Bridging the divide: The hybrid future of stablecoins and traditional finance

The financial landscape is undergoing a profound transformation driven by the imperatives of the digital economy and the internet which have reshaped modern businesses. The speed and global reach of the digital economy are amplifying the perceived shortcomings of traditional finance: cost, speed, and accessibility. While the push for real-time payment systems in traditional finance is addressing some of these issues domestically, the continued significant investment in fintech, along with the persistent challenges in cross-border payments, suggests many fundamental problems remain to be solved.  

Central to this evolving landscape is the world of decentralised finance (DeFi) which envisions a peer-to-peer future where intermediaries are no longer necessary to facilitate financial needs. At the heart of this revolution are stablecoins: digital currencies engineered to maintain a stable value, typically against a trusted fiat currency like the US dollar. President Trump's ‘Executive Order on Strengthening American Leadership in Digital Financial Technology,' issued in January 2025 champions the responsible growth and adoption of US Dollar backed stablecoins with calls for the establishment of a clear regulatory framework and mandating federal agencies to explore stablecoin integration. In response, the GENIUS Act passed through the US legislature on July 18, 2025, and will provide much needed legal clarity and oversight for these digital assets.

As stablecoins continue their remarkable growth – with transaction volumes accounting for nearly half of cross-border crypto flows and the total outstanding supply crossing $250 billion by June 2025 – a key question emerges: how will they interact with traditional finance (TradFi) and the established banking sector?

While one model, adhering to DeFi's fundamental peer-to-peer principle, might suggest stablecoins could displace many traditional financial market players altogether, recent developments strongly indicate a more integrated future. Initiatives like the Circle Payments Network or the UBYX whitepaper, along with the explicit differentiation between banks and stablecoin issuers within the GENIUS Act, suggest that banks, at least, are here to stay and will play a central role. This article explores why this integration is likely and what such a hybrid model could look like.

The stablecoin rationale: A response to tradFi limitations

Stablecoins have emerged as a compelling solution to some of the inherent limitations of the current financial system. Their core value proposition rests on several key principles:

1. Uninterrupted, instantaneous global payments with finality: Traditional banking systems, with their reliance on conventional business hours and multiple intermediaries, struggle to keep pace with the demands of an increasingly globalised and interconnected world. In contrast, stablecoins facilitate near-instantaneous transactions, 24 hours a day, 7 days a week, 365 days a year, across borders. This capability aligns seamlessly with the operational tempo of the internet age and global commerce. While the concept of "finality" can vary across different blockchain consensus mechanisms, well-established stablecoin networks offer a high degree of transaction irreversibility within a short timeframe, providing a robust foundation for reliable low-value transfer.
2. Price stability: Anchoring value in familiarity: A key barrier to the widespread adoption of cryptocurrencies has been their inherent price volatility. Stablecoins address this challenge by pegging their value to a stable fiat currency, most commonly the US dollar. This strategic design choice provides users with a familiar unit of account, fostering confidence and mitigating the risks associated with price fluctuations. This stability is not merely a convenience; it is a critical prerequisite for the broader integration of digital currencies into everyday transactions and their acceptance as a reliable store of value.
3. Cost efficiency: Streamlining transactions, reducing friction: The traditional financial system is often characterised by layers of intermediaries, each adding to the overall cost of transactions. This is particularly evident in cross-border payments and microtransactions, where fees can be disproportionately high. Stablecoins, by leveraging blockchain infrastructure and reducing the reliance on intermediaries, offer the potential for significantly lower transaction costs. This efficiency gain has the potential to unlock new economic opportunities, making financial services more accessible and affordable for individuals and businesses alike.
4. Programmability: Unleashing the power of smart contracts: Stablecoins are not simply digital representations of fiat currency; they are also powerful tools that inherit the programmability of their underlying blockchain platforms. This programmability is made possible through smart contracts: self-executing agreements written in code. Smart contracts can automate complex financial processes, eliminate the need for manual intervention, and enable the creation of innovative financial products and services. This opens the door to a new era of finance, characterised by increased efficiency, transparency, and the emergence of novel applications such as collateralised lending, automated market makers, and decentralised applications (dApps). Indeed, some industry leaders have referred to stablecoins as "room-temperature superconductors for financial services."

The challenge of reconciling innovation with tradition

While the vision of a frictionless, peer-to-peer stablecoin ecosystem is compelling, it encounters friction with three deeply entrenched aspects of the existing financial order:

1. Navigating the regulatory landscape: Regulatory bodies worldwide, such as the Financial Action Task Force (FATF), have established stringent Anti-Money Laundering (AML) and Counter-Financing of Terrorism (CFT) requirements. These regulations are designed to safeguard the integrity of the financial system and prevent its use for illicit purposes. However, the decentralised and often pseudonymous nature of peer-to-peer systems poses significant challenges for enforcing these regulations. Identifying and monitoring potentially illicit transactions becomes considerably more complex without the presence of centralised intermediaries responsible for implementing Know Your Customer (KYC) procedures and transaction monitoring.
2. The enduring role of private money creation: The fractional reserve banking system, a cornerstone of modern economies, is predicated on the ability of banks to create money through lending. This mechanism plays a crucial role in providing liquidity and credit to the economy. A truly peer-to-peer stablecoin system, where value is transferred directly between users without the involvement of traditional financial institutions, would fundamentally disrupt this model. Banks would face significant challenges in maintaining their traditional role in credit creation and generating revenue through interest on loans. This raises important questions about the future of banking and its role in a digital asset-driven economy, and how capitalist societies can facilitate economic growth easily.
3. The economics of yield intermediation: Beyond regulatory compliance and the preservation of private money creation, the fundamental economics of yield generation also drive the re-intermediation of third parties in the stablecoin ecosystem. Most prominent stablecoins, such as USDC, are designed to be non-interest bearing for the direct holder. The yield generated from the highly liquid reserve assets backing these stablecoins is typically retained by the issuer to cover operational costs, compliance efforts, and profitability. This structure creates an economic incentive for intermediaries to emerge, particularly as stablecoins seek broader adoption and compete with traditional interest-bearing financial products. The stablecoin issuers pay the intermediary distribution fees, which are used, in turn, to attract stablecoin “deposits”.

Towards a hybrid model: Balancing decentralisation with compliance, private money creation and yield intermediation

The prevailing approach to addressing the AML/CFT challenge involves the re-introduction of regulated "endpoints," such as cryptocurrency exchanges. These entities act as gatekeepers, performing essential identity verification and transaction monitoring before allowing users to interact with the stablecoin ecosystem. While this approach enhances regulatory compliance, it inevitably introduces a degree of centralisation, potentially diluting some of the core benefits of a decentralised system.

However, this recognition of the need for regulated intermediaries opens a pathway to also address the challenge of private money creation. The solutions proposed in whitepapers by entities like Ubyx and Circle via the Circle Payments Network suggest a future where banks play a central role as these regulated endpoints. In this model, banks would facilitate the conversion between fiat currency and stablecoins, effectively serving as on-ramps and off-ramps to blockchain-based payment rails.

This re-introduction of intermediaries is not solely driven by regulatory needs or the fractional reserve model; it is also a direct consequence of how stablecoin yield is managed and distributed. While stablecoin issuers retain the direct yield from their reserve assets, many have adopted a "distribution fees" model. Under this model, issuers often pay fees to large platforms, such as cryptocurrency exchanges like Coinbase, for distributing their stablecoins and facilitating user access. These platforms, in turn, may pass on a portion of this revenue to users as a form of "yield" or reward for holding stablecoins. This mechanism inherently requires intermediaries to manage the yield generation, collection, and distribution, adding a layer of complexity that moves beyond purely peer-to-peer transfers.

This dynamic highlights a natural advantage for traditional banks, whose deposit products inherently accrue interest and distribute it directly to account holders without requiring complex intermediary structures for yield pass-through. Furthermore, the act of providing yield to stablecoin holders by these distributors, effectively making stablecoins behave like interest-bearing deposits, could eventually lead to the regulatory reclassification of these distributors as deposit-taking institutions, akin to banks. This would subject them to more stringent banking regulations, including capital, liquidity, and consumer protection requirements, further solidifying the re-intermediation trend and potentially blurring the lines between traditional banking and digital asset services.

In this evolving hybrid model, banks would serve as crucial regulated endpoints: a user seeking to send funds, for example, would instruct their bank to convert fiat currency into stablecoins for transfer to a beneficiary's bank, which would then facilitate the conversion back to fiat. This mechanism effectively preserves banks' essential role as deposit takers and financial intermediaries, offering a clear contrast to a purely peer-to-peer stablecoin system.

Banks could also issue deposit tokens to compete with stablecoins. The GENIUS Act contemplates deposit tokens which, as the name suggests, have the features of commercial bank deposits in tokenised form, i.e. liabilities of the issuing bank. In contrast to stablecoins, deposit tokens could pay interest and may be a compelling alternative.

Whether stablecoins or deposit tokens, the key feature of this model becomes the infrastructure.  Stablecoins, deposit tokens etc would be exchanged on public blockchains. This would ensure that many of the model benefits that are perceived for stablecoins would be retained: speed, efficiency and programmability. The ability for stablecoins to carry rich, programmable, and structured data directly within the transaction (e.g., beneficiary/sender details, AML/KYC data, or other ecommerce details) will enable streamlined processes.

What would banks do with the stablecoins they received? Banks are disincentivised from holding them as stablecoins generally do not pay interest to the holder and may impact balance sheet measures; instead, the interest earned on the underlying high-quality, liquid reserve assets is typically retained by the stablecoin issuer to cover operational costs and profitability. Therefore, banks would likely need to return these stablecoins to their respective issuers for fiat currency. While there's an argument for swapping stablecoins for fiat in the open market, it's not clear who would consistently buy non-interest-bearing stablecoins if not for direct redemption.

The mechanism for returning to the issuer would ideally involve banks sending stablecoins on a blockchain to the issuer, and the issuer's bank sending fiat currency to the redeeming bank. From a bank's perspective therefore, ultimate settlement would happen in fiat currency.  To make this interbank process more efficient and reduce settlement risk, Central Bank Digital Currencies (CBDCs) or wholesale DLT-based settlement propositions like Fnality could form a dedicated blockchain-based bank-only settlement layer. This layer would have a settlement asset with the same economic characteristics as central bank money, offering benefits for the banking industry by providing immediate and final settlement of each transaction and minimising settlement risk.

While in principle this interbank settlement layer could exist on a public blockchain, adherence to the "Principles for Financial Market Infrastructures" (PFMI) makes a permissioned blockchain, such as those being explored for wholesale CBDCs or initiatives like Fnality, the more pragmatic route to satisfy overseers while still providing significant efficiency benefits.  Permissioned blockchains where the members all operate nodes, would still provide significant benefit versus traditional centralised payment systems with superior resilience per unit cost and programmability of the settlement asset and its process flows.

A robust two-tier system appears poised to persist in the digital world. The general public will be able to transact on public blockchains, often using banks to send and receive stablecoins (or tokenised deposits), and will likely derive many of the promised efficiencies from doing so, such as faster and cheaper payments, especially cross-border. Banks, in turn, will need a digital real-time gross settlement (RTGS) system (or similar DLT-based interbank settlement layer) to ensure they are not absorbing the cost of those efficiencies in their operational processes, maintaining financial stability and liquidity.

What is the UK’s position on stablecoin?

The UK is actively shaping the evolving landscape of digital finance, embracing a hybrid model that integrates stablecoins with traditional financial structures. The Bank of England not only explores the potential of a 'digital pound' but also focuses on how central bank money can support asset settlement on new ledgers through "synchronisation". Initiatives like Project Meridian FX, demonstrating the feasibility of Payment Versus Payment (PvP) for GBP and EUR transactions, highlight this approach.

Furthermore, the Bank of England is developing a regulatory framework for stablecoin-based payment systems, particularly sterling-denominated ones, adhering to the principle of "same risk, same regulatory outcome". This includes addressing risks associated with unhosted wallets and vertical integration within crypto firms, aiming to modernise the UK's financial infrastructure while maintaining stability and trust. This proactive stance aligns with the paper's vision of banks playing a central role as regulated endpoints, facilitating the conversion between fiat and stablecoins.

Conclusion

The confluence of the digital economy's demands and the transformative potential of stablecoins is undeniably reshaping the global financial landscape. A nuanced, two-tier digital finance system is not only emerging but appears to be the most pragmatic path forward, balancing the innovative power of blockchain technology with the enduring requirements of financial stability and regulatory compliance.

Stablecoins, designed for price stability and leveraging blockchain for unprecedented speed and cost efficiency in global payments, offer a compelling response to the inherent limitations of traditional finance. Their programmability further unlocks new avenues for automated financial processes and innovative products, positioning them as a superior development infrastructure for modern financial services. The explicit support from executive orders alongside the recent legislation, underscores the official commitment to integrating these assets responsibly within the U.S. financial system.

For banks to effectively embrace this role, a corresponding digital transformation of the interbank settlement layer is crucial. The need for immediate and final settlement of high-value transactions, coupled with the disincentive for banks to hold non-interest-bearing stablecoins, necessitates a robust, blockchain-based wholesale settlement system.

Ultimately, the future of finance is not a zero-sum game between traditional and digital systems but rather a dynamic convergence. This emerging two-tier digital finance system, blending the innovation of stablecoins on public blockchains with the regulated backbone of the banking sector and advanced interbank settlement mechanisms, holds immense potential. It promises to deliver a more efficient, resilient, and inclusive global payment infrastructure, paving the way for new business opportunities and enhanced financial services that truly align with the demands of the digital age.