Bridging Worlds: The Role of Public Blockchains and Stablecoins in Modern Banking
Why Banks should Transform from Gatekeepers to Facilitators of Decentralized Transactions
In a remarkably short span, we’ve witnessed a transformation of the financial landscape that would have seemed like science fiction just a few years ago. Today, cryptocurrencies are no longer fringe assets; they’ve become integral components of mainstream financial offerings.
Major banks now routinely offer crypto services, a concept that was once met with skepticism and resistance. But the integration doesn’t stop there. We’re seeing crypto woven into the fabric of traditional financial products — ETFs, ETPs, and various funds are now crypto-inclusive. Moreover, the advent of Real-World Asset (RWA) tokenization is bridging the gap between traditional finance and the crypto world, making tokenized versions of conventional financial products increasingly accessible.
These developments are undoubtedly significant milestones in the journey of crypto adoption. But we must ask ourselves: Is this the endgame of industry adoption? Have we truly arrived at our destination, or are we merely at a waypoint in a much longer journey?
This article examines the potential foundations of a financial system designed for the digital asset era. It describes a system anchored in stablecoins, fortified by digital identity, and operating on public blockchains. The focus extends beyond merely integrating cryptocurrencies into existing structures; rather, it proposes a comprehensive reimagining of the financial architecture to accommodate a decentralized, digital future.
Understanding the Core Function of Banks
To understand the need for a new banking paradigm, let’s first dissect the core function of banking. At its essence, banking means matching capital demand with capital supply. It’s a deceptively simple concept.
In the current banking system, this capital matching act is primarily performed through two key mechanisms: deposit-taking and lending. Here’s how it works:
1. Deposit-Taking: Banks act as secure vaults for individuals and businesses to store their excess capital. When you deposit $1,000 into your savings account, it becomes a liability on the bank’s balance sheet. The bank now owes you $1,000, plus any agreed-upon interest.
2. Lending: Simultaneously, the bank uses these deposits as a foundation for lending. They might lend out $900 of your $1,000 deposit to a business seeking capital for expansion. This loan becomes an asset on the bank’s balance sheet.
Through fractional reserve banking, banks can lend out multiple times the amount they hold in deposits, effectively creating money and amplifying their impact on the economy.
This model has served as the backbone of our financial system for centuries, enabling economic growth and providing a mechanism for capital allocation. However, even if this system worked well in the industrialization era, it is not well positioned for the digital age.
From Banking Services to Integrated Finance: A Paradigm Shift in Financial Systems
The transition from the Industrial Age to the Digital Age has shifted the global economy from being driven by physical assets to one powered by knowledge, innovation, and intangible resources like data and software. Digital platforms and global connectivity have disrupted traditional industries, enabled new business models and reshaped how products and services are created, delivered, and consumed. Automation and AI are accelerating this transformation, redefining efficiency and empowering businesses to compete in an interconnected, technology-driven world.
In the transformed economy of the Digital Age, finance must evolve from being a parallel system of transactions to becoming deeply integrated into the fabric of economic activity. Financial services should no longer operate as distinct, separate processes but must seamlessly merge with business transactions, enabling a single, unified flow of value exchange. This requires 24/7 availability to support the continuous nature of global digital commerce, as well as the capability for reliable micro-transactions that align with the real-time needs of automated and interconnected industries. Additionally, finance must embrace composability, allowing businesses to integrate and customize various financial services — such as payments, credit, and insurance — directly within their operational processes, creating tailored, context-aware solutions. By embedding itself as a service within the digital economy, finance can enhance efficiency and truly serve the dynamic needs of the industries.
The Legacy Burden: Why Old Core Banking Systems Stifle Innovation
Banks will find it difficult to implement this innovation and one of the reasons lies in the technological basis that is used today. The core IT-systems of banks, often built decades ago using programming languages like COBOL or PL/SQL, are a significant inhibitor to innovation in the banking industry. These monolithic systems are inflexible and lack the modularity needed to integrate seamlessly with modern technologies such as AI, machine learning, or blockchain, forcing banks to work around their limitations rather than with them. Their batch-based processing models, requiring regular downtime for reconciliations, are increasingly out of sync with the 24/7 availability demanded by today’s digital economy.
Adding to the challenge, each new innovation is typically built around these legacy cores, creating layers of complexity, escalating maintenance costs, and extended implementation timelines. As banks continue to layer modern capabilities on top of outdated foundations, the risk of system failures grows, making it clear that legacy core banking systems are not only holding back innovation but actively increasing operational risk and inefficiency.
It’s tough to build a modern financial system on top of this existing stack. To really bring about change, it requires a completely new financial architecture at its core, designed for agility, scalability, and seamless integration with today’s digital-first economy.
How Public Blockchains, Digital Identities, and Stablecoins Could Redefine Banking
The future of digital banking demands a reimagined core architecture designed to leverage cutting-edge technology for interoperability, transparency, and regulatory compliance. As a possible way to meet these challenges, I want to introduce a three-layer model that provides a modern and resilient framework for digital finance, integrating foundational infrastructure, essential financial services, and business-oriented solutions.
Layer 0: The Foundational Infrastructure
This foundational layer establishes the core principles of trust, transparency, and compliance necessary for a digital financial ecosystem. At its heart is a public blockchain, which serves as the immutable, decentralized ledger for all transactions. By ensuring interoperability of financial transactions and offering real-time transparency for regulators, the blockchain serves as unified settlement layer and eliminates the inefficiencies of today's siloed systems.
This is complemented by a digital identity infrastructure, that enables secure identity verification for individuals and businesses while complying with KYC and AML regulations. Through cryptographic techniques such as zero-knowledge proofs, sensitive data can be protected, allowing privacy-preserving yet compliant financial transactions. Additionally, stablecoins act as digital representations of fiat currency, enabling instant, low-cost, and programmable transactions with the stability needed for everyday financial operations. Together, these components form the backbone of a scalable and adaptable digital financial ecosystem.
Layer 1: Core Banking Services
Built on the foundational infrastructure, this layer delivers essential banking functionalities in a regulatory-compliant manner. Custodial and non-custodial wallet management provides secure storage for digital assets, catering to the diverse needs of clients by supporting both bank-managed and user-managed solutions. Lending and borrowing services leverage automated, smart contract-driven systems to facilitate access to capital, accommodating both collateralized and uncollateralized loan models using on-chain assets.
In addition, digital asset exchanges enable seamless trading between cryptocurrencies, stablecoins, and tokenized real-world assets, integrating directly with the foundational blockchain layer for transparency and security. By providing these core services, Layer 1 creates a bridge between traditional financial systems and the evolving needs of the digital economy.
Layer 2: Business-Oriented Financial Services
The top layer is designed to address specific business and customer needs by offering tailored financial solutions. Payment services, leveraging the real-time settlement capabilities of Layer 0, provide fast and cost-efficient domestic and cross-border transaction capabilities. Delivery versus Payment (DvP) solutions ensure secure and simultaneous transfer of goods and payments in supply chain finance, enhancing operational efficiency.
Additionally, on-chain insurance products use smart contracts to deliver programmable and transparent coverage, enabling instant claims processing. These business-focused services enable enterprises to integrate digital asset solutions seamlessly into their operations, driving innovation and growth across industries.
This three-layer approach not only addresses the limitations of traditional banking systems but also sets the stage for a future-proof financial ecosystem. By leveraging public blockchains, digital identities, and stablecoins at its core, this model facilitates the instant settlement of digital asset-based transactions in a secure and regulatory-compliant manner. It empowers banks to transition from gatekeepers to facilitators, supporting a decentralized yet cohesive financial network that meets the diverse needs of modern businesses and consumers.
The New Role of Banks: Trust Anchors in a Decentralized World
Will banks be replaced by DeFi? Of course not. But their role is destined to evolve in the era of decentralized finance. Rather than owning the customer relationship and providing services exclusively to their own clientele, banks will transform into actors within a decentralized financial ecosystem. Their primary function will shift toward embedding trust in this system, ensuring that all transactions adhere to financial market regulations while enabling secure, compliant, and inclusive participation for all. In this new role, banks will offer essential services that integrate seamlessly with decentralized infrastructure, supporting the dynamic needs of the global economy. Some of these services could include:
Banks as Custodians of Digital Assets
Of course, Self-Custody is a core pillar of DeFi. While self-custody provides users with control and autonomy, it places the full burden of responsibility on individuals and institutions to manage their private keys and security protocols. This comes along with risks, including the potential loss of keys, susceptibility to cyberattacks, and the absence of recovery mechanisms. These challenges make pure DeFi custody impractical for many, especially institutional investors and clients with limited technical expertise.
Banks can address these shortcomings by offering institutional-grade custody solutions that combine advanced security measures, such as multi-signature wallets, multi-party computation and insured storage. This level of protection not only safeguards assets but also instills confidence among institutional clients and regulators. Beyond pure institutional custody, banks are well-positioned to facilitate hybrid models that integrate self-custody with bank-managed services. For instance, a client could maintain control over their private keys while relying on the bank for backup and recovery services in case of emergencies.
This flexibility allows banks to cater to a wide range of clients, from highly skilled individuals preferring self-custody to organizations requiring fully managed solutions. By providing these options, banks ensure that digital asset management is secure, scalable, and adaptable to the diverse needs of the modern financial ecosystem.
Liquidity Providers and Stablecoin Issuers
As outlined in this article, Stablecoins are of crucial importance for a digital finance system. That does not mean that the Stablecoins we know today will be the ones used by such a system. In the current DeFi landscape, stablecoins issued by private companies have become integral to facilitating transactions and providing liquidity. While these stablecoins are not inherently problematic, they present certain challenges. Firstly, holders face counterparty risks, as the stability of these coins depends on the issuer’s financial health and reserve management. Secondly, the absence of yield distribution mechanisms means that while issuers benefit from the assets backing the stablecoins, holders do not receive interest, making stablecoins less attractive from a yield perspective. For instance, Tether reported a net profit of $2.5 billion in Q3 2024, contributing to a nine-month consolidated profit of $7.7 billion, highlighting the significant earnings issuers can generate
Banks can address these issues by issuing regulated, asset- or fiat-backed stablecoins with transparent reserve holdings, thereby mitigating counterparty risks. Additionally, banks could implement yield distribution mechanisms, allowing stablecoin holders to earn interest, thus enhancing the appeal of holding such assets. By leveraging their regulatory compliance and financial expertise, banks can offer stablecoins that provide both security and financial benefits to holders, fostering greater trust and adoption in the digital asset ecosystem.
Trust Anchors for Digital Identities (KYC/AML Gatekeepers)
The anonymity inherent in DeFi poses a fundamental challenge: while anonymity is critical for privacy on public blockchains, it is incompatible with the stringent requirements of regulatory compliance, particularly in areas like AML (Anti-Money Laundering) and CFT (Countering the Financing of Terrorism). A purely anonymous DeFi ecosystem will never achieve regulatory acceptance. At the same time, fully transparent systems that expose personal financial data are impractical and undesirable for both individuals and institutions.
To reconcile these needs, a system is required where the identities and eligibility of participants are verified without compromising privacy. Banks are ideally positioned to serve as trust providers in such a system. With their established commitment to global AML and CFT regulation, banks can verify users’ identities and the sources of their funds. Importantly, they can issue credentials — using advanced cryptographic techniques such as Zero-Knowledge Proofs (ZKP) — to enable transaction eligibility verification without revealing sensitive personal information.
In simple terms, a ZKP credential allows someone to prove they meet certain criteria (e.g., passing KYC or having sufficient funds) without disclosing the underlying data. For example, a bank could issue a credential certifying that a user is over 18 and has passed AML checks without revealing their name, age, or address. These credentials can then be used for blockchain transactions, enabling privacy-preserving compliance.
Banks’ role as trust anchors bridges the gap between regulatory requirements and blockchain’s promise of decentralization. By enabling privacy-compliant transaction screening and identity verification, banks create a framework where DeFi and regulatory systems can coexist, unlocking the full potential of public ledgers while adhering to global financial regulations.
Credit and Lending
In the current DeFi ecosystem, lending is often constrained by its reliance on overcollateralization, which requires borrowers to lock up more value than they wish to borrow. While this ensures low credit risk for lenders, it significantly limits accessibility, particularly for individuals and businesses without substantial digital asset holdings. DeFi protocols also lack the ability to assess creditworthiness based on off-chain data, making undercollateralized or credit-scored lending nearly impossible.
Banks can bridge this gap by leveraging their deep expertise in credit assessment, risk management, and underwriting. Unlike pure DeFi, banks can use a comprehensive risk management framework by integrating on-chain transparency with off-chain data, such as credit scores, income history, and business performance, to offer tailored lending solutions. This enables banks to provide loans that are either fully or partially collateralized, opening up lending opportunities for a broader range of borrowers.
Furthermore, banks can innovate by tokenizing traditional loan structures, allowing borrowers to secure funding against tokenized real-world assets such as property or equipment. They can also partner with DeFi platforms to offer hybrid solutions, where blockchain’s transparency and efficiency are combined with banks’ ability to manage credit risk.
By acting as intermediaries in the lending process, banks ensure compliance with regulatory frameworks while reducing systemic risks. Their ability to provide flexible, undercollateralized credit solutions makes them indispensable in creating a lending ecosystem that is both inclusive and scalable — bridging the traditional financial world and decentralized finance.
Conclusion
In the digital asset era, banks must undergo a fundamental transformation — not only in their roles but also in their technological foundations. To move from gatekeepers to facilitators, banks cannot rely on building innovations atop outdated core banking systems. Instead, they must embrace a new paradigm, creating a financial system that integrates public ledgers, stablecoins, and digital identity at its core.
This shift is essential to enable the instant settlement of digital asset-based transactions while maintaining the highest standards of security and regulatory compliance. In this ecosystem, banks no longer “own” the customer but provide access to a decentralized financial network composed of diverse services from multiple providers. These providers, all adhering to shared rules, collaborate to deliver decentralized yet compliant financial services that can be seamlessly composed to meet clients’ unique economic and transactional needs.
Bringing about this transformation will demand significant strength, resources, and determination from the banking sector. It requires dismantling deeply entrenched systems and navigating complex challenges to implement a technological realignment that aligns with the digital age. Yet, this effort is not optional — it is essential. Only by embracing a profound shift can banks facilitate a truly digital financial system, one that combines speed, privacy, compliance, and interoperability while unlocking the full transformative potential of digital assets.
