currency issuance," meaning that issuers issue stablecoins without real 100% reserves, which is overissuance; second is the emergence of high leverage amplification, meaning that the operation after issuance can produce a multiplier effect of currency derivation. In this regard, the U.S. "GENIUS Act" and Hong Kong's "Stablecoin Regulation" have already paid attention, but there is still a significant lack of control. First, it should be clear who the custodian of the issuance reserves is; in practice, there are cases where custodians do not fulfill their duties, as seen in many past cases. In 2019, Facebook initially planned to self-custody the reserves for Libra's issuance, which allowed for strong autonomy and the ability to retain the income from the custodial assets. However, the custody of reserves must be reliable and should be conducted by the central bank or a custodian recognized and regulated by the central bank; otherwise, it is not very reliable. (2) Second, how to measure and manage the amplification effect during the operation of stablecoins? Even if the issuer places 100% reserves, stablecoins will still exhibit a multiplier effect in subsequent operational stages (such as lending, collateralization, trading, and revaluation), and the potential amount to be addressed in a bank run could be several times the issuance reserves. On the surface, relevant regulations may prevent amplification, but a deeper observation of the laws of currency issuance and operation reveals that existing rules are far from sufficient to address derivation and amplification. We can refer to the example of three commercial institutions issuing Hong Kong dollar cash: the issuance mechanism of the three note-issuing banks in Hong Kong is that for every 7.8 Hong Kong dollars issued, they need to pay 1 U.S. dollar as reserves to the Hong Kong Monetary Authority, while also obtaining a liability certificate. (3) Based on the M0 of Hong Kong dollars, the economic financial system generates M1 and M2 through derivation and multiplier effects. In the case of a bank run, it will target not only M0 but also M1 or M2; even if the base currency M0 has a 100% reserve, it cannot rely on M0 reserves to respond to a bank run and maintain currency stability. The amplification effect of stablecoins has three known typical channels: first is the lending channel; second is the collateral financing channel; third is the asset market trading channel (which can additionally purchase or revalue the issuance reserve assets). Therefore, regulators need to statistically measure the actual circulation of issued stablecoins; otherwise, it is impossible to ascertain the potential scale of redemption risk. The amplification multiplier effect of stablecoins also provides opportunities for fraud and market manipulation. (4)

Comments:

"Nowadays, they can also have the function of printing money through stablecoins, but due to a lack of deep understanding and responsibility regarding monetary policy, macroeconomic regulation, and public infrastructure functions, they may lack sufficient self-discipline, potentially leading to uncontrolled issuance, high leverage, and instability. (1)"

This statement is problematic; banks today also create money; otherwise, there would be no concepts of M1 and M2. The core of money creation by stablecoins is that the created money is detached from central bank regulation. It relies on an unreasonable monetary system of currency control that is out of control. Is the money created by commercial banks through collateralized assets not "uncontrolled issuance"? Why do banks have "off-balance-sheet assets"? Using credit to create money is far riskier than the asset-based money creation of stablecoins.

The early currency control policies were beneficial to China; now China accounts for 11% to 13% of global trade, while the settlement volume of the renminbi is only about 3%, which is a serious imbalance. This time, stablecoins present a new opportunity to correct past mistakes, and the possibility of making the wrong choice is almost zero. Initially, Bitcoin was priced in renminbi. We handed it over to the United States without even a thank you.

"But the custody of reserves must be reliable and should be conducted by the central bank or a custodian recognized and regulated by the central bank; otherwise, it is not very reliable. (2)"

"It can refer to the example of three commercial institutions issuing Hong Kong dollar cash: the issuance mechanism of the three note-issuing banks in Hong Kong is that for every 7.8 Hong Kong dollars issued, they need to pay 1 U.S. dollar as reserves to the Hong Kong Monetary Authority, while also obtaining a liability certificate. (3)"

This is correct; this is one of the biggest problems with stablecoin issuance, and Mr. Zhou has keenly identified it. The proposed methods are similar to mine. For the unreliability issues existing in opaque stablecoin issuance, delegating fiat currency to the Hong Kong Monetary Authority for regulation improves the unreliability caused by opacity. However, the Hong Kong regulatory authorities do not have a high-level person like Mr. Zhou.

"Regulators need to statistically measure the actual circulation of issued stablecoins; otherwise, it is impossible to ascertain the potential scale of redemption risk. The amplification multiplier effect of stablecoins also provides opportunities for fraud and market manipulation. (4)"

This sentence indicates that Mr. Zhou's understanding of cryptocurrencies is insufficient; the circulation of cryptocurrencies, including stablecoins, can be measured in real-time. There is no need to manage it using the original methods for managing commercial banks and the circulation of the renminbi.

The issuance of stablecoins is not a multiplier amplification but rather the direct generation of equivalent stablecoins from asset collateral, such as U.S. Treasury bonds. There is a risk here; I have discussed the risk of circular collateral in my article. It is not that using credit to issue currency eliminates the multiplier effect. In the field of cryptocurrencies, the multiplier effect cannot be completely ruled out, but it is very limited.

2. Financial Service Model Perspective: The Real Demand for Decentralization and Tokenization

Assuming that the future ecosystem is characterized by large-scale decentralization of financial activities and large-scale tokenization of assets and trading tools, stablecoins will be very useful. First, stablecoins can adapt to the development of decentralized finance (DeFi); second, tokenization is a necessary foundation for the operation of DeFi. It is essential to delve into why or to what extent we are moving towards decentralization and tokenization. From the supply side, blockchain and distributed ledger technology (DLT) indeed provide characteristics for decentralized operations; however, from the demand perspective, how much demand is there for decentralization as a new operating system? Will most financial services transition to this new system? Calmly looking at it, not all financial services are suitable for decentralization, and there are not many financial services that can achieve significant efficiency improvements through decentralization. The real demand for tokenization as a technological foundation also needs to be calmly estimated. (5) From the perspective of upgrading and transforming the hoped-for payment system (especially cross-border payments), the retail payment systems in China and several Asian countries have made successful progress based on mobile phones, with applications using QR codes and near-field communication (NFC) as merchant interfaces, which are still account-based. Currently, the digital currency developed in China is also account-based, extending and iterating the existing financial system. Additionally, some rapid payment systems in Asian countries have direct cross-border connections without choosing the decentralization and tokenization route. As of now, centralized account systems still demonstrate good applicability. There is insufficient basis for replacing account-based payment systems with comprehensive tokenization. The Bank for International Settlements (BIS) has proposed a centralized ledger architecture—Unified Ledger—that tokenizes bank deposits and other financial services, where central bank digital currencies (CBDCs) can play an important role, combining centralization and tokenization. It must be questioned that not all types of financial assets are suitable for tokenization, nor are all financial service links suitable for decentralization; each must be analyzed and compared specifically. (6)

Comments

"Calmly looking at it, not all financial services are suitable for decentralization, and there are not many financial services that can achieve significant efficiency improvements through decentralization. The real demand for tokenization as a technological foundation also needs to be calmly estimated. (5)"

"It must be questioned that not all types of financial assets are suitable for tokenization, nor are all financial service links suitable for decentralization; each must be analyzed and compared specifically. (6)"

The above statements indicate that Mr. Zhou has misunderstood cryptocurrencies as decentralization. Decentralization is merely a technical means of cryptocurrencies. Public transparency is the true cornerstone of Bitcoin. We need a transparent financial system, transparent exchanges, transparent brokers, and transparent stablecoins. Improving the opacity of the existing fiat currency system is another financial transformation in human history. The unified ledger of the Bank for International Settlements has significant limitations. If we cannot fundamentally understand cryptocurrencies and rely on traditional financial cognition, China will repeat the problem of Bitcoin being expelled from China.

3. Payment System Perspective: Technical Path and Compliance Challenges

The upgrade of payment systems has two major concerns: first is payment efficiency, and second is compliance. Improving payment efficiency is considered one of the potential advantages of stablecoins. In the current process of digitalizing payment systems, there are roughly two paths to enhance efficiency. The first path is to continue being account-based, optimizing and innovating based on IT and internet technology. The second path is a brand new payment system based on blockchain technology and cryptocurrencies. (7) From the current development of payment systems in China and Southeast Asia, the main progress achieved so far is still based on internet and IT technology, including the development of third-party payment platforms, advancements in central bank digital currencies (CBDCs), reliance on NFC hard wallets, and interconnection of rapid payment systems. These advancements have significantly improved payment efficiency and convenience. The technical route itself is not the only criterion; the comparison of payment performance must also highly emphasize security and compliance, including Know Your Customer (KYC), identity verification, account management, anti-money laundering (AML), counter-terrorism financing (CFT), anti-gambling, and anti-drug trafficking compliance requirements. Some believe that since stablecoins are based on blockchain, they do not involve account opening. This is not accurate. Even when using "soft wallets," user identity verification is required, and the account opening process must be followed to meet compliance requirements. Currently, stablecoin payment services still have significant deficiencies in KYC and compliance.

Comments

"The first path is to continue being account-based, optimizing and innovating based on IT and internet technology. The second path is a brand new payment system based on blockchain technology and cryptocurrencies. (7)"

This statement is also problematic. Cryptocurrencies are also account systems, just anonymous accounts. Improvements are needed. Internet technology is essentially the technical foundation of cryptocurrencies; the difference is that one is built on a foundation of public transparency, while the other is built on a closed foundation. Both have their advantages. The management cost of KYT for cryptocurrencies is much lower than the current management. From the characteristics of the Bitcoin system that does not require regulation, it can be seen that the regulatory cost of a transparent system is very low.

4. Market Trading Perspective: Market Manipulation and Investor Protection

From the perspective of financial markets and asset market transactions, the most pressing issue to guard against is market manipulation, particularly price manipulation. To address this, sufficient transparency and effective regulation need to be established. (8) In fact, such manipulation has already occurred, with several related cases having taken place. Some of these price manipulation behaviors have clear fraudulent characteristics. However, under the improved current institutional framework, whether it is the U.S. "GENIUS Act," relevant regulations in Hong Kong, or regulatory provisions in Singapore, there is still a lack of reassurance regarding these issues. A new phenomenon is the mixed use of hybrid coins or multiple currencies, meaning that multiple currencies are used simultaneously for transactions or payments within a single system, and not all combinations are true stablecoins, nor do they necessarily adhere to a consistent, recognized standard for stablecoins. In the current asset market, especially in virtual asset exchanges, many trading objects can be paid for with stablecoins, other non-stable cryptocurrencies, or even completely unstable currencies. This arrangement provides opportunities for market manipulation and has become one of the key concerns for regulators. It is noteworthy that some market promoters have mentioned that through stablecoins and RWA (Real World Assets) and other technical means, the shares of asset transactions can be divided into very small portions, thereby achieving broader investor participation, claiming that this model has attracted a large number of students under 18 to participate in trading. Although some believe this helps cultivate youth participation in capital markets and contributes to the future prosperity of capital markets, from the perspective of investor protection, whether this practice is truly beneficial remains to be seen. In the past, there has been an emphasis on the adaptability and qualification requirements of investors; there is currently insufficient basis to determine whether minors are suitable for participating in asset market transactions. If market manipulation cannot be effectively prevented, attracting unqualified investors will significantly amplify risks.

Comments

"From the perspective of financial markets and asset market transactions, the most pressing issue to guard against is market manipulation, particularly price manipulation. To address this, sufficient transparency and effective regulation need to be established. (8)"

This is correct; he is an expert, and he sees the issue accurately. Regulating transparency in cryptocurrencies is very easy. The flow of funds in any account can be monitored. The problem lies in centralized cryptocurrency exchanges, just like fiat currency brokers, where it is unclear who is trading. The regulation of cryptocurrency exchanges should be improved by referencing the regulatory structure of stock markets, which I have described in my articles.

5. Microbehavior Perspective: Motivations of Participants

Stablecoin issuers are generally profit-driven commercial entities, and many subjects involved in stablecoin-related payment and asset trading businesses are also commercial institutions, which inherently have their commercial motives. However, stablecoins and payment systems include some functions or links with infrastructure and inclusive attributes, which cannot be guided by the logic of maximizing corporate self-interest but should embody the spirit of public service. There should be a clear distinction regarding which areas are suitable for market-oriented entities and which belong to infrastructure nature. A micro-level analysis is needed to examine the motivations and behavioral patterns of various participants in stablecoins. What considerations do people using stablecoins for payments have? Why are payees willing to accept stablecoins? What motivations do stablecoin issuers have? What trading scenarios do private exchanges pursue? Currently, Hong Kong has issued licenses to 11 virtual asset trading platforms; what trading subjects and trading varieties do these licensed institutions focus on? How do they profit? Although many believe that stablecoins will reshape the payment system, objectively speaking, the current payment system, especially in the retail payment sector, has little room for cost reduction. (9) In China, the existing retail payment system, including third-party payment platforms, central bank digital currencies (CBDCs), soft and hard wallets, and clearing infrastructure, has not adopted a decentralized and tokenized route. After years of development, it has become very efficient and low-cost, making it very limited for any new entrants to reduce costs and profit in this field. In the United States, there may still be some room for cost reduction and profit in the retail payment system, due to the long-term reliance on credit card payment systems, where merchants typically bear a 2% price discount, thus having the motivation to try new, lower-cost payment systems. This also indicates that, from the perspectives of payers and payees, the situations vary across different countries and regions. Cross-border payments and remittances are often highlighted when discussing the application scenarios of stablecoins. To delve deeper into this issue, it is necessary to break down the reasons for the high costs of current cross-border payments and specifically examine which links lead to high fees. It is important to note that some claims about traditional cross-border payment systems being "very expensive" technically may be exaggerated. In reality, many cost factors are not technical but involve foreign exchange controls, which are related to various institutional issues such as balance of payments, exchange rates, and monetary sovereignty. Another portion of costs comes from compliance costs such as KYC and AML, which cannot be avoided even when switching to stablecoins. Additionally, some costs arise from cross-border foreign exchange operations as a licensed "rent." In summary, the appeal of stablecoins in cross-border payments is not as great as imagined. Of course, scenarios where the local currency has been mishandled and there is a need to introduce dollarization should be treated differently. From the perspective of stablecoin issuers, if they perceive insufficient appeal in local and cross-border payments, the most likely focus of application will be in asset market transactions, particularly virtual asset trading. Certain assets in such markets have strong speculative attributes and are prone to price manipulation, thus attracting stablecoin issuance, especially since some virtual assets can also serve as qualified or semi-qualified reserves for stablecoin issuance. From the current microbehavior perspective, it is essential to be wary of the risk of stablecoins being excessively used for asset speculation, as directional deviations may lead to fraud and instability in the financial system. Furthermore, the behavior of the stablecoin-related industry leveraging the popularity of stablecoins to enhance their company's valuation is also worth noting. Some companies may use this to "raise money" through the capital market or realize capital appreciation and cash out, while the sustainability and profitability of the stablecoin business itself are not their primary focus. This is detrimental to the healthy development of the entire financial system and may accumulate systemic risks.

Comments

"Although many believe that stablecoins will reshape the payment system, objectively speaking, the current payment system, especially in the retail payment sector, has little room for cost reduction. (9)"

Indeed, China's retail payment and remittance systems are the best in the world. Our infrastructure is excellent, but it has lost its rightful international status due to the inability to freely convert the renminbi under capital accounts.

6. Circulation Path Perspective: The Circular Mechanism from Issuance to Redemption (10)

The circulation path of stablecoins involves the entire cycle from issuance to market circulation in specific scenarios and back. Taking the issuance of paper money by the People's Bank of China as an example, the printed banknotes are first stored in a specific issuance vault, and whether and when these banknotes enter the market depends on whether commercial banks have cash demand. Commercial banks will only withdraw cash from the People's Bank of China’s issuance vault when their customers have net demand or show a lending gap. After withdrawal, it incurs a cost of occupancy for commercial banks, so when they have excess inventory, they will return it. This indicates that the flow of currency into circulation does not happen automatically. Similarly, the stablecoin issuer obtaining the relevant license and paying the reserves does not equate to the issuance of stablecoins. If there is insufficient demand in the market, stablecoins may not enter effective circulation, meaning that they could obtain an issuance license but fail to issue. Theoretically, the circulation path should be networked, often with several major lines of flow. If the main line used for payments is not smooth, the main channel for stablecoins to enter circulation may overly rely on the speculation of virtual assets, raising concerns about health. Additionally, whether stablecoins are used as temporary payment mediums at the time of transaction or as value preservation tools over a certain period will affect the amount of stablecoins remaining in the market after issuance. If they are primarily used for transactions with minimal holding, the role of stablecoins is weakened, and the issuance volume is reduced, which relates to the circulation path, holding motivations and behaviors, and supporting systems. This is not something that can be automatically granted by issuing a license. In summary, in facing this new entity of stablecoins, scholars, researchers, and practitioners need to observe and analyze its functions and realization paths from multiple dimensions to avoid using imprecise concepts, data, and one-sided thinking. By comprehensively discerning various important dimensions, we can better grasp market trends.

Comments

"The circular mechanism from issuance to redemption (10)"

This is market behavior; the bank asset-backed issuance model is more like M2, requiring no concern from the central bank. Taking USDT as an example, it is responsible for issuance and redemption, which has no relation to the Federal Reserve.

Comment Summary

Zhou Wen's article is a high-level analysis. It is a rare good piece in the industry. He has consistently grasped the term cryptocurrency accurately, indicating a certain depth of research into cryptocurrencies. His level is much higher than that of Hong Kong regulators using the term digital currency.

I won't mention the advantages; as a top figure in China's financial sector, he is overly confident in his knowledge, using his knowledge to comment on cryptocurrencies that he does not fully understand; the advantages in details outweigh the strategic vision. He has not clarified that centralized fiat currency is a product of the industrial age, while cryptocurrencies are products of the internet age. The two have fundamental differences in system structure, operational methods, and judgment standards. The underlying difference is in the fundamental logic of thinking. When the internet emerged, there was a lot of skepticism, but since January 9, 2009, when Bitcoin was first launched, it pointed out three fundamental flaws of fiat currency. The emergence of Bitcoin aims to eliminate central banks and the fiat currency system. The call to abolish fiat currency was sounded by Satoshi Nakamoto. The introduction of the U.S. stablecoin bill has already sounded the horn for the demise of traditional fiat currency, including traditional finance. If there is no transformation, it will certainly lead to death; the renminbi will not be able to hold its ground. The U.S. has reformed itself, and abandoning the Federal Reserve is the next step we will see. The "GENIUS Act" of the Americans is terribly flawed, but its openness and rapid iteration may keep them ahead. We missed this opportunity, which is even worse than missing the chance with Bitcoin.

_Statement: My views are a supplement to Mr. Zhou's views. Reading both perspectives is beneficial for understanding cryptocurrencies. All my views are in the following article; if one has not read it and lacks a background in cryptocurrencies, they may find my statements ignorant, sharp, and extreme._

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