From Wildcat Banks to Digital Stablecoins minted on Blockchains
A Brief History of Private U.S. Dollar Minting
A Glimpse into the Past
For much of the 19th century in the United States of America, private banks and businesses issued their own paper money, creating a decentralized and often unstable financial system. Known as the Free Banking Era, this period saw the rise of “wildcat banks,” whose notes were often unreliable and lost value when the issuing banks collapsed.
Fast forward to today, companies like Circle, Tether are issuing stablecoins, which are digital currencies pegged to national fiat currencies like the U.S. dollar. These stablecoins represent a new era of privately minted money, much like private banknotes did over 150 years ago. But will they encounter the same challenges of trust and regulation?
The Free Banking Era in the United States
During the Free Banking Era (1837–1866) in the United States, almost anyone — from private banks to railroads — could issue their own paper money. By 1860, an estimated 8,000 types of private banknotes were in circulation across the country. This chaotic system allowed for significant financial innovation, but it also bred confusion and instability.
Wildcat Banks were notorious for issuing unreliable currency. These banks were often located in remote areas and went bankrupt easily, leaving their notes worthless. This unpredictability mirrors some of the challenges faced by today’s stablecoins, particularly concerns around the transparency and stability of issuers like Tether.
As the inefficiencies and risks of the free banking system became more apparent, the U.S. government sought to bring order to the financial system through regulation and oversight. The National Bank Act of 1863 was introduced as a direct response to these challenges, marking a significant shift towards a more centralized and stable monetary system.
The National Bank Act of 1863
The National Bank Act of 1863 was a key turning point in U.S. financial history. Passed on February 25, 1863, this law established a federal banking system and a national currency to replace the inefficient state banking system. It was introduced in response to the failures of the First and Second Banks of the United States and aimed to stabilize the country’s monetary system during the Civil War.
Key goals of the act included:
- Creating a market for war bonds: The government could sell bonds to help finance the Civil War.
- Reestablishing a central banking system: The act reestablished the central banking system that had been destroyed during President Andrew Jackson’s administration.
- Developing a stable currency: The act introduced a national currency backed by government bonds.
Some of the key features of the act were:
- National Banks: The act allowed for the creation of national banks, which were federally chartered and supervised.
- National Currency: It established a national currency secured by bonds deposited by banks with the Treasury.
- Reserve Requirements: Different reserve requirements were set for different types of banks.
- Redemption: National banknotes could be redeemed for gold or silver coins at the issuing bank or at reserve banks.
- Bond Sales: If a bank couldn’t meet cash redemption demands, the government could sell the bank’s bonds to pay off noteholders.
This act laid the groundwork for a more stable and regulated banking system. However, it wasn’t until the passage of the Federal Reserve Act of 1913 that the modern U.S. banking system and monetary issuance truly took shape.
The Federal Reserve Act of 1913
Building on the foundation laid by the National Bank Act, the Federal Reserve Act of 1913 established the Federal Reserve System, the central banking system of the United States. Signed into law on December 23, 1913, by President Woodrow Wilson, the act aimed to stabilize the U.S. economy and prevent future financial crises, such as the Panic of 1907, which exposed the fragility of the existing system.
Key elements of the Federal Reserve Act include:
- Background: The act was a response to the financial panic of 1907, where the stock market crashed, banks failed, and credit evaporated, highlighting the need for a central bank.
- Goals: The law was designed to create economic stability by overseeing monetary policy, with a dual mandate for price stability and job creation.
- Structure: The act established a regional Federal Reserve System, with a supervisory board in Washington, D.C., and divided the country into districts, each with its own Federal Reserve City.
- Tools: The Federal Reserve controls monetary policy through three main tools: open market operations, the discount rate, and reserve requirements.
The Federal Reserve Act helped to solidify the U.S. banking system as we know it today, providing centralized control over monetary issuance and creating a system of financial oversight that has endured for more than a century.
Stablecoins
Today’s stablecoins, like USDC and USDT, offer a range of benefits that make them invaluable in the cryptocurrency ecosystem. They are digital assets pegged to fiat currencies like the U.S. dollar, giving users the ability to stay within the crypto space without being exposed to the volatility of assets like Bitcoin or Ethereum.
How Stablecoins Work:
Stablecoins use smart contracts on various public blockchains (such as Ethereum, Arbitrum and Solana) to issue and manage the tokens. The process works as follows:
- Minting Stablecoins: When a user deposits one U.S. dollar into the bank account of a stablecoin issuer (e.g., Circle for USDC or Tether for USDT), the company mints an equivalent amount of stablecoins on a public blockchain. These tokens are then transferred to the user’s wallet, effectively turning one dollar in the bank into one token on the blockchain.
- Redeeming Stablecoins: The reverse process is called redeeming. When a user wants to convert stablecoins back into U.S. dollars, they can deposit the stablecoins into the issuing company’s wallet via a blockchain transaction. In return, the company transfers the equivalent amount of U.S. dollars from its bank account to the user’s bank account. This system ensures that each stablecoin token is backed 1:1 by actual U.S. dollars.
This process is decentralized, automated, and transparent, as blockchain technology allows anyone to track the issuance and redemption of stablecoins on the public ledger. This also makes stablecoins highly efficient for cross-border payments, as they can be sent across the globe in minutes, even seconds, without the delays and high fees associated with traditional systems like SWIFT.
Stablecoins are also a key source of liquidity in cryptocurrency markets, facilitating decentralized finance (DeFi) activities and trades across multiple blockchains. They provide a stable store of value during uncertain market conditions, enabling investors to remain in the crypto ecosystem without exposure to volatile assets.
Importantly, stablecoins like USDT and USDC have become a decentralized way to swap cryptocurrencies for U.S. dollars, without the need for centralized exchanges. This has been a game-changer, especially in light of high-profile exchange collapses like Mt. Gox and FTX, where users lost access to their funds due to bankruptcy. Stablecoins allow users to maintain custody of their assets and avoid the risks associated with centralized platforms.
This are the two biggest stablecoins pegged to US Dollars nowadays:
Circle’s USDC:
- Circle, an American company, is highly regulated, adhering to strict U.S. regulatory standards. As of June 2024, Circle has issued 33 billion USDC and holds around $30 billion in U.S. Treasury notes. It generates $1.77 billion annually from the yield on these treasury notes. However, Circle’s business has been challenged by decreasing interest rates and a 40% drop in USDC supply since 2021.
Tether’s USDT:
- Tether, on the other hand, has a more controversial history. Over the years, Tether has frequently changed its lawyers and accountants responsible for verifying that it holds sufficient U.S. dollars to back its issued tokens. Despite these transparency concerns, Tether remains widely used, particularly in Asia and Eastern Europe, where it plays a major role in crypto markets. In Q2 2024, Tether issued $8.3 billion USDT, with $83 billion in circulation as of mid-2024. Tether’s $5.2 billion profit in the first half of 2024 underscores its growth, but concerns about its governance and transparency persist.
Tether and Circle Profits: A Tale of Diverging Strategies
This chart highlights the profit growth of Tether and Circle’s revenue between 2022 and 2024. While Tether’s profits have surged, rising to $5.2 billion in the first half of 2024, Circle’s revenue has remained steady at around $2 billion. Tether’s business model of investing in a broad range of assets — including U.S. Treasuries, Bitcoin, and precious metals — has helped it weather market fluctuations better than Circle, which relies heavily on U.S. Treasury yields.
The Decline of USDC and the Rise of USDT
This chart shows the volume of USDC and USDT in circulation from 2022 to 2024. While USDC saw a sharp decline — from $45 billion in 2022 to $33 billion in 2024 — Tether’s USDT has experienced continuous growth, increasing from $66 billion to $83 billion in the same period. This divergence highlights how Tether’s dominance has grown, especially as Circle’s USDC faced challenges, such as the Silicon Valley Bank collapse in 2023, which briefly caused USDC to lose its peg to the dollar.
The Future of Stablecoins and the Impact on DeFi
As stablecoins become deeply embedded in the global financial system, their impact on the decentralized finance (DeFi) space is undeniable. The potential $5 billion IPO of Circle could be a watershed moment, signaling traditional finance’s increasing interest in crypto. However, Circle’s relatively low 2.5x revenue multiple reflects traditional finance’s cautious approach toward crypto companies.
- IPO Valuation: Circle’s potential IPO could shake up the crypto world. But while Circle’s business model is conservative, relying on U.S. Treasury yields, DeFi projects like Maker might command higher multiples due to their software-centric models.
In addition to the traditional stablecoins such as USDT and USDC, the proliferation of new stablecoins shows how dynamic the market has become, with some big contenders entering the scene. One of the most notable entries is PayPal USD (PYUSD), which is fully backed by U.S. dollar deposits, U.S. treasuries, and similar cash equivalents.
PayPal USD (PYUSD):
- PYUSD is a stablecoin available for eligible U.S. PayPal users and can be used for a variety of purposes such as sending money, converting to other cryptocurrencies, and making payments. One of the key advantages of PYUSD is that it can be sent to Ethereum and Solana wallet addresses that support the stablecoin, making it a flexible solution for users looking to bridge the gap between traditional financial systems and blockchain technology. Given PayPal’s massive reach, PYUSD could significantly increase the adoption of stablecoins in mainstream financial transactions.
Similarly, we see innovations in the decentralized finance space with stablecoins backed by major financial institutions. Ethena Labs, for example, has introduced the UStb stablecoin, fully backed by BlackRock’s on-chain BUIDL fund. Ethena’s UStb offers a more traditional stablecoin structure, while USDe, another of Ethena’s products, is a synthetic stablecoin. The UStb stablecoin, backed by real-world assets like U.S. dollars and U.S. Treasury bills, provides stability to the ecosystem, especially during turbulent market conditions.
- Ethena Labs UStb: UStb functions as a complement to Ethena’s synthetic USDe dollar, providing a stable alternative during times of market volatility. Backed by BlackRock’s USD Institutional Digital Liquidity Fund, UStb offers users a lower-risk stablecoin option, making it attractive for both individual users and exchange partners.
These new entrants are helping to diversify the stablecoin market and address different needs — whether it’s for day-to-day payments, providing liquidity for DeFi, or hedging against market risks. PayPal’s PYUSD and Ethena’s UStb demonstrate how the landscape is evolving, and these innovations could further solidify the role of stablecoins as the backbone of the crypto economy.
Bridging Stablecoins and CBDCs
The future of stablecoins might lie in their ability to serve as bridges between public and permissioned blockchains. Central Bank Digital Currencies (CBDCs) represent the next evolution in fiat currency, and they are being tested by many central banks around the world. A CBDC is a digital version of a national currency, issued and regulated by a central bank. These digital currencies are designed to offer the benefits of cryptocurrency — such as efficiency and transparency — while maintaining the stability and regulation of traditional fiat money.
One of the most advanced CBDC initiatives is Brazil’s DREX, which is in its second phase of testing. DREX, developed by the Central Bank of Brazil, aims to tokenize the Brazilian Real and certain types of assets within a permissioned blockchain. The DREX initiative is currently exploring use cases like tokenizing real estate and automobile transactions, improving the foreign exchange market, and creating a liquidity pool for public bond trading. The DREX CBDC is part of a broader trend where central banks aim to digitize national currencies, making them more efficient for various financial services.
The relationship between stablecoins and CBDCs is expected to be crucial in the coming years. Stablecoins have already proven their utility in providing liquidity across decentralized networks and offering a safe haven during market volatility. However, as CBDCs like DREX gain momentum, they could form bridges between the traditional financial system and the world of cryptocurrencies. This would enable users to move assets seamlessly between CBDCs and stablecoins, creating a more interconnected and efficient global financial ecosystem.
This bridge between CBDCs and stablecoins could revolutionize cross-border transactions, providing faster and cheaper alternatives to systems like SWIFT, and reshaping the way we think about money transfers. Stablecoins, with their established presence in public blockchains, will likely complement CBDCs, ensuring liquidity, transparency, and ease of transaction across different financial networks. It is this synergy between CBDCs and stablecoins that could be a game changer for the world financial system, providing the best of both worlds: the stability of traditional finance and the innovation of blockchain technology.
Conclusion
As the financial landscape evolves, stablecoins have proven to be a critical innovation, bridging the gap between traditional finance and decentralized technologies. They provide stability in volatile markets, offer higher-yield investment opportunities, and allow users to remain within the crypto ecosystem without relying on centralized exchanges. This has been transformative, particularly as new players like PayPal and Ethena Labs enter the space, adding credibility and expanding the market.
I’m bullish on stablecoins because they enable users to earn better returns than traditional banking systems and unlock new financial products. Moreover, as stablecoins like USDC and USDT continue to scale globally, especially in regions like Asia and Eastern Europe, they are becoming essential for liquidity and cross-border payments.
The rise of Central Bank Digital Currencies (CBDCs), such as Brazil’s DREX, is further pushing the boundaries of innovation. DREX’s advanced testing and tokenization of assets demonstrate the potential for CBDCs to modernize national economies. The future lies in bridging CBDCs and stablecoins, enabling seamless transfers between public blockchains and government-backed currencies. This bridge will reduce transaction costs, increase liquidity, and provide new, secure, and efficient ways to move money globally.
In short, stablecoins, combined with CBDCs, are poised to reshape the global financial system. By providing better returns, enhancing liquidity, and improving accessibility, they offer a game-changing solution that will continue to evolve and influence the world of finance.
About the author: Rafael is a seasoned fintech expert, blockchain engineer and entrepreneur, passionate about enlightening others on the potential of blockchain and DeFi. He strives to demystify complex concepts and make them accessible and engaging for all.
