Zhou Xiaochuan: A multi-dimensional look at stablecoins

Written by Zhou Xiaochuan

Note: This article is compiled based on part of the speech delivered by Zhou Xiaochuan, former governor of the People's Bank of China, at the CF40 biweekly closed-door seminar on "Opportunities and Prospects for RMB Internationalization" on July 13, 2025. The main content is derived from the speech at the International Capital Market Association (ICMA) Frankfurt Annual Meeting on June 5, 2025, with slight adjustments.

Some current discussions about stablecoins are based on a single perspective. To understand the operation and future prospects of stablecoins, a multi-dimensional and multi-perspective examination is necessary. If we hope to promote the development and healthy growth of digital payment systems, we must also focus on the performance and balance of multiple dimensions.

1. Central Bank Dimension: Preventing Excessive Money Issuance and High Leverage

Stablecoin issuers aim to maximize stablecoin issuance and adoption while minimizing costs. They might wonder, "If the central bank can print money, shouldn't I be able to do the same?" While they can now print money through stablecoins, they lack a deep understanding of monetary policy, macroeconomic regulation, and the functions of public infrastructure, and lack a sense of responsibility. This can lead to a lack of self-discipline, potentially leading to uncontrolled issuance, high leverage, and instability. The stability of a stablecoin isn't a self-declared statement; it requires a mechanism for determining it.

Central banks currently have at least two concerns. First, excessive money issuance—that is, issuing stablecoins without 100% reserve requirements, a phenomenon known as over-issuance. Second, high leverage—that is, the multiplier effect of monetary derivatives generated by post-issuance operations. Both the US GENIUS Act and Hong Kong's Stablecoin Ordinance have addressed this issue, but control remains significantly insufficient.

First, the identity of the custodian for the issuance reserve should be clarified. In practice, there have been numerous cases of custodians failing to fulfill their responsibilities. In 2019, Facebook initially planned to self-custody the Libra issuance reserve assets, which would provide greater autonomy and allow the company to retain the returns on the custodial assets. However, the reserve custody must be reliable, either by the central bank or one approved and regulated by the central bank; otherwise, it is less reliable.

Secondly, how can we measure and manage the amplification effect of stablecoins? Even if the issuer maintains 100% of its reserves, stablecoins can still experience a multiplier effect in subsequent operations (such as deposits, lending, collateralization, trading, and revaluation). The potential run volume that needs to be addressed could be several times the amount of the issued reserves. While it may appear that relevant regulations will prevent amplification, a deeper look at the laws governing currency issuance and operation reveals that existing rules are far from adequate to address derivatives and amplification.

Consider the example of Hong Kong's three commercial institutions issuing Hong Kong dollar banknotes: Their issuance mechanism requires them to pay US$1 as a reserve to the Hong Kong Monetary Authority for every HK$7.8 issued, and they also receive a certificate of indebtedness. Based on Hong Kong dollar banknotes (M0), the economic and financial system generates M1 and M2 through derivative and multiplier effects. In the event of a bank run, not only M0 but also M1 or M2 would be targeted. Even if the base currency (M0) was fully covered by reserves, M0 reserves alone would not be sufficient to mitigate a bank run and maintain monetary stability.

There are three typical channels for the amplification effect of stablecoins: deposits and loans; collateralized financing; and asset market transactions (which can be used to purchase or revalue assets in reserve for issuance). Therefore, regulators must compile statistics and measure the actual circulation of issued stablecoins; otherwise, the scale of potential redemption risks cannot be accurately determined. The amplification multiplier effect of stablecoins can also provide opportunities for fraud and market manipulation.

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

Assuming a future ecosystem characterized by the large-scale decentralization of financial activities and the widespread tokenization of assets and trading instruments, stablecoins will prove highly useful. First, stablecoins are well-suited to the development of decentralized finance (DeFi); second, tokenization is a necessary foundation for DeFi's operations. A deeper investigation is needed to understand why and to what extent we will move towards decentralization and tokenization.

From a supply-side perspective, blockchain and distributed ledger technology (DLT) offer the advantages of decentralized operations. However, from a demand perspective, how much demand is there for decentralization as a new operating system? Will most financial services transition to this new system?

A sobering look reveals that not all financial services are suitable for decentralization, and only a limited number can achieve significant efficiency improvements through decentralization. The true demand for tokenization, the underlying technology, also requires sober assessment.

Looking at the promising upgrades and transformations of payment systems (especially cross-border payments), China and several other Asian countries have made successful progress in developing mobile-based retail payment systems using QR codes and near-field communication (NFC) as merchant interfaces. These systems remain account-based. Currently, China's digital currency is also account-based, extending and iteratively updating the existing financial system. Furthermore, some Asian countries have also adopted direct cross-border fast payment systems, which have also not chosen a decentralized, tokenized approach.

To date, the centralized account system has shown good applicability. The argument for replacing the account-based payment system with full tokenization is insufficient.

The Bank for International Settlements (BIS) has proposed a centralized ledger architecture, the Unified Ledger, to tokenize bank deposits and a wide range of other financial services. Within this centralized framework, central bank digital currencies (CBDCs) can play a significant role, representing a combination of centralization and tokenization. However, it's important to note that not all financial assets are suitable for tokenization, nor are all financial services suitable for decentralization. Specific analysis and comparison are required.

3. Payment System Perspective: Technical Paths and Compliance Challenges

There are two major concerns in the replacement of payment systems: one is payment efficiency, and the other is compliance.

Improved payment efficiency is considered one of the potential advantages of stablecoins. In the current process of digitalizing the payment system, there are two broad paths to improving efficiency. The first is to continue using an account-based system while optimizing and innovating based on IT and internet technologies. The second is to develop a completely new payment system based on blockchain technology and cryptocurrency.

The current development of payment systems in China and Southeast Asia reveals that the main progress achieved to date is still based on the internet and IT technologies. This includes the development of third-party payment platforms, progress in central bank digital currencies (CBDCs), NFC-based hard wallets, and the interconnection of fast payment systems. These advances have significantly improved payment efficiency and convenience.

Technology alone isn't the sole criterion. Payment performance comparisons must also prioritize security and compliance, including Know Your Customer (KYC), identity verification, account opening management, anti-money laundering (AML), counter-terrorism financing (CFT), anti-gambling, and anti-drug trafficking compliance requirements. Some believe that since stablecoins are blockchain-based, account opening isn't necessary. This is incorrect. Even using a "soft wallet" requires user identity verification and account opening to meet compliance requirements. Currently, stablecoin payment services still have significant shortcomings in KYC and compliance.

IV. Market Trading Dimension: Market Manipulation and Investor Protection

From the perspective of financial and asset market transactions, the most pressing issue to guard against is market manipulation, particularly price manipulation. This requires full transparency and effective oversight. In reality, such manipulation already exists, with several cases already underway. Some of these price manipulations are clearly fraudulent. However, under the improved current institutional framework, whether it's the US Genius Act, relevant regulations in Hong Kong, or regulatory provisions in Singapore, these issues remain reassuring.

A new phenomenon is the mixed use of multiple currencies, or hybrid currencies. This refers to the simultaneous use of multiple currencies for transactions or payments within a single system. Not all of these currencies are truly stablecoins, nor do they necessarily have consistent, recognized stablecoin standards. In current asset markets, particularly on virtual asset exchanges, many transactions are conducted using stablecoins, other unstable cryptocurrencies, or even completely volatile currencies. This arrangement creates the potential for market manipulation and has become a key regulatory concern.

It is worth noting that some marketers mentioned that through technical means such as stablecoins and RWAs, the share of asset transactions can be cut into very small pieces, thereby achieving wider investor participation, and claimed that this model has attracted a large number of students under the age of 18 to participate in transactions.

While some believe this will help foster youth participation in the capital market and contribute to its future prosperity, its true beneficial effects from an investor protection perspective remain to be seen. While investors' adaptability and qualifications have historically been emphasized, there is currently insufficient evidence to determine whether minors are suitable for asset market transactions. If market manipulation is not effectively prevented, and unqualified investors are subsequently attracted, the risks will be significantly increased.

5. Micro-behavioral Dimension: Motivations of Each Participant

Stablecoin issuers are generally commercial institutions with profit-driven objectives. Many entities involved in stablecoin-related payment and asset trading are also commercial, and these entities inevitably have commercial motives. However, stablecoins and payment systems contain functions or links that possess infrastructure and inclusive benefits. Their micro-level activities cannot be guided by the logic of maximizing corporate profits, but rather by the spirit of public service. A clear distinction should be made between areas suitable for market-based entities and those that are infrastructure-based.

A micro-perspective is needed to analyze the motivations and behavioral patterns of various stablecoin participants. What are the considerations behind using stablecoins for payments? Why are recipients willing to accept stablecoins? What are the motivations of stablecoin issuers? What kind of trading landscape do private exchanges pursue? Hong Kong has currently issued licenses to 11 virtual asset trading platforms. What are the key trading entities and products these licensed institutions focus on? How do they profit?

While many believe stablecoins will reshape the payment system, objectively speaking, the current payment system, particularly in the retail payment sector, has little room for cost reduction. 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 approach. After years of development, it has become highly efficient and low-cost, leaving any new entrants with limited room to reduce costs and profit.

Looking at the US, there may still be room for cost reduction and profit in its retail payment system. This is due to the US's long-standing reliance on the credit card payment system, where merchants typically bear a 2% price discount. This creates an incentive to experiment with new, lower-cost payment systems. This also demonstrates that from the perspectives of both payers and payees, the situation varies across countries and regions.

Cross-border payments and remittances are key areas frequently discussed when discussing stablecoin applications. To delve deeper into this issue, we first need to analyze the current high costs of cross-border payments, specifically identifying the specific processes that contribute to these high fees.

It's important to note that some claims that traditional cross-border payment systems are technically "very expensive" may be exaggerated. In reality, many of the cost factors aren't technical, but rather relate to foreign exchange controls, which are linked to numerous institutional issues such as the balance of payments, exchange rates, and monetary sovereignty. Another portion of the cost comes from compliance costs like Know Your Customer (KYC) and Anti-Money Laundering (AML), which are also unavoidable when switching to stablecoins. Furthermore, some costs arise from the "rent" of cross-border foreign exchange business as a franchise. In short, the appeal of stablecoins in cross-border payments is not as great as one might imagine. Of course, this applies to situations where a country's currency is failing and dollarization is necessary.

From the perspective of stablecoin issuers, if they find that domestic and cross-border payments are lacking in appeal, they are most likely to focus on asset market transactions, particularly virtual asset trading. Certain assets in these markets are highly speculative and prone to price increases, making them attractive for stablecoin issuance. Furthermore, some virtual assets can serve as qualified or semi-qualified stablecoin issuance preparations.

Judging from the current micro-behavior, we should be wary of the risk of stablecoins being over-used for asset speculation. Deviations in direction may lead to fraud and instability in the financial system.

Furthermore, the use of stablecoins' popularity to boost their own valuations is also a noteworthy practice. Some companies use this to raise capital through the capital markets or cash out after realizing capital appreciation, while the stablecoin business itself, its profitability, and its sustainability are not their primary focus. This is detrimental to the healthy development of the entire financial system and could potentially accumulate systemic risks.

6. Circulation Path Dimension: The Cycle Mechanism from Issuance to Recycling

The circulation path of stablecoins involves the entire cycle from issuance to market circulation and withdrawal in specific scenarios.

Taking the People's Bank of China's banknote issuance as an example, printed banknotes are first stored in a designated issuance vault. Whether and when these banknotes enter the market depends on whether commercial banks have cash demand. Commercial banks only withdraw cash from the People's Bank of China's issuance vault when their customers have net demand or when there is a loan gap. This withdrawal incurs a cost for commercial banks, so when their inventory is high, they withdraw the banknotes. This demonstrates that the entry of currency into circulation is not automatic.

Similarly, obtaining the relevant licenses and paying reserve requirements for a stablecoin issuer does not guarantee the issuance of the stablecoin. Without sufficient demand, the stablecoin may not enter effective circulation. This means it may receive an issuance license but remain unissued. In theory, circulation should be network-like, with several main routes carrying significant traffic. If this main route for payments is blocked, the primary channel for stablecoin circulation will rely heavily on speculation in virtual assets, raising concerns about its health.

Furthermore, whether a stablecoin is used as a temporary payment medium for transactions or as a store of value for a specific period of time will affect its remaining volume in the market after issuance. If it is used solely for transactions and held as little as possible, the stablecoin's role will be weaker and issuance will be smaller. This involves factors such as circulation channels, holder motivations and behaviors, and support systems. These factors are not automatically conferred by an issuing license.

In short, facing the new concept of stablecoins, scholars, researchers, and practitioners need to observe and analyze its functions and implementation paths from multiple perspectives, avoiding the use of loose concepts, data, and one-sided thinking. Only by comprehensively analyzing various important dimensions can we better understand market trends.