How Banks Can Save The Crypto Industry

Stablecoins are risky assets. Banks can stabilize the crypto industry by issuing tokenized deposits.

Cryptocurrency enthusiasts like to point out that crypto is the future and fiat currencies, such as the US Dollar, will eventually fail. However, the elephant in the room is that the crypto market depends on access to fiat money. The USD is its oxygen. Without easy access to fiat money, the crypto market would be small. Moving fiat money into the crypto world used to be cumbersome and slow until the arrival of the stablecoin. Stablecoins made it easy, cheap, and fast to move fiat money in and out of crypto exchanges and OTC desks without the involvement of banks. 

However, there are problems with stablecoins. In a post on April 1, 2022, I discussed tokenized deposits as an alternative to CBDC and stablecoin (not an April Fools’ joke!). I pointed to two problems with stablecoins:

  1. They’re unregulated, and the dollar-for-dollar claim isn’t guaranteed

  2. Money is siphoned out from the banking system, locking up liquidity and limiting banks’ ability to extend credit

The first point has become painfully clear in the last couple of weeks to many people.

Stablecoins are cryptocurrencies designed to be stable in price against a fiat currency such as USD, EUR, or other assets (e.g., gold). There are four types of stablecoins:

Fiat-backed: The stablecoin is supposedly backed one-for-one by fiat money held in a bank account or other liquid assets. Examples: Tether (USDT) and US Dollar Coin (USDC).

Cryptocurrency-backed: The stablecoin is backed by cryptocurrencies such as bitcoin and ether. Since the price of cryptocurrencies fluctuates, a cryptocurrency-backed stablecoin is over-collateralized. For example, every one dollar of stablecoin may be backed by two dollars worth of bitcoin. Example: Makerdao’s DAI.

Commodity-based:  The stablecoin is backed by commodities such as gold or oil. They’re designed to be stable against the price of gold.

Algorithmic:  The stablecoin is backed by an algorithm that manages the supply of tokens following demand. Those tokens can be anything. Examples: TerraUSD (UST), DEI.

While all four types of stablecoins share the same two problems, the algorithmic type has recently shown to be the least fit for purpose as both the UST and the DEI lost their pegs and tumbled freely.

TerraUSD (UST)

UST is, as mentioned previously, an algorithmic stablecoin. The price of UST is kept stable (or so they thought) by controlling the supply of the LUNA cryptocurrency. To acquire UST, you’d buy LUNA, which is then burned (destroyed) by the Terra protocol. However, as the crypto market declined in the last couple of months, the UST could no longer maintain its value. UST and LUNA eventually imploded in early May of this year, erasing $15 billion and $40 billion, respectively, for investors, dragging down the crypto market even further.


On May 15, 2022, another algorithmic stablecoin, the DEI from Deus Finance, lost its peg. The issuer claims to be working on restoring the 1:1 peg and at the time of writing, the DEI is back from a low of $0.55, to $.079. That would be good news for those still holding DEI, but I believe the future of DEI is gone. Fortunately, the market cap of DEI was much smaller than UST, limiting losses to about $40 million.

Tether (USDT)

On May 12, 2022, USDT, the largest stablecoin in terms of market cap, briefly sunk as low as $0.95, creating jitter in the crypto market. The USDT market cap declined from $83 billion to $73 billion in the wake of the UST fallout, and the latest attestation report by MHA Cayman, states 

“Management have applied a going concern basis of accounting to value the Group’s assets. The going concern assessment requires significant management judgement with regards to the Group’s liquidity, market and credit risks. We do not provide any assurance in respect of such assessment.“ 

This is saying that management believes they can honor the liabilities, but the accountant will not yet stand behind that statement. 

As USDT is a fiat-backed stablecoin, it will not be exposed to the same issues as UST or DEI, but since USDT was created, there has been a lack of transparency about the collateralization. How can we rest assured that the issuer of USDT has the coin fully backed? Herein lays the problem. Stablecoins are not regulated. Anyone can issue a stablecoin using whatever mechanism, and unlike customer deposits at banks (in the US), funds are not FDIC insured. So should we be worried about USDT? Yes, probably. A run on the USDT and the inability by the issuer to honor its liabilities would cause the USDT to lose its USD peg, and most likely wreak havoc in the crypto market in a way we haven’t yet seen.

Tokenized deposits

The good news is that there is a regulated, safe alternative with the same properties and benefits as stablecoins. It’s called “tokenized deposits.” (By the way, The NY Fed agrees.) Tokenized deposits are what it sounds like. Banks tokenize customer deposits and put them “on-chain”. Only regulated financial institutions would be able to issue tokenized deposits. Tokenized deposits can reside outside the traditional banking system, which allows them to be used in Web3 and DeFi applications. Programmable payments and micropayments are other uses.

There is only one problem. Banks issue tokenized deposits, and banks are notoriously slow. To save the day, regulators should regulate stablecoins and help banks navigate toward tokenized deposits. By quickly bringing tokenized deposits to market, the demand for stablecoins will recede, and we will avoid a catastrophe in the crypto market.

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