by Thorsten Polleit

The GENIUS Act was passed in the U.S. on July 17, 2025, expanding and promoting the possibilities for issuing stablecoins. People seem to be quite excited about stablecoins’ utility in, say, payments, trading, decentralized finance (DeFi), and financial inclusion.

Let us ask: What are stablecoins? Stablecoins are tradable, liquid “tokens”. They represent an underlying asset and promise to have a constant exchange ratio with the underlying asset; in that sense they can be described as a kind of “money substitute.”

Stablecoins can be divided into four different types:

(1.) Fiat-backed stablecoins are backed by a fiat currency such as U.S. dollar or euro and are pegged to the underlying fiat currency at a 1:1 ratio. The backing consists of bank deposits and short-term government bonds in fiat currencies. Examples include Tether (USDT), USD Coin (USDC), and TrueUSD (TUSD).

(2.) Crypto-backed stablecoins are backed by cryptocurrencies like Ethereum or Bitcoin, often over-collateralized to offset price fluctuations. An example is DAI (backed by ETH or other cryptos).

(3.) Algorithmic stablecoins use algorithms to control supply and demand to keep their market price stable without direct collateral. Examples include TerraUSD (UST, before its collapse) and Ampleforth (AMPL).

(4.) Commodity-backed stablecoins are backed by gold or silver. Examples include Tether Gold (XAUT) and Pax Gold (PAXG).

It should be briefly noted here that digital central bank money (Central Bank Digital Currency, or CBDC) is not a stablecoin. It is (primitive) fiat money issued by the central bank—in addition to banknotes and central bank reserves; it is essentially a new type of central bank money made available to consumers and producers.

Stablecoins are issued by private companies and are stored and traded on public or private blockchains. How does one acquire fiat-currency-backed stablecoins? It is simple: They are purchased on a trading platform (e.g., Coinbase).

In return, based on the prevailing exchange rate between the fiat currency and the stablecoin (after accounting for fees/costs), a certain number of stablecoins is credited to the buyer’s electronic wallet. These stablecoins can then be traded for other stablecoins and/or used for payments, provided other market participants accept stablecoins in an exchange.

However, there is one important aspect of stablecoins that has so far been overlooked, ignored, namely that stablecoins have a (huge) inflationary potential—which must raise doubt as to whether they are really “stable”coins).

To explain this, we make use of a simple explanation, pointing out the transactions that related to the creation and the use of stablecoins. Suppose an individual has a $100 bank deposit and buys stablecoins (tokens). This results in an asset swap in their balance sheet: they give up $100 for stablecoins worth $100.

The bank records a liability swap: the individual’s bank balance is transferred to the stablecoin issuer’s account. And the stablecoins issuer records the $100 as an asset and a corresponding liability from issuing the stablecoins (ignoring fees).

So far, the purchasing power of the $100 remains unchanged: the individual can no longer spend the $100 but has equivalent purchasing power in terms of stablecoins. The stablecoin issuer holds the $100 as collateral without using it for demand purposes.

However, the situation changes if the issuer backs the stablecoins with debt securities instead of bank balances. Suppose the issuer uses $60 to buy U.S. government bonds. This creates an asset swap in the issuer’s balance sheet: $60 in bank balances is replaced by $60 in bonds.

The government receives $60 from the bond sale, which it can use for additional spending, paying social transfers or wages to the private sector. In this case people now effectively hold $160 in purchasing power ($100 in stablecoins plus $60 in bank balances).

The illustration shows that the issuance of a stablecoins, which is backed by newly issued government debt, effectively raises the quantity of the means of payments, which is, no doubt, inflationary in the economic sense.

It effectively amounts to increasing the velocity of money of U.S. balances, which leads, other things being equal, to an increase in goods prices (or, to more precise: it leads to higher goods price inflation compared to a situation in which there was no issuance of stablecoins).

That said, the scale of the stablecoin market, and the extent to which issuers back them with government debt, are of critical importance as far as the U.S. dollar’s future purchasing power is concerned.

In August 2025, the stablecoin market was estimated at $280 billion, with USDT and USDC accounting for around 90 per cent of the market volume. This is significant, amounting to nearly 16 per cent of the estimated U.S. budget deficit of $1.8 trillion.

What is more, the potential for funding U.S. dollar-based stablecoins is vast, with $16.5 trillion in short-term U.S. bank deposits available—almost half of the $37 trillion in outstanding U.S. public debt.

If the stablecoin market grows significantly, and issuers invest heavily in government debt, it leads to substantial goods price inflation—unless counteracted by monetary policy. In sum, stablecoins have the potential to significantly fuel U.S. dollar inflation.

Finally, note that a stablecoin pegged 1:1 to the U.S. dollar loses purchasing power if the U.S. dollar inflates. That said, stablecoins, as far as they are backed with fiat currency, are certainly not an alternative to, an escape from, the inflationary fiat currency regime.

The truth is that fiat-currency-backed stablecoins leverage the inflationary potential of the fiat currency regime and its economic and political problems it causes. And so it may not be too far-fetched to say that fiat-currency-backed stablecoins are an inflationary time bomb.