Stablecoins and the Era of Full Reserve Digital Banks

Banking is undoubtedly undergoing a reformation. Read more about how ARYZE envisions the future of digital payments.

Author: Carl Christian Jenster — Co-author: Morten Christorp Nielsen


The earliest form of modern banking traces its roots back to the warrior monks of the Order of the Temple — also known as the Knights Templar — who first issued notes of credit to be redeemed by pilgrims venturing to the holy lands.

The concept was further refined by the Medici family in Florence during the Renaissance. However, the form of banking that resembles the current system can likely be traced back to the 1800s, where US banks became part of the Federal Reserve System and could lend out depositor funds to other customers in exchange for an interest rate.

Stablecoins and the era of Full Reserve Banks - Templars issued the first banking IOU
Templars issued the first banking IOUs.

This was the birth of the fractional reserve system, which has become standard practice in modern commercial banking. Fractional reserve is a practice where banks can accept deposits and issue loans while keeping a reserve corresponding to a fraction of the bank’s liabilities.

While this practice enables banks to offer more services, it also demands that governments by necessity provide deposit insurance as a safety net and potentially act as a lender of last resort, in the event of bank runs.

It also means that because commercial banks issue loans that exceed the actual underlying capital, money is being created. This money creation requires regulators to impose restrictions to limit the debilitating impact it could have on the economy.

There are various sectors to consider when discussing banks; private banking, investment banking, retail, and commercial banking all vary in their areas of focus. The primary function of private banking is wealth management for high-net-worth individuals and offering personalized financial services to satisfy the needs of their clients, such as investment and portfolio management, tax services, trust, and estate planning. Retail and commercial banks engage in deposits and loans for consumers and corporations, respectively.

Investment banks often deal in large and complex financial transactions — these types of banks handle the issuance of Initial Public Offerings, mergers and acquisitions, distribution of securities and financial derivatives, and underwriting of debt financing.

However, besides advising clients on investments, investment banks also trade for their own accounts and therefore have faced criticism that there could be conflicts of interest — something IBs have countered by separating the two departments from sharing information.

Nearly all banks engage in lending and trading activities with one another, and as they become increasingly interconnected, the economies of the world become entwined as well.

Modern banking is an intricate system, relying on information relayed across the world.

There is another important factor to consider about modern banking. Essentially, when you deposit cash into your bank account, the money is no longer yours — it belongs to the bank! The bank will issue an I-Owe-You note in return for handing over your cash. What if the bank can’t honor the IOU sometime in the future?

Financial Crisis

The reality is, though, that banks take risks with consumer and corporate deposits, leading to huge economic implications if a bank for some reason goes bankrupt.

We saw financial giants like AIG and Citibank and countless others in need of being rescued after 2007. Had it not been for government and central bank interventions across the world, many corporations and individuals without government or general credit insurance would have lost billions.

Millions of regular people ultimately paid a hefty price for this misconduct. Throughout 2008 and 2009, nearly nine million jobs were lost in the US, and many more lost their pensions. No country was unaffected. For many nations, it would be more than six years before their economies would recuperate somewhat to pre-crisis levels.

Leading up to the housing crisis, there were indicators of a ticking timebomb.

The following is a chronological list of causes for the financial crisis:

  • During the Bush administration, the Federal Reserve lowered interest rates to reinforce the American dream of homeownership; keeping the interest rates low, combined with relaxed financial regulations, created cheap mortgages.
  • Aggressive mortgage brokers could sell mortgages to people, who would never have qualified to receive these loans under normal circumstances, as banks would inevitably buy these mortgages that were subsequently pooled together as securities.
  • Certain rating agencies issued somewhat inflated ratings on these securitized mortgages, known as mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs)
  • Due to a lack of regulatory oversight, bankers became greedy as their primary concern was selling more MBSs and were not concerned with the actual contents of the CDOs, which were filled with risky loans.
  • As people began to default on their mortgage loans, the value of the MBSs began to collapse, and financial institutions were forced to take losses of immense proportions.
  • Most financial institutions were invested in not only MBSs but also new and underregulated financial instruments like credit-default swaps.
  • Financial giants like Freddie Mac, Lehman Brothers, and Washington Mutual, which were in many ways pillars of the US financial system, were forced to declare bankruptcy. Banks like Goldman Sachs and Morgan Stanley only survived the crisis because they changed their status from investment banks into bank holding companies, and therefore could qualify for bank bailouts.
  • In all the panic, consumers started to withdraw their money from banks and funds.
  • Banks stopped lending money to clients and to each other in a fight for survival, which subsequently caused liquidity to dry up and a full-blown global recession was underway.

The current banking system (called fractional reserve banking) is based on the idea that people are very unlikely to demand all their deposits back at once.

Dr. Matthew Partridge, MoneyWeek 2014

Following the financial crisis of 2008, the Great Recession, frequent discussions regarding the fractional reserve model have brought a major issue to light. It became quite clear that regulators must be better at managing the risks that banks can take. Little did they know that there was an alternative, of sorts, to banking in the works.

Birth of Crypto

While the world was still reeling from the consequences of irresponsible banking and poor regulatory oversight, technological innovation was brewing. In 2009, the bitcoin network was born and with it, a way for consumers to become their own bank. Cryptocurrencies gradually started popping up that built on the fundamental technology behind bitcoin, named blockchain.

Bitcoin — a decentralized, peer-to-peer electronic cash system.

Despite gaining traction with the crypto-technic communities, the “real world” kept dragging its feet. There were frequent warnings and debates regarding the risks that were inherent with crypto, as regulators struggled to understand the implications of a code-based currency with no central authorities. Monetary policy oversight and anti-money laundering authorities had little role to play in blockchain-enabled transactions, which naturally was a cause for alarm among the established financial players of the world.

Over the last ten years, unregulated exchanges, “silk roads,” ICO scams, and other criminal activities have come and gone. After much trial and error, we finally have an answer to the question of how to integrate blockchain with financial systems. The solution lies in a mix between cryptocurrencies and traditional national currencies — but more on that later.


In recent years, stablecoins have been on the rise, and have seen an explosion of interest from the establishment in stable cryptocurrencies. Central banks have been re-examining central bank-issued digital currencies (CBDCs).

Banks like JP Morgan have issued their own internal settlement coin, and venture capitalists like Andreesen Horowitz have expressed great interest in the space. This was all because stablecoins suggest an innovative combination of mobile payments, digital banking, and cryptocurrencies. In a nutshell, stablecoins are stable cryptocurrencies that are pegged to fiat money, commodities, or a basket of assets (cryptocurrencies or otherwise).

The main propositions of payments on distributed ledger technology are lowered fees, security, and stability. However, the need to intermingle with the existing banking and financial oversight infrastructure is ultimately required, as well as credit risk management.

Furthermore, the fact that most stablecoins are traded on exchanges means that in classic terms of supply and demand, the value of these “stable” assets ultimately fluctuate. In times of market downturn, even as much as 10% on occasion. This is utterly unacceptable for corporations and financial institutions that trade hundreds of millions of dollars daily.

Full Reserve Banking

Central banks, together with regulators and politicians, can have some control over the risks associated with money creation, but only to a certain extent. The alternative to fractional reserve banking is what is called full reserve banking. Its’ proposition is not to facilitate loans, but purely to facilitate core banking operations like payments and deposits, where 100% of the liabilities are backed up at all times in the bank.

With modern technology, handling primary money in a non-leveraged fashion is possible because we can keep money safe using distributed ledgers, without engaging in fractional lending.

The Chicago Plan

In recent years, there have been discussions regarding banks, and in particular about fractional lending and the systemic risks that it poses. After the depression in the 30s, economists theorized full reserve banking in the Chicago Plan, and the IMF revisited this in 2012.

They found that all of the conclusions were valid in modern times, so theoretically, there is no reason why consumer deposits cannot be placed in a banking system that does not actively engage in fractional lending.

With the added transparency of distributed ledger technology, we could recreate the system that was proposed in the Chicago Plan and create a much more risk-free environment for the core management of money.

ARYZE has an infrastructure acquisition roadmap for obtaining direct access to banking infrastructure in multiple jurisdictions, and thereby a direct link into various central banks.

This will allow us to keep accounts directly with central banks for the majority of our collateralization. Furthermore, this will allow us to achieve the highest possible credit rating and reduce exposure to counterparty risk significantly.

The best of both worlds?

We have begun to see several tech companies and financial institutions make investments into building stablecoins for a variety of purposes. Perhaps the most famous of these, Facebook’s Libra, highlights the fact that even social media giants, with a history of privacy breaches, could enter the race for a global reserve currency. A scary thought, for sure.

However, deciding not to replace current dominant currencies with a global stablecoin, but instead innovating upon the format in which money is transferred may be a valid argument for stable digital currencies.

There needs to be a balance between legacy financial systems and modern technology. Companies like ARYZE are seeking to bring global payments systems into the digital age with an improved method for transferring ownership of value.

ARYZE has chosen an approach of creating an accurate and stable digital representation of sovereign cash. Digital Cash, as it is referred to in their white paper, is a series of stablecoins that have the same value as cash notes would have, as issued by central banks.

The deposited money is stored in a low-risk ecosystem, and the aim is to stabilize the volatility by placing user deposits back into the central banks which issued the relevant currency to begin with.

In order to do this, and control risks associated with KYC/AML, ARYZE will acquire infrastructure to create a full reserve banking model for user deposits. It gets a bit technical at that point. However, by following this model, ARYZE can facilitate transactions, even cross-border, at near-zero cost.

Finding the balance between centralized and decentralized, the plan for ARYZE’s ecosystem is to gradually increase the degree of decentralization of the system towards a Decentralized Autonomous Organization. This DAO will have automated processes for solvency and auditing, becoming an ultimate network of trusted payments.

However, the question remains: do we need blockchain for running a digital version of a traditional currency? If it is merely completing payments, not necessarily. Existing payments infrastructure runs rather smoothly, although the fees involved can present an inconvenience.

If we consider money beyond payments, blockchain offers excellent propositions for a variety of transactions. Smart contracts will likely transform business processes and alleviate risks associated with third-party validators and services.

According to Yoni Assia, CEO of eToro, trillions of dollars’ worth of assets will likely be tokenized on the blockchain in the next ten years. That’s everything from securities and real estate to IoT devices and sensors, which could integrate with programmable “sovereign currency” tokens.

In the future, billions of smart devices can participate in the machine economy through blockchain wallets, enabling a new era of automation where bots could be incentivized to perform services for each other.

Rather than creating new cryptocurrencies that require a learning curve and an in-depth understanding of the underlying technology, let’s make “dumb money” smart! Through both financial and technological innovation, we can give money that we are already familiar with a much-needed facelift.

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