Free Banking Stablecoins

Abstract

Monetary policy and central banks faced significant challenges in recent decades, like the Great Recession and the 2008–2009 financial crisis, and the Global Inflation Surge of 2021–2022. The introduction of blockchain technology triggered major financial innovations. Nevertheless, the adoption of digital currencies and stablecoins in particular has been limited and does not have wide and everyday use, like national currencies. To understand non-national currency usage better, we examine free banking in Scotland and the U.S., and specifically note issuance. Lessons from these periods suggest the importance of reserves and coordination mechanisms. Based on these free banking cases, we propose that banks and corporations should have the freedom to issue their own stablecoins. More specifically, we examine the freedom for regulated banks to issue their own stablecoins in a competitive environment, learning from historical precedents how to manage such a system. Free banking stablecoins could provide significant benefits, especially in countries with unstable monetary systems, like emerging economies. Such benefits can range from better monetary policy, inflation targeting, and stability, to a broader range of innovative financial markets and services that can contribute towards entrepreneurship, investments, and economic development. Citizens, entrepreneurs, and domestic and foreign investors can gain from these benefits. At the same time, the banking sector and financial institutions can maintain an important role and further expand and develop by offering innovative financial services in an evolving and challenging environment due to financial technology and disintermediation. Finally, governments and central banks could also benefit from increased financial inclusion, higher economic growth and development, but also from more competition and financial stability, and from financial innovation and technology services.

1. Introduction

The introduction of blockchain technology in 2009 created an innovative financial market, the cryptocurrency and stablecoin market, which in 2025 for the first time reached a value of USD 4 trillion (Reuters, 2025). Thousands of digital currencies and stablecoins have been created and traded. At the dawn of the internet age, Nobel Prize winner Milton Friedman foresaw digital currencies’ potential and the opportunities for financial innovation stating that “the one thing that’s missing, but that will soon be developed is a reliable e-cash, a method whereby on the Internet you can transfer funds from A to B without A knowing B or B knowing A.” (Cawrey, 2014).

Friedman also recognized the challenges and risks that digital currency could have for illegal activity, but pointed out that such potential exists with traditional cash, which is also practically untraceable and preferred for illegal transactions. In addition, Friedman highlighted that competition against the government monopoly in the creation and control of money, broadly known as free banking, would have many positive benefits, concluding “that leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through governmental involvement” (Friedman & Schwartz, 1987).

This paper examines how the free banking experiences of the past can provide something of a blueprint for innovative alternatives and further enable and contribute to the adoption of stablecoins. It should be emphasized that our discussion focuses on the issuance of notes, rather than other aspects of free banking. More specifically, we examine the freedom for regulated banks and corporations to issue their own stablecoins, learning from historical precedents on how to manage such a system. We define this as free banking stablecoins.

In addition, we explore the potential benefits of a free banking stablecoin on monetary stability and economic development. Monetary and financial instability have been significant problems in recent decades. The Global Great Recession and the 2008–2009 financial crisis created unprecedented monetary instability (Cukierman, 2013; Keen, 2013; Kim & Mehrotra, 2016; Obstfeld et al., 2009). Similarly, the global inflation surge of 2021–2022 in emerging economies and developed countries can indicate significant challenges in monetary policy and stability (Aguilar et al., 2024; Lane, 2024; Ha et al., 2024). Free banking stablecoins can have applications and significant benefits, especially in emerging markets and, in general, countries where monetary and other problems, such as a lack of development and high inflation rates, characterize the monetary and financial systems.

What follows is a discussion of free banking and an examination of some notable cases of free banking. We focus on the cases of Scotland and the U.S. The former is considered the most notable and successful case of free banking (White, 1984). The latter concerns the biggest economy in the world and the most developed financial system. Then a section is dedicated to the study of the main characteristics of stablecoins and potential free banking applications. We continue by discussing potential benefits of stablecoins for monetary policy and stability, economic development, and the role of central banks.

2. Free Banking and Currency Issuance

2.1. Free Banking

It is challenging to define the term free banking. While free baking is usually associated with laissez-faire, it can be argued that hardly, if ever, has it been observed in pure laissez-faire conditions (Dowd, 2023). “Despite both the logic of the argument and the apparent real-world success of free enterprise economies, there has been one industry, one economic activity, that even ardent proponents of laissez-faire have been afraid to leave to the vicissitudes of the free interchange of supply and demand. This is the business of banking, an industry that most believe is inherently unstable.” (Rolnick & Weber, 1983). Therefore, banking can be considered an exceptional case for laissez-faire.

Moreover, banking is an aggregate term for many financial markets and operations. It is beyond the scope of this paper to analyze the different forms of banking, which have evolved over time and are currently experiencing digital innovation and transformation. Nevertheless, the accumulation, wide range, and continuous changes in financial products, services, and operations complicate a good definition of free banking. Based on the concept of laissez-faire, free banking can be defined as banking with the absence of any regulation and freedom of banks to conduct any financial operation. This pure laissez-faire form of free banking does not exist in practice; national banks and the banking system are among the most highly regulated institutions in many societies (Office of the Comptroller of the Currency [OCC], 2005).

Although banks do many things, their primary role is to take deposits and lend them (Gobat, 2012). Concerning free banking (in the U.S.), it is related to competition for deposits and loans, no federal regulations, low entry barriers, and banks being free to issue their notes (Rolnick & Weber, 1983). In this paper we are mainly interested in the freedom of banks to issue their own notes. Regulation, competition, low entry barriers, and other free banking topics are important aspects, but secondary to our analysis. Due consideration for the reader’s time caused us to limit this paper to two cases of free banking, but this is a limitation that also leaves opportunities for further examination.

Selgin and White (1987) discuss the evolution of free banking and recognize different periods. This highlights how difficult it is to clearly define free banking since, like any free market, it is dynamic and changes not only between countries but across time. They suggest that there is a stage of development characterized as ‘mature free banking system’ (Selgin & White, 1987). The banks in this mature system are free to issue inside money as paper notes and demand deposit accounts and can also issue redeemable token coins (Selgin & White, 1987).

2.2. Note Issue and Central Banks

Therefore, for the purpose of this paper, we define free banking in terms of the ability of banks to freely issue notes and token coins. We argue, in accordance with Hayek (1976) and others, that central banks should not monopolize the issuance of money, and banks should have the freedom to issue notes and token coins. We examine and argue for the freedom for regulated banks and other corporations to issue their notes in a competitive manner. We learn from free banking historical precedents and apply these lessons to digital currencies issuance.

It is important to highlight for bank currency issuance that even national (federal) banks that assimilated and later evolved and transformed into central banks were issuing their own notes. Notable examples are the Bank of North America and the First and Second Bank of the United States (of America), mentioned later. The Bank of England charter was used as the basis for the (first) Bank of the United States, and while the former was privately owned, the latter would be owned 20% by the U.S. government (Federal Reserve Bank of Philadelphia, 2021a). It was not only that the national private banks were private and issued currency, but also that state banks had the freedom to issue their notes. This allowed competition in currency and, at the same time, also the freedom of private money.

There are a lot of interesting features of national banks in these periods, some discussed later. One fact that should be highlighted is that the operation of the First Bank of the United States lapsed in 1811, and it was not until 1817 that the Second Bank opened. This period is not studied much in the literature, but it is important since banking operated without a National (Federal) bank. Once again, as in the case of the First Bank, the reasons for the Second Bank were largely debated, but included arguments about stable currency (Federal Reserve Bank of Philadelphia, 2021b).

Nevertheless, the U.S. endured without a national bank, and by 1811, the number of state banks had increased greatly (Federal Reserve Bank of Philadelphia, 2021a). Finally, it should be noted that the Second Bank expanded the mandate and not only issued and redeemed banknotes but also regulated the economy by keeping state banks’ issuance of notes in check (Federal Reserve Bank of Philadelphia, 2021b), possibly paving the way for more centralization, regulation, and central bank control in currency operations.

2.3. A Short History of Free Banking and Notable Cases

In his pioneering work, Hayek (1976) analyzed the great debate on ‘free banking’ focusing on the right to issue money, and concluded that the outcome of the debate resulted in the establishment of a single (central) bank. This single bank is privileged by the government to issue notes in all European countries, and, later in 1914, the United States also followed this approach. By the beginning of the 20th century, not only had most European countries and the U.S. implemented this approach to issuing money, but also many other countries around the world, which remains till today. In this section we will briefly examine some cases of free banking before the 20th century.

There have been many instances of (relatively) free banking in history (Dowd, 1994). These episodes varied widely concerning the degree of government regulation (Schuler, 2023), which differs from country to country and makes them relatively free banking systems, since in all of them, there is some form of regulation. There have been around sixty cases in the history of the free banking system in different time periods, which lasted from a few years to more than a century (Schuler, 2023). The purpose of this paper is to examine some key free banking systems and notable cases. Therefore, the paper focuses on some notable cases, namely the development of Scottish free banking, which was frequently replicated in the British colonies, and the U.S. experience, because of its importance in the evolution of banking and financial markets.

2.4. Scottish Free Banking (1716–1845)

The Scottish free banking case is critical for three reasons: (1) it provides a unique paradigm, (2) it is largely considered a successful experience, and (3) it has been diffused to many (former) British colonies and other countries. Moreover, the Scottish free banking case seems to have been dramatically different from the American one (Gorton, 1985a), but more on that below. White (1984), in his seminal work Free banking in Britain, examined the case of free banking in Scotland, which, along with England and Wales, Ireland, and Japan, is among the oldest cases of free banking (Schuler, 2023).

Cowen and Kroszner (1989) suggest that the Scottish system is considered ‘the paradigmatic case’ of the free evolution of a financial system, and laissez-faire could create a banking system in which banks, among other things, could issue non-interest-bearing notes with a fractional reserve basis. Therefore, the issue of notes is a key feature of the Scottish free banking. However, the Scottish experience has been subject to much debate, as we examine below.

Free banking in Scotland started with the Bank of Scotland, established by an Act of the Scottish Parliament in 1695, just one year after the Bank of England. This legislation provided the Bank of Scotland a monopoly on the issuance of notes until 1716 (White, 2023). The Scottish free banking system is also important due to the attention it drew. In the 1772 financial crisis, David Hume sent an anxious letter to Adam Smith, who was working on The Wealth of Nations, asking him how these banking events would affect his theory (Goodspeed, 2016). Curott (2017) concludes that Smith was an influential and innovative banking theorist. In The Wealth of Nations, Smith argued that commercial banks should be free to issue their own redeemable, fractional reserve banknotes and that banking competition could regulate the supply of money.

The founders of the Bank of Scotland intended it to be a purely private commercial bank, and, in that sense, it was unique among European banks at that time, since it was not a state institution (White, 2023). In 1727 the Royal Bank of Scotland was established, and competition was initiated between the banks, including note issuance. Immediately a ‘duel’ started between the banks using banknotes, but also encouraged financial innovation, like the ‘cash credit account’, which helped the bank increase the circulation of its notes, which Hume praised as an ‘ingenious idea’ (White, 2023).

Of the important developments in the history of free banking in Scotland, bank-issued notes and the Scottish note-exchange system are foremost for our project. Many of the important developments were a result of the Act of 1765, which, among other consequences, led to the increase in banks from 5 in 1740 to 32 by 1769, with further expansion due to the development of branches (White, 2023).

The issuance of notes is our key theme, and Scottish banks were freely issuing their own notes until the (Scottish) Bank Act of 1845. The Bank Notes (Scotland) Act 1845 intended to regulate the issue of bank notes, and it gave to the ‘Governor and Company of the Bank of England’ privileges for the issuance of bank notes in any part of the U.K., including Scotland. The impact of the Bank of England is immediately noticeable. This Act made further provisions for the amount of notes and the returns to be made by banks, imposed limitation of issue, prohibited the issue of notes for fractional parts of a pound, and most importantly implemented reserve requirements: “it shall not be lawful for any Banker in Scotland to have in Circulation, upon the Average of a Period of Four Weeks, to be ascertained as herein after mentioned, a greater Amount of Notes than an Amount composed of the Sum certified by the Commissioners of Stamps and Taxes as aforesaid and the monthly average Amount of Gold and Silver Coin held by such Banker” (Legislation.gov.uk, 1845). Moreover, there were additional reserve requirements about the proportion of gold and silver coins, and there was a penalty on banks issuing an excess. It can be argued that the most critical feature was the empowerment given to Commissioners of Stamps and Taxes, not only to inspect reserve requirements and the bank’s books, but also to make a monthly return and to certify banks of issue and limitations of issue.

During the free banking period, the number of banks increased, as did the diversity of currencies in circulation and consequently competition. Interestingly enough, companies other than banks also entered the banking market and could issue notes. It was not only merchants and parentships entering the banking industry, such as the Glasgow Ship Bank and the Glasgow Arms Bank, but also the British Linen Company, a corporation for promotion of linen wholesalers, which later expanded to 18 branches, and by 1845 had the most banknotes in circulation of any issuer (White, 2023). As different notes were issued, their exchange became difficult. A note-exchange system was initiated by the Bank of Scotland and the Royal Bank of Scotland, which exchanged one another’s notes, with other banks joining later, resulting in the development of a clearing system (White, 2023).

The free banking systems of the British colonies can be considered similar, although slightly more regulated than the Scottish system. Free banking was not only common in the British Empire but also in the Orient and the Americas (Dowd, 2023). The British colonies resembled the Scottish free banking system rather than the English system, the latter being heavily regulated (Schuler, 2023). There were locally competing banks in the colonies, and the British government encouraged bank promoters to establish banks in the colonies who agreed not to compete in Britain with the Bank of England or other banks (Schuler, 2023). At that time there were numerous important colonies, such as Australia, Canada, India, New Zealand, South Africa, and smaller colonies like the British Caribbean Colonies. Furthermore, it can be argued that the influence of free banking in the colonies extended to adjacent countries and regions. For example, in Asia, British banks were allowed to issue notes in Thailand, and they also had a role in the free banking system that developed in some Latin American countries like Mexico, Colombia, Argentina, Peru, and Uruguay (Schuler, 2023).

The free banking paradigm of Scotland can correspond to other free banking cases. First, because Scotland has a long banking history, it had an impact on other (free) banking systems. Secondly, Scotland, like many colonies, was less regulated than England and Wales. Moreover, both Scotland and the British Colonies were not under the Bank of England’s direct legal authority, although the level of its influence has been largely debated. Australia is analogous to the Scottish free banking system. The period of free banking in Australia started in 1817 with the establishment of the Bank of New South Wales, followed by many others, especially in the late 1830s, with several colonial bank formations and rapid development of branches in Australia from 24 in 1850 to 197 in two decades and a sevenfold increase in note issue. This period ended in 1901 with the Commonwealth Act (Doi & Cassell, 1997). Thus, Scottish free banking is not only important on its own, but also because of free banking cases’ resemblance with it around the world.

2.5. Free Banking in the United States (1837–1865)

The term free banking, when applied to the American experience, can be somewhat confusing. The American experience was far more regulated than the Scottish; the banks were largely free from federal regulation in the aftermath of the end of the Second Bank of the United States, but states still regulated banks. Maybe a more appropriate term would be non-federal banking. The period of free banking in the U.S. started with the expiration of the charter of the Second Bank of the United States in 1836 and ended with the introduction of the National Banking Act in 1864 (Sanches, 2016).

“After the Second Bank of the United States closed its doors in 1836, the United States went through a period of approximately 76 years during which it had no central bank. Instead, the U.S. banking system during this time is generally divided into two periods: the state, or free, banking era, which ran approximately from 1837 to 1863, and the national banking era, which lasted roughly from 1863 to 1913. Also, the United States still had no uniform national currency during this period. State-chartered banks issued their own banknotes, and some nonfinancial companies issued notes that also circulated as currency” (Federal Reserve Bank of Philadelphia, 2021c). The fact that non-financial companies, such as rail and bridge construction companies, also issued notes is a topic much neglected, but is crucial as we are going to argue later. (Federal Reserve Bank of Philadelphia, 2021c).

In the 1830s, Michigan, Georgia, and New York adopted free banking, but by 1860, 15 other states had joined them (Sanches, 2016). The difference in the American experience with free banking can be seen in the early adopting states: Michigan and New York (Rockoff, 1991; Rolnick & Weber, 1983). Most economic historians agree that Michigan’s experience was a complete failure while New York’s experience was a solid success (Sanches, 2016).

In one of the earliest and most detailed works on free banking, Rockoff (1972) states that “When people in the 1850s used the term free banking, they meant something very specific: they meant a banking system modelled after the free banking system of New York, with free entry and a bond secured note issue”. Despite the wide variance in the way states implemented the free banking laws, it was eventually adopted by 18 states, while the 15 other states remained without free banking laws (Rolnick & Weber, 1983). Nevertheless, even if modeled after the successful New York free banking system, the free banking among states varied according to idiosyncratic conditions. Therefore, the experience of free banking also varies concerning the degree of success or failure.

Under free banking laws, a prospective bank had to secure a charter from the state legislature and deposit financial security with the state banking authorities in the form of specie, state-approved bonds, or other assets. (Dowd, 1992) The two early cases of Michigan and New York established precedents for other free banking state systems. Nevertheless, these systems were set on different fundamental premises. The New York free banking law centralized the issuance of notes, with prospective bankers depositing bonds with the state comptroller, and if this bank did not redeem its notes, the comptroller could redeem them by selling the bonds (Federal Reserve Bank of Philadelphia, 2021c). On the other hand, under free banking laws in Michigan, someone who wanted to start a bank had to pay 30 percent of the bank’s capital into a safety fund and could start operating the bank and issue notes on the full amount of capital, even before the full 30 percent was paid (Federal Reserve Bank of Philadelphia, 2021c). To further exacerbate this problem of capital requirements in redeeming the notes, the safety fund accepted as capital risky securities, notably mortgages, where land was the subject of speculation and overvaluation (Federal Reserve Bank of Philadelphia, 2021c).

Therefore, it might not be surprising that the free banking case of Michigan was not successful after all, since the value of the notes did not correspond to enough reserves. Another severe problem that arose from that was the phenomenon of ‘wildcat banking’. Although more complicated, in simple terms, a wildcat bank was one that issued more notes than could reasonably be redeemed, and Michigan was more prone to having them (Federal Reserve Bank of Philadelphia, 2021c). In addition, the adequacy and value of these reserves changed over time.

At this point, it is useful to briefly mention the 1837 panic and crisis. One characteristic of the 1837 crisis is that several factors, among them falling asset prices, “drained the specie reserves of U.S. banks”. (Federal Reserve Bank of Philadelphia, 2021c). The effects of this banking crisis were deep and prolonged. It would be hard to assume that enough specie was available for the free banking system to function well. So, the transition to the free banking era was off to a rocky start. This can explain why bonds and other assets were used as reserves, on top of specie.

However, this was also problematic, since the value of bonds and securities varied over time. These risks were amplified in the case of speculative assets and led to bank failures. In states where the bonds retained their value, like in New England, the system worked well. But in states where the bonds depreciated or the state had imposed other collateral restrictions the banks had little flexibility (that is they were not very free) and the system tended to fail, as Briones and Rockoff (2005) concluded, “[bank failures] appear to have been the result of restrictions imposed on the American free banks—restrictions on branch banking and the peculiar bond security system.”

The free banking era officially ended in 1863. There are some critical events that should be examined in relation to their end. The first is the 1857 bank panic, triggered by the collapse of the Ohio Life Insurance and Trust Company, which led to an economic crisis (Federal Reserve Bank of Philadelphia, 2021c). There was another bank panic in 1854 (Gorton & Winton, 2003), although under the definition provided by Calomiris and Gorton (1991), the episode does not qualify as one. An interesting observation is that even after the bank panics, states were still introducing free banking laws, namely Iowa (1858), Minnesota (1858), and Pennsylvania (1860) (Rolnick & Weber, 1983).

Nevertheless, the most important event is the American Civil War from 1861 to 1865. The federal government in Washington had to pay for the war, and it did so by borrowing money and issuing notes as collateral, issued as demand notes; a paper currency called legal tender or U.S. notes; and creating a national banking system to further raise money for the war (Federal Reserve Bank of Philadelphia, 2021c). It resulted in two important laws: the Legal Tender Act in 1862 and the National Bank Act in 1863 (and 1864), the latter signaling the start of the national banking era.

The Legal Tender Act authorized “the creation of paper money not redeemable in gold or silver” (Britannica, n.d.). This further promoted a uniform currency and undermined the role of specie as currency. The financial crisis in 1862 and the spiraling costs of war depleted gold and silver coin reserves, which were, at the time, the only legal tender of the United States. Eventually, Congress authorized the issuance of paper U.S. Notes (popularly called ‘greenbacks’), declaring them lawful money “The Legal Tender Act, intended as an emergency measure, dramatically extended federal power and changed the nation’s monetary standard … [and] revolutionized the U.S. monetary system by making paper notes legal tender and creating a national currency for the first time.” (U.S. Capitol Visitor Center, 2025).

The National Bank Act of 1863 was originally passed as the National Currency Act, which, more importantly, established the federal Office of the Comptroller of the Currency, a federal government agency with the mandate to issue national bank charters and promulgate banking regulations. The National Currency Act also applied a 2% annual tax to bank notes issued by state banks, which did not discourage them much from issuing notes. (Federal Reserve History, 2022). The National Bank Act of 1864 promoted a national banking association, capital levels, and reserve requirements for state banks and put some limitations on state bank-issued notes that were backed by U.S. Treasury bonds (Federal Reserve History, 2022). This further increased centralization, and many banks switched from a state to a national charter, although in later years the balance between them almost equaled (Federal Reserve Bank of Philadelphia, 2021c).

2.6. Lessons from Free Banking and Currency Issuance

The examination of the history of free banking in Scotland and the U.S. indicates the importance of reserve requirements. In the Scottish free banking period, banks had clauses to convert the notes to specie, and therefore, they kept reserves to honor such requirements. White (2023) suggests that banks learned from experience to maintain a sufficient specie reserve. Nevertheless, the evidence and data on reserves can be considered rather limited. Dow and Smithin (1992) analyzed the debate on free banking in Scotland concerning reserves and observed that the Scottish system had a small base of specie and banks held the notes of public banks as reserves, and mentioned the influence of the London bills as reserves for the Scottish banks (Munn, 1981; Goodhart, 1987).

It is a critical observation that the two public banks, the Bank of Scotland and Royal Bank of Scotland (the extended literature also includes the British Linen Company as a public bank), performed some of what is considered today central bank functions, of storing reserves and acting as lender of last resort. Therefore, there was coordination among the banks concerning reserves. At this point it would be worth mentioning again the Scottish note-exchange system.

The note-exchange system is another piece of evidence that banks in Scotland were coordinating effectively during the free banking period. Selgin and White (1987) emphasize the importance of regular note-exchange and clearinghouses, multilateral note exchanges in reserve holding economies, for the evolution of free banking. Banking coordination is an important issue for bank runs and panics (for example, see Garratt and Keister (2009), Temzelides (1997). The note exchange mechanisms and coordination of Scottish banks, even with relatively small specie reserves, might be an explanation for the success and stability of free banking in Scotland, and can constitute a subject of future research.

Our discussion of the Scottish free banking experience would be incomplete without noting that there is some dissent about its level of freedom and success. Rothbard (1990) discusses what he calls ‘The myth of free banking in Scotland’, and his arguments revolve around reserves. This debate is not the focus of our paper, and we leave it for another time, but it is appropriate to acknowledge that there are alternate views.

It can be said that the U.S. case was more illustrative due to the comparisons between the states. Rockoff (1991) discusses lessons from free banking in the U.S. and mentions that although there were inconveniences because of a lack of a uniform currency, merchants and, in general, customers dealt with banks they knew well, and when this was not the case, there were ways, like a banknote reporter that listed the value of notes or a counterfeit detector.

At the same time there were advantages from having a variety of notes. Probably the most compelling reason to issue currency by banks is that it would encourage innovation in the supply of currency, and the role of technology and innovation in communications technology is highlighted (Rockoff, 1991). Similarly, Yeager (1962) examined free banking and connected it with incentives to innovate around reserve requirements (White, 2023). We not only agree with this innovation argument, but we also expand this argument and suggest that innovation in the supply of currency could further enable and boost financial innovation. As we analyze later, free banking stablecoins can offer a broader range of innovative financial services, most notably payment systems.

To highlight the differences among states, Rockoff (1991), in discussing the lessons of free banking, mentions a free banking law in Louisiana in 1853, which contained a reserve requirement of one-third against deposits following a Louisiana tradition rather than the free banking model of the states in the North. As discussed above, the reserve requirements varied among U.S. states, and New York state banks had better reserves than the state of Michigan. It is not only that reserve requirements were different, but also the quality of reserves. Reserves included risky assets, and in some cases, these assets were in much larger proportions than specie or less risky assets.

The recent literature on bank runs also reveals that there was a relationship between bank runs and asset prices (Liu, 2023). Despite the many fundamental changes to banking since the era of free banking, there is a proposal for 100% reserve banking, which, however, reduces the overall amount of liquidity (Diamond & Dybvig, 1986). We recognize that the focus on reserves has its limitations, but at the same time, it is a key theme concerning free banking, and as we discuss later, it is crucial for free banking stablecoins.

2.7. Using Historical Lessons for Free Banking Stablecoins

The lessons from the Scottish and US free banking periods illuminate some important issues for the effective operation of free banking. We map these historical lessons and analogies, with considerations for the creation of free banking stablecoins, analyzed in section five Lessons and analogies are effective methods analyzed and justified in the next section. The dominant issue arising from the free banking narratives is reserves and their management. We analyze reserve requirement and management in financial considerations (Section 5.2), along with issues of reserve transparency and mechanisms to better manage them as note exchanges and clearinghouses. Note exchanges, clearinghouses, and financial market infrastructure (FMI) for free banking stablecoins are enabled by technology. The innovation and advantages of issuing notes are underlined by technological considerations, which we analyze (Section 5.1). Because we adopt a global approach, free banking stablecoins can behave like foreign exchange, requiring and accordingly we examine Foreign Exchange considerations, once again associated with FMI and exchanges (Section 5.3). Although that regulation and other issues of free banking and beyond the scope of this paper, policy and regulation are directly intertwined, and therefore, we present some key regulatory and other considerations (Section 5.4).

3. Methods

In the previous sections we presented a brief history and associated lessons from the Scottish and American free banking eras. Empirical narrative economics are empirical approaches to analyze economic stories and are becoming increasingly popular (Roos & Reccius, 2023). Shiller (2020) defines economic narratives as “stories that offer interpretations of economic events, or morals, of hints of theories about the economy”. McCloskey (1983), who is considered a pioneer in narrative economics, suggests that the “literary theories of narrative could make economists self-conscious about what use the story serves” and that economists often tell ‘stories’, use ‘parables’ or metaphors to simplify the story.

Smart (1999) examines storytelling in the Canadian Central Bank and employs theories of narrative that are used for decision making in monetary policy. Such narratives can be used in our context to understand free banking and apply it to today and future contexts for monetary policy. Adorisio (2014) is ‘Storying the past in banking’ and uses narratives for organizational remembering. It can, therefore, be argued that the storytelling and narratives of free banking periods can help remember and teach useful lessons that can be applied in the modern digital context. Finally, Whittle and Mueller (2012) argue that storytelling concerning banking in the 2009 financial crisis is important because it displays how the crisis was understood and acted upon. Storytelling of free banking periods can highlight significant events and crises, and indicate how they can be managed. We apply these methods and use storytelling and narratives to highlight some useful lessons from the free banking periods in Scotland and the U.S.

Kindleberger (1973) studies financial centers and monetary issues using comparative economic history. Boettke et al. (2013) use comparative historical political economy as our contribution and a collection of methodologies, and decompose it into political–economic analysis, historical analysis, and comparative analysis. In this paper we mainly use historical analysis. However, comparative historical analysis has a range of methodologies. Møller (2016) argues that historical analogies and controlled comparisons are used in comparative historical analysis, and they highlight the danger of creating false analogies. Allison and Ferguson (2016) suggest that analyzing historical precedents and analogies in applied history can help understand current challenges and choices. Therefore, analogies are a common method used in historical analysis, comparative, and applied, and we should, therefore, utilize them.

Events and episodes from economic history provide lessons for current topics in economic policy and research (Sokoloff & Engerman, 2000), in our case note issue. Mokyr (2018) examines the past and future of innovation by presenting some lessons from economic history. We follow a similar method to analyze financial innovation in note issuance and the broader banking and financial sectors. The analysis of free banking revolved around note issuance, which can be compared to the issuance of digital stablecoins. As we argue later, the lessons and examination of reserves from the free banking period can provide important lessons for stablecoin failures, as in the case of Terraform Labs.

The main line of our argument is informed by Kroszner (1995). His discussion is founded on a historical analogy. This analogy suggests that the Scottish free banking can be used as a model for emerging economies. Kroszner (1995) firstly argues that the free banking era Scottish economy characteristics can be seen in emerging market economies, and although there are variations, some aspects remain relevant. He argues that some financial contracts and markets were innovative to the Scottish population in the free banking era, as they were also in transition and a developing economy. Moreover, Kroszner (1995) focuses on note-issuing banks and competition, the innovative note contracts, the private clearing system, and the stability of the banking system.

These issues largely coincide with the most important lessons concerning monetary policy in the free banking periods. The research design of this study utilized storytelling and narrative in the first part. We concluded by identifying some important issues related to note issue, the freedom of banks and other corporations to issue their own notes, the management of reserves, and the note exchange system and clearinghouses. In the next part we described the evolution of technology and its impact on intermediation and banks, stablecoins, and how banks are offering stablecoins. The research design continued by using analogies between the historical lessons from the free banking periods and presented different types of considerations to better understand current challenges and choices for creating free banking stablecoins. The next part used events and analogies from free banking for practical applications for free banking stablecoins in emerging markets based on Kroszner (1995).

4. Towards a Free Banking Stablecoin

4.1. DLT, Decentralized Finance (DeFI) and Financial (Dis)Intermediation

The peer-to-peer distributed network underlying DLT points to the broader concept of decentralization. Decentralization is the “weakening of the central authority and distribution of its functions” (Oxford English Dictionary, 2025). Thus, it not only denotes the lack of authority and control by a single central authority but also that this authority moves to other entities. Jersey Finance (2025) examines decentralization and argues that, in simple terms, it refers to no single entity holding centralized control over an ecosystem, and this is at the heart of Decentralized Finance (DeFI). DeFI provides financial services using blockchain or distributed ledger technologies in a decentralized, open, and permissionless way (ESMA, 2023). “Decentralised finance (DeFi) represents a novel way of providing financial services that cuts out traditional centralised intermediaries and relies on automated protocols instead” (Born et al., 2022). There is a plethora of DeFi applications. This can mean that the structure and degree of decentralization might differ among stablecoins and associated applications. For example, Lin et al. (2021) measured decentralization and found that the degree of decentralization in Bitcoin is higher, while Ethereum is more stable. The evolution of DLT (i.e., Ethereum 2.0i, Cardanao, Solana, etc.) raises further questions and opportunities for future research on the degree of centralization.

Decentralization is crucial because it can involve many participants and competition. As was stated in a report by the Congressional Research Service (CRS), “Cryptocurrencies (and stablecoins) are digital money in electronic payment systems that generally do not require government backing or the involvement of an intermediary, such as a bank.” (Perkins et al., 2020). This definition aligns with others, except for the no central authority clause; it additionally highlights the changing role and lack of intermediation. The distributed networks and distributed ledger technologies have enabled a shift in control from the traditional centralized intermediaries to decentralized individuals (peers).

‘The savings/investment process in capitalist economies is organized around banks and bank-like financial intermediaries, making them a central institution of economic growth. These intermediaries borrow from consumer/savers and lend to companies that need resources for investment’ (Gorton & Winton, 2003). Financial intermediation in that sense focuses on banks. Merton (1995) discussed two frames of financial intermediation: one that takes as given the institutional structure of financial intermediaries and public policy helps this structure to survive and flourish, and the functional perspective, which takes as given the economic functions of financial intermediaries and attempts to find which is the best institutional structure. It is a visionary approach because it highlights improved computer and telecommunications technology as a key factor for the rapid and dramatic change in the structure of financial institutions and markets. We adopt this approach and further emphasize the catalytic role of DLT in the intermediation changes.

4.2. Stablecoins

‘Stablecoins are a type of cryptocurrency whose value is pegged to another asset, such as a fiat currency or gold, to maintain a stable price.’ (Hertig & Bochran, 2024). Therefore, stablecoins can be subject to much financial innovation, depending on the choice of asset to which it is pegged. As the name implies, stablecoins try to provide some price stability. This, of course, depends on the stability of the underlying asset. “A stablecoin is a form of digital asset that can be used to make payments…Stablecoins are backed by a specified asset or basket of assets which they use to maintain a stable value against that asset. This is usually a country’s currency, such as the U.S. dollar. This makes stablecoins different from crypto assets, which tend not to have assets as backing and so, are more volatile.” (Bank of England, 2023). For example, the majority of stablecoins are pegged to the U.S. Dollar, like Tether and USDC. There are other stablecoins which are pegged to rather ‘weak’ currencies as the Argentinian Peso (ARS), the Colombian Peso (cCOP), Nigerian Naira (cNGN), and the Turkish Lira (TRYB). These fiat currencies in which these stablecoins are pegged experienced relatively high volatility, and the respective countries experienced rather high inflation and monetary and financial instability.

The issue of price stability of an asset and currencies can be debatable, especially in cases of inflation. Different assets and fiat currencies have different volatility. In some cases, this volatility is considered high and can cause instability. There is literature on currency instability (for example, McKinnon, 1982; Dornbusch et al., 1995; Rogoff & Reinhart, 2003). However, it can be simplistically argued that there are monetary issues and instability when inflation passes the standard 2% benchmark, especially if this figure is significantly higher.

Nevertheless, stablecoins are not without problems. The most illustrious case of a stablecoin failure is TerraUSD and Terraform. Briola et al. (2023) analyze the Terra-Luna case stablecoin’s failure and highlight the need for reserve asset composition transparency. Terra USD failed after a coordinated liquidity attack, which depleted its reserves, causing its peg to the U.S. dollar to collapse. Therefore, the inadequate reserves and requirements were the key determinants for this stablecoin failure. “Although the term ‘stablecoin’ is commonly used, there is no guarantee that the asset will maintain a stable value in relation to the value of the reference asset when traded on secondary markets or that the reserve of assets, if there is one, will be adequate to satisfy all redemptions.” (Hertig & Bochran, 2024).

4.3. Development in the Issuance of Stablecoins

Stablecoins have been issued for a significant period. It is interesting that the different forms that stablecoin organizations have. Stablecoins can be related to foundations such as The Maker Foundation and DAI, associated with companies like Bitfinex and Tether, and USDC and the Circle Internet Group, listed on the NYSE. Big Tech also attempted to be involved in stablecoins such as Facebook’s Diem (formerly known as Libra).

It might be of particular interest to note that Diem was acquired by Silvergate Bank, but its effort to eventually launch Diem failed. Silvergate Capital, the parent company of Silvergate Bank, filed for bankruptcy after a run on the bank and a series of crypto companies failing in 2022, including FTX (Knauth, 2024). Silvergate Bank focused on crypto-assets, and its digital asset customers were about 58% of Silvergate Bank’s overall deposits in 2021, and although the bank managed to repay all customer deposits, the sudden withdrawals forced the bank to sell long-term assets at a loss (Knauth, 2024).

The first bank to launch a stablecoin was JP Morgan Chase in 2019, which used its stablecoin internally to enable payments between institutional accounts in its wholesale payments business, but not in retail (Russon, 2019). JP Morgan’s digital token, JPM Coin, reached USD 1 billion in daily transaction value in 2023, and the bank planned to expand its usage. During the writing of this paper, JP Morgan announced that it is taking a further step and launching a token called JPMD (Browne, 2025). JP Morgan Deposit Token (JPMD) is an electronic payment instrument issued by a bank, representing funds that have been deposited by a customer. It can be deployed on public and private blockchain networks and is intended to be transferable among the issuing bank’s direct customers as well as between their eligible customers.’ (Kinexys by JP Morgan, 2025). However, as with JPM Coin, JPMD would be only available to JP Morgan’s institutional clients, but it is a first small step into using the tokens for retail purposes, but it falls short of stablecoins, which are available to the public (Browne, 2025). While JP Morgan’s initiative is an important step for the development of bank stablecoins, it is not available to the public; therefore, it is not characterized as a stablecoin, and it might be subject to scalability and other limitations hindering its broader adoption.

Major banks in different countries, such as Société Générale (France) (EURCV), ANZ Bank (Australia) and Sumitomo Mitsui (Japan) have launched stablecoins mainly due to the GENIUS Act in the U.S. (2025) and EU’s MiCA regulations (2024), while other international banks like Citigroup and Bank of America are exploring stablecoins (Stablecoin Insider, 2025). Financial institutions from Bank of America to Fintech companies like Fiserv, (big tech as Amazon and global companies like Walmart are reported to be considering tokens or launching their own U.S. dollar-backed stablecoins (Lang, 2025).

This is a breakthrough in the development of stablecoins. Not only are banks entering digital currency, but also other companies. This can be compared to the free banking period during which not only banks, but also other companies issue notes. Most importantly, some of the banks that are introducing digital currency, or plan to, are large global institutions that can have substantial influence and transform financial markets. Fintech companies like PayPal and FinServ can provide financial innovation in the issuance of stablecoins, along with complementary services (i.e., payments) and create synergies that can further transform currencies and financial products and services. In addition, the reported participation of Big Tech, like Amazon, with a predominant impact on e-commerce and electronic payments, and Walmart, the biggest retailer in the world, can trigger further adoption of stablecoins.

Stablecoins are managed by a mix of organizations, mainly foundations but also companies. In unique cases, Big Tech has launched stablecoins, such as Meta (Facebook) mentioned above, and PayPal, which launched in August 2023 the PayPal USD (PYUSD), a stablecoin backed by U.S. dollar deposits, U.S. treasuries, and similar cash equivalents, that can be redeemed 1:1 with U.S. dollars (PayPal, 2023). Other technology companies have successfully launched and operated stablecoins, but it can be argued that they have not been tested under adverse conditions (i.e., crises, etc.). Facebook did not manage to launch its own digital currency for various reasons. There are also notable scandals surrounding the Terraform Labs case.

Regulatory changes, namely the U.S. GENIUS Act and the EU’s MiCA regulations, have paved the way for stablecoins and digital currency issuance by banks and other corporations. The type of organization is crucial, since in the case of failure, responsibility, accountability, and in some cases, liability should be assigned. The participation of reputable banks, financial corporations, and FinTech companies, as well as Big Tech and other technology and large global companies, provides added trust to the already secure and transparent (trustless) DLT and its applications. However, technological, regulatory, financial, and other challenges remain.

4.4. Financial and Monetary Innovation and Free Banking Stablecoins

While regulatory developments have opened the door to issuance of stablecoins, they are not without challenges. Since they are pegged most frequently to a state-issued fiat currency, that are only as stable as the underlying asset, fiat currencies are subject to government monetary and fiscal policies that can cause inflation and other problems. This can happen even in hard currencies, as the 2021–2022 inflation surge proves. Therefore, the main challenge for a stable digital currency is to be independent from government and central banks’ policies. We examine and argue for the freedom for regulated banks and other corporations to issue their own stablecoins. This issuance of free banking stablecoins is performed in a competitive manner. As Adam Smith would tell us, competition is the solution. State-issued currency is a monopoly, but digital currency faces competition, not only domestically but also globally, especially since the corporations involved possess tremendous resources.

Schuler (2000) argues for the freedom of banks to issue notes, moving away from regulation and later the effective monopoly of governments on note issuance. Selgin (2020) examines monetary freedom and refers to the Scottish free banking period for allowing banks to issue notes and compete. He also discusses future monetary freedom and future monetary innovations, arguing that there will be more and better innovations in an open and competitive monetary and banking system than in a centralized and regulated system, as the Scottish free banking paradigm indicates. Similarly, DLT and DeFi can enhance financial and monetary innovation. Interestingly enough, Selgin (2020) mentions that free monetary system firms like Walmart and Amazon could play a larger role in payments. We argued above that such corporations can have a role not only in financial innovation and payments but also in monetary innovation and participate in free banking stablecoins.

While banks and financial firms have more expertise in financial operations as reserve management, free banking should enable other corporations to issue stablecoins. Technology and other companies can bring new perspectives and innovations. This is a reason why the discussion above examined the different entities and organizations of the stablecoin markets. The evolution of this ecosystem would not only bring technological and financial innovations, but also it can result in new firm creation, strategic alliances, mergers and acquisitions, and, in general, can shape the corporate environment and industries.

5. Consideration for Free Banking Stablecoins

With all this discussion we propose some considerations for free banking stablecoin issuance. We should emphasize that this paper does not attempt to propose definite infrastructure or system(s) of free banking, but rather considers some critical factors for structuring free banking stablecoins. This is performed to encourage innovation. These considerations cover a range of important issues and can be separated into four broad categories: (1) technological, mainly examining DLT; (2) financial, with a focus on intermediation, reserves, and clearing; (3) exchange rates and international issues; and (4) other considerations. These considerations can be applied to other financial firms and any corporation that would like to issue stablecoins.

5.1. Technological Considerations

Technology has enabled stablecoins and associated applications. The introduction of blockchain and later other types of DLT made it possible to have digital currencies. In a survey Savadatti et al. (2025) examine DLT for scalable computing, as a paradigm shift from traditional centralized models, which has profound implications for security, transparency, and scalability in computing systems. Although they recognize the potential, they also find several challenges. They suggest that scalability and performance are critical concerns, with performance limitations in transaction throughput and latency (Savadatti et al., 2025).

Scalability can be considered the most severe problem. DLT has significant scalability challenges as it grows and is adapted, mainly because it prioritizes security and decentralization over scalability (Savadatti et al., 2025; Zheng et al., 2018). It is widely known that Bitcoin is limited to 21 million coins, and other cryptocurrencies and stablecoins have similar limitations. Although there is progress on DLTs and related applications in latest versions of cryptocurrencies (i.e., Cardano, Solana, etc.), the scalability issues remain. There is significant literature on the challenge of scalability (for example, Khan et al., 2021; Rao et al., 2024; Rebello et al., 2024; Sanka & Cheung, 2021).

Scalability becomes an even bigger challenge if examined under the lens, magnifying in this case, the total amount of money. The IMF’s World Economic Outlook (April 2025) estimates that the global GDP is around 113.4 trillion USD, while the broad money (M2) as a percentage of the world GDP is around 140%, so in total, the broad money amounts to almost 160 trillion USD. This rough estimate does not account for other types of money (M0, M1, etc.) and associated measurement issues. Nevertheless, it is evident that the cryptocurrency and stablecoin market is just a small proportion of the broad money supply. Scalability to these levels can be a significant technological challenge.

It is important to present some technical considerations concerning financial aspects of free banking stablecoins, as note exchange and clearinghouses, which are also connected to scalability. As argued in the next part, it is hard to predict the form of innovative financial market infrastructure for stablecoins. First, there are different types of DLTs varying in the degrees of decentralization and access. While Bitcoin and other cryptocurrencies are public and permissionless, stablecoins like Tether and USDT are public, but some permissions exist, and recent banking stablecoins like JP coin have even more permissions and restrictions to access, allowing only a small number of selected participants.

This variation in DLTs, applications, and associated business models raises considerable technical challenges not only for the development and evolution of free banking stablecoins but also for the broader digital transformation of financial market infrastructure (FMI). An example is the Digital Financial Market Infrastructure (D-FMI) platform, which is based on Distributed Ledger Technology (DLT) and aims to improve market efficiency, connections, and integration through innovation (Euroclear, 2025). D-FMI is connected to the Euroclear Bank and its settlement platform, and it is also fully integrated within Euroclear Bank, providing compliance with the Central Securities Depositories Regulation (CSDR) (Euroclear, 2025). It is very interesting that such a platform is also integrated with regulatory issues, analyzed in more detail below. Even if we assume that such a platform can be created for free banking stablecoins, the integration with different types of stablecoin DLTs would be challenging, to say the least.

The note exchange and clearinghouse mechanisms among stablecoins with different DLTs can present further technical issues. First, it can be a complicated FMI with bilateral and multilateral note exchanges as well as clearinghouses, with free banking stablecoins around the world denominated in various fiat currencies. Even some organizations and companies that already offer stablecoins should have independent internal systems to manage and settle the transactions of the different types of DLTs for the same stablecoin. As technological innovation increases and there are new types of DLTs, the task of note exchange and clearing is becoming even more complicated and difficult. As already mentioned the problem of interoperability among DLTs has not been solved by interoperable blockchain protocols.

There is significant literature on blockchain interoperability. Ren et al. (2023) conduct a systematic and comprehensive survey on blockchain interoperability and identify security and privacy challenges in interoperability across permissioned and permissionless blockchains and interacting with scripting blockchains. Several blockchain architectures and solutions are being proposed. Most proposed solutions have been developed in isolation, without a standard protocol or cryptographic structure to work with. The state of heterogeneous blockchain-to-blockchain communication, where different blockchain platforms are unable to communicate and limit use, leading to interoperability problems, has been reviewed and analyzed, and the creation of blockchain-specific standards has been proposed (Kotey et al., 2023). Pang (2020) noticed that the current blockchain landscape is fragmented, with many blockchain systems being in silos, and therefore, interoperability becomes a critical factor for blockchain adoption. An innovative consensus protocol, Multi-tokens Proof of Stake (MPoS), has been proposed for blockchain interoperability architecture (Pang, 2020). However, even such an interoperable architecture is limited to Proof of Stake systems, and there are still questions about scalability and performance. Finally, Belchior et al. (2021) surveyed more than 404 documents, categorized solutions as blockchain of Blockchains and hybrid connectors, and found, among other issues, that connecting public and private blockchains remains a problem, while blockchain interoperability has a much broader scope than cryptocurrencies and cross-chain asset exchange.

Interoperability is a critical issue for DLTs. It creates significant challenges for free banking stablecoins and associated financial market infrastructure as note exchanges and clearinghouses. It is argued later, from a financial perspective, that note exchanges, clearinghouses, and other FMI could start from a simple form of bilateral exchanges and evolve to more complex clearinghouses and FMI. This would be subject to technological innovations in blockchain interoperability as well as policy and regulatory issues that can facilitate such developments.

While it can be argued that interoperability and scalability remain the biggest challenges, there are additional issues. There is a complex nexus of trade-offs among key features of DLTs such as security, decentralization, scalability, and performance. There are additional challenges, such as governance and management (Savadatti et al., 2025). Such technical issues are beyond the scope of this paper.

Energy consumption considerations should be highlighted because energy costs can be significantly high, and this discussion can be related to other considerations presented below. Energy consumption is important because it can be considered a transaction cost of stablecoins, although the latest technology advancement (move from Proof-of-Work to Proof-of-Stake) has improved energy efficiency in DLT. Within more efficient Proof-of-Stake (PoS) consensus mechanisms, there are different DLTs. There are various PoS-based DLTs, and there can be further improvements concerning the energy consumption, while PoS systems are an under-researched area (Ibañez & Rua, 2023). Energy consumption involves transaction costs. At the same time, energy consumption and DLTs imply additional resources and costs, as hardware (i.e., computing power, etc.).

The question rising from an economic and financial point of view is who is going to be responsible for these energy and associated transaction costs? This is why types of organizations and corporations, and the respective business models, are critical for this analysis. Organization, along with technology as smart contracts and governance, would define the operations and business models of stablecoins.

5.2. Financial Considerations

Transaction costs bring the discussion into the financial and economic considerations. The first financial consideration is the type of organization and ownership, and therefore, the corporate governance and decision making of who is responsible for such transaction costs. Ownership would also decide on the business model and financial operations. The broader issue of organization, ownership, governance, and theory of the firm can have significant implications for our discussion. For example, Gorton (1985b) mentions the theory of the firm literature seeking to explain why organizations, such as firms, are preferred to a price system for allocating resources and highlights that the U.S. banking industry, prior to the existence of the Federal Reserve System, is such a unique example. This organizational structure is essential to effectively and efficiently manage reserves and other aspects of a free banking stablecoin system, which is, however, subject to future research.

5.2.1. Reserves

Probably the most important financial consideration, following the lessons of free banking, is reserve requirements and management. Calomiris (2021) proposes that fractional reserve stablecoin banking can replace Bitcoin and some traditional banking payments. He argues that a fractional reserve stablecoin can be possible and be based on banking. Reserves would depend on the structure of the stablecoins, since they should encapsulate the assets they are pegged to. Bank and corporate reserve management might be a challenging task. It is not only that banks and corporations issuing notes are unprecedented, but also, they would undertake reserve management that, for many decades, was the responsibility of central banks. Bianchi and Bigio (2022) suggest that monetary policy operates through the banking system. A bank’s liquid assets are composed of bonds and reserves, and monetary policy affects the bank’s liquidity, while the bank can reduce liquidity risk at the cost of profits from intermediation (Bianchi & Bigio, 2022).

The bank can sell bonds or other assets to replenish its reserve. These assets should be liquid enough to be exchanged for reserves when depositors demand their money, to avoid a bank run. The bank can also borrow liquidity for reserves from the interbank market. A similar market mechanism, such as interbank markets or a market including other corporations, can also serve this function. We should not forget that regulation can distort the banking and financial markets. In this case, deposit insurance and capital requirements can play a critical role. Calomiris and Jaremski (2016) examine deposit insurance and other regulatory aspects as minimum equity capital and cash holding requirements, limits on lending practices, and other prudential policies, and conclude that liability insurance has been associated with increases in systemic risk. Therefore, in the case of free banking stablecoins, a market mechanism might work better.

Reserves could also depend on regulation, like deposit insurance, minimum capital requirements, discussed in more detail below. As mentioned above, the reserves should be liquid to react effectively to panics and potential bank runs. This consequently depends on the existence of reserve management mechanisms, like note exchanges and/or clearinghouses, or any other innovative financial mechanism, which coordinates and manages reserves among banks and other note-issuing organizations. We examine note exchanges and clearinghouses in the next parts.

Stablecoin and issuing organizations should decide if they would like to hold 100% reserves or fractional reserve banking, and if the latter which looks more likely, to what extent. The Diamond–Dybvig model and related fractional reserve literature would be an interesting area of future research on stablecoins. Fractional reserve banking for free banking stablecoins would depend on the associated systems, like note exchanges and/or clearinghouses, as well as regulation discussed later. This is an issue for considerable future research.

It should be however emphasized that we consider stablecoins and associated applications in Fintech unique. This is due to the speed of transactions, which is unprecedented. This can have a significant effect on bank runs. The Terra/Luna collapse unfolded in approximately a week. Rose (2023) studied several banks in 2002 and 2023 experiencing deposit runs, which were extraordinarily fast, and it was attempted to be explained by three factors: technology that has enabled faster deposit withdrawals, social media providing information and coordination among depositors, and uninsured deposits. Social media can be considered part of technological advancements. All three of these factors apply in the case of stablecoins.

5.2.2. Reserves and Transparency

A major issue has been the transparency of reserves. Cukierman (2013) suggests that “transparency has become a widely acclaimed ingredient of good practice in monetary policy” and highlights private information about liquidity or solvency problems in parts of the financial system, and finds that in the Diamond and Dybvig (1986) model, immediate transparency can have negative effects. Therefore, transparency remains a challenging issue. Similarly, Issing (2005) emphasized the importance of transparency not only as a public obligation but also as a real benefit to monetary policies and connected it to accountability and communications. We mentioned just above the importance of communications in reference to social media. This highlights the increasing importance of digital technologies but also the interrelation of technological with financial issues, and as we would argue later, with regulatory and other considerations.

Although the discussion revolves around central banks and monetary policy, the transparency of reserves is an argument directly relevant to free banking stablecoins. We believe that information and transparency are essential for stablecoins. Transparency also applies to banks. For example, Ratnovski (2013) examines banks and argues that an unregulated bank may choose insufficient liquidity and transparency while suggesting that liquidity requirements should be complemented by measures that increase bank incentives to adopt transparency. In this case liquidity can be associated with reserves and how liquid they are. Concerning stablecoins, it is demonstrated that transparency provides incentives to stablecoin issuers to have a larger proportion of reserves in liquid assets, and therefore, reduces the risk of bank runs and bankruptcy (Castren & Russo, 2024).

Free banking stablecoins could also adopt or create their own transparency standards. The adoption of the IMF’s International Reserves and Foreign Currency Liquidity Data Template standard is associated with a significant decrease in volatility and changes in the relationships between exchange rate volatility and both indebtedness and reserve adequacy indicators (Gonzalez-Garcia & Cady, 2006). This can be related to the next part on exchange rate considerations. “Transparency calls for robust, not more, financial regulation” and there can be a combination of legal rules with self-regulation (Kaufmann & Weber, 2010). Self-regulation can be an effective way for free banking stablecoins.

Carapella (2025) states that stablecoin issuers are like banks, because they allow investors to withdraw their funds on demand, and therefore, it is a fractional reserve model, with the risk of becoming illiquid when many depositors withdraw their money. A mutualization fund is proposed related to reserve assets, comparable to what we suggested above, and this institutional arrangement can be purely private and self-enforcing. Fong and Yahya (2022) examine free banking stablecoin and reserves and suggest that regulation should come at the state level. We already displayed that reserves and their transparency can be related to other considerations as exchange rates and regulation, examined below, and that all these issues are interrelated and form a complex nexus. Finally, it should also be highlighted that financial considerations and reserve management, and transparency can be strongly related to technological considerations.

An important concept that bridges financial consideration, and, in particular, reserve requirements, which is a main theme and lesson for free banking stablecoins, and technology consideration, is Proof of Reserves (PoR). PoR, also known as Proof of Assets, provides ownership of digital assets in the blockchain, and in an exchange, should prove that assets are equal to or greater than liabilities (Chalkias et al., 2020). Dutta et al. (2021) argue that Proof of Reserves protocols enable cryptocurrency exchanges to prove that they have enough reserves to meet liabilities towards their customers; comment on MProve, which was the first PoR for Monero; and propose MProve+ as an alternative. Lazirko et al. (2025) propose a Double-Helix Framework Proof of Reserves system because cryptocurrency exchanges face increasing pressure for reserve adequacy and regulatory compliance, as well as investor protection in digital asset management. This highlights that the perspectives of financial and technology are also related to regulatory and other perspectives, forming a complex nexus, which is continuously changing. In addition, there is increasing technological financial innovation, which can enable free banking stablecoins.

5.2.3. Note Exchanges

In addition to the interbank market, other market mechanisms that can contribute to monetary and financial stability are exchanges and clearinghouses. We already discussed the Scottish free banking period note-exchange system that helped in the coordination of banks and reserve management. A similar note exchange system that also facilitates exchange of reserves can be implemented for free banking stablecoins. This system can be initially administered by a bank or even a technology company related to trading cryptocurrencies and stablecoins, and later evolved to more complex systems.

Selgin and White (1987) discuss how the note exchange mechanism evolved into clearinghouses. They mention that bilateral note exchanges are the most readily available, while in a system of more issuers, multilateral note exchanges provide greater economies. Selgin and White (1987) mention reserve holding economies and the offsetting of claims by multilateral clearing and suggest that the institutional structure of multilateral note and deposit exchange in the form of clearinghouses may have evolved from simpler note exchange arrangements. We adopt this evolutionary approach.

Free banking stablecoins might start with bilateral note exchanges between banks, like JP Morgan and Société Générale. As more banks are considering launching stablecoins, in some cases, like consortia of ING, UniCredit, Danske Bank, Banca Sella, KBC, DekaBank, SEB, CaixaBank, and Raiffeisen Bank International (Sims et al., 2025), the note exchange mechanisms can become more complex. Consortia can launch their own multilateral note exchanges to serve their members. These multilateral note exchanges can then service other parties and cryptocurrencies and interact with other multilateral note exchanges, for example, between stablecoins from different countries and fiat currencies (i.e., USD and Euro). This can assimilate foreign exchange markets, and we will analyze it later.

Munn (1981) analyses the origins of the Scottish note exchange and describes that the two biggest banks in Scotland started a bilateral note exchange Bank of Scotland and the Royal Bank, and then smaller banks imitated such bilateral exchanges as Aberdeen and Perth United Banking Companies of Scotland, and then the Perth bank made a bilateral note exchange arrangement with the Dundee Banking Company. While there were bilateral exchanges, the Ayr Bank arranged for note exchange with several of the provincial banks, and then the British Linen company, and later the two major banks, the Bank of Scotland and the Royal Bank of Scotland, joined (White, 2023). This displays that the Ayr bank, while not one of the biggest banks, innovated by creating a multilateral exchange. Similar lessons can apply to free banking stablecoins and smaller banks, which can initiate multilateral note exchanges. As we discussed earlier, technological innovation can play a critical role in the evolution of the note exchange and the clearinghouse.

5.2.4. Clearinghouses

At this point, although they can be considered as synonyms, it would be useful to distinguish between a note exchange and a clearinghouse. An exchange, in simple terms “the action, or an act, of reciprocal giving and receiving” and in the note exchange context “the action of giving or receiving coin in return for coin of equivalent value either of the same or a foreign country, for bullion, or for notes or bills; a bargain respecting this; the trade of a moneychanger. bank of exchange: the office of a moneychanger or banker” while a clearinghouse is “An institution in London established by the bankers for the adjustment of their mutual claims for cheques and bills, by exchanging them and settling the balances (often with capital initials) (Oxford English Dictionary, 2025). Clearinghouses can imply many more financial considerations, as a settlement mechanism, managing counterparty risk, and emergency lending that can be connected to reserve management. Therefore, a clearinghouse is a more complicated, sophisticated, and evolved system than a note exchange, and its study in the context of clearinghouses can be a distinct topic of future research.

Gorton (1985b) emphasized the importance of clearinghouses. He traces the first clearinghouse in the United States in New York City banks in 1853, established by banks and simply created an organized market where exchange between banks occurred, because rise in demand for deposits related to bank notes in the free banking period. Gorton (1985b) makes two important observations, among others: the functions of clearinghouses resembled those of a central bank and “in fact, it is almost literally true that the Federal Reserve System, as originally conceived, was simply the nationalization of the private clearinghouse system”, and that there is a floating exchange rate system between bank notes and specie, which was functioning well because secondary markets in bank notes.

The first observation is critical for free banking stablecoins, since it indicates that clearinghouses can be sufficient and central bank intervention and regulation might not be necessary. This would also be discussed in the regulation part. Concerning the free-floating exchange rates argument, it emphasizes the importance of exchange regimes discussed in the following parts. Finally, it should be suggested that an innovative clearinghouse system for free banking stablecoins could provide liquidity and act as a ‘lender of last resort’.

Timberlake (1984) traces the development of the clearinghouse association from its inception in 1857, related to payments, to 1907, when its function Federal Reserve System ended a quasi-central banking institution. He concludes that a fractional reserve banking system has some instability, and clearinghouses presented a solution for creation of temporary currency. In the same way, technological, financial innovations, and circumstances can enable digital clearinghouses to improve monetary and financial stability for free banking stablecoins. Jaremski (2015) also examined clearinghouses before the establishment of the Fed and found that they provided emergency liquidity and might have led to reserve efficiency, avoiding contagion and therefore greater stability. Kroszner (2000), examining the period before the establishment of the Fed, finds that a critical feature of bank clearinghouses is the effective integration of the members in times of distress, displaying how the private markets develop contracts and institutions to manage risk and therefore improve financial and monetary stability. Clearinghouses can also complement, mainly bilateral note-exchange systems, or even act independently.

5.3. Exchange Rate Considerations

The discussion of note exchanges, clearinghouse, and the broader FMI and their technological and financial considerations have been related to foreign exchange. Free banking stablecoins, especially if pegged or related to fiat currencies, could behave as national currencies, and therefore, foreign exchange mechanisms would be essential. M. R. King et al. (2012) analyze the technological advances in trading practices and market structure in recent decades, from FX trading involving the telephone and all trading involving institutions, while individuals were rather excluded, to innovative electronic trading platforms with streamlined trade processing as well as settlement, and reduced trading costs enabling retail traders. While the electronic revolution in FX has transformed the market structure, improved transparency, and reduced transaction costs, many aspects of the FX market have remained the same for decades, as the markets remain decentralized, with continuous trading and high liquidity (M. R. King et al., 2012). Similarly, Chaboud et al. (2023) found that the FX has become far more complex in the past three decades, has been subject to notably less regulation than other markets in most countries, and is an increasingly fragmented electronic market.

This decentralization and fragmentation can facilitate DLT applications. Adams et al. (2023) compare the traditional FX trading and settlement with blockchain-based implementations using stablecoins and automated market-making protocols (Uniswap). Agarwal et al. (2023) surveyed papers related to blockchain-based clearing and settlement systems, including applications in FX. However, FX applications are very limited, especially taking into account the size and importance of these markets. Future work can focus on these aspects.

The IMF has a ‘Classification of Exchange Rate Arrangements and Monetary Policy Frameworks’ ranging from Exchange Arrangements with No Separate Legal Tender and Other Conventional Fixed Peg Arrangements to Independently Floating. Stablecoins deviate from their peg. Duan and Urquhart (2023) find compelling evidence of instability of stablecoins, although these deviations are gradually corrected. Eichengreen et al. (2025) observe that stablecoins experience devaluation risk like traditional currencies under pegged exchange rate regimes and find that interest rates can mean higher devaluation risk. It is therefore critical to understand the behavior of fiat currencies upon which stablecoins are based, and which are the factors for the variation in fiat currencies and exchange rates. Exchange rates and their variation, especially in the form of devaluation, are important for the adoption of stablecoins, as we will see in the section below.

The stablecoin pegging is a fixed peg arrangement. These stablecoin fixed pegs do not allow much, if any, flexibility. A justification of free banking was to allow choice in currency issue. This can be translated to pegged arrangements, allowing some fluctuations. To further enhance individual choice, other regimes as independent floating might be allowed, according to conditions.

But stablecoins do not need to be pegged to fiat currency. They can be pegged to other assets, such as metals and commodities. Gold is the most illustrative example, since there is a long history of the gold standard, but not the only option. Stablecoins pegged to different assets can provide significant opportunities for financial innovation and competitive differentiation, and provide more consumer choice. Nevertheless, careful consideration must be paid to the assets, their combination, and particularly their volatility, in order to avoid deviation of stablecoins from their primary objective to offer stable currencies.

5.4. Regulatory and Other Considerations

However, before we move to the next section, we should highlight the variety and complexity of factors that can influence the creation and adoption of free banking stablecoins. One of the key challenges is regulation. It should be emphasized, as in the beginning of this paper, that the note issuance rather than other aspects like regulation and competition are analyzed. Although recent regulations have encouraged the development of stablecoins, there are still significant regulatory hurdles, especially regarding the legal tender of cryptocurrencies and stablecoins. Concerning (free) banking, there is also significant banking and financial regulation. This is becoming much more complicated on the international level, since there are diverse regulations. To make things even more complex, countries around the world have radically different policies (i.e., China has banned stablecoins and cryptocurrencies).

There are significant regulations that encourage the development of stablecoins and are directly related to the development of free banking stablecoins. The Executive Order on Strengthening American Leadership in Digital Financial Technology suggests “promoting and protecting the sovereignty of the United States dollar, including through actions to promote the development and growth of lawful and legitimate dollar-backed stablecoins worldwide”. The GENIUS act followed, with the purpose of making the U.S. the leader in digital currencies. It created a Federal regulatory system for stablecoins, ensuring their stability with 100% reserve backing, with liquid assets like U.S. dollars or short-term Treasuries, and with transparency requirements for consumer protection (U.S. Congress, 2025a). Additional regulations like the Stablecoin Transparency and Accountability for a Better Ledger Economy Act of 2025, or the STABLE Act of 2025, would establish a regulatory framework for payment stablecoins and have reserve requirements (U.S. Congress, 2025b). These regulations facilitate the development of stablecoins, but at the same time, they suggest pegging to the US dollar and have strict reserve requirements.

In the European Union, the Markets in Crypto-Assets Regulation (MiCA) covers crypto-assets that are not currently regulated by existing financial service legislation and covers transparency of transactions, financial stability, consumer information, and protection (ESMA, 2025). MiCa also has significant reserve requirements. However, MiCa does not use the term stablecoins, and it is different in some aspects, raising the issue of conflict of laws at the international level. It also gives significant authority to the European Banking Authority (EBA). There are additional regulatory issues that are not the direct concern of this paper and could be subject to future research.

Policymakers and central banks would have to assess how stablecoins can affect monetary sovereignty, financial stability, payment systems, and international policy coordination, while it is pivotal to have stronger global coordination on the regulation of stablecoins (Schaaf, 2025). This has much broader implications and requires tremendous political and international effort to coordinate policies and regulations, particularly since countries could have opposing and significantly diverse policies. Consequently, the role of international financial organizations, notably the IMF and BIS, should be re-examined.

6. The Benefits of Free Banking Stablecoins

Stablecoins and cryptocurrencies are becoming from a niche market a significant feature of Venezuela’s economy, “as locals see the blockchain as a bulwark against their cratering currency and a government crackdown on black market dollars.” (Daniels & Brazón, 2025). They suggest that the use of stablecoins as USDT pegged to the dollar is becoming widespread. In Bolivia, with 25% inflation, crypto has started to replace the domestic fiat currency (Cobo & Mendoza, 2025). In Bolivia, a range of regulations and restrictions in obtaining foreign currency encourage the adoption of stablecoins, and stablecoins are also adopted in Indonesia, since they are convenient for international payments and they involve less transaction costs (Boos, 2025).

While inflation and price stability are the primary reasons for stablecoin adoption in emerging and frontier markets, there are other reasons and benefits of free banking stablecoins. Access to foreign exchange, international payments, and, in general, international trade and services is another major benefit of stablecoins. Stablecoins can provide alternatives to fiat currencies when government restrictions exist. Capital controls and additional regulations can prevent international transactions and limit trade and economic growth. Kroszner (1995) suggests that international trade played a key role in the Scottish economy in the free banking period, which was subject to external shocks, like many emerging countries today, and associated developments in the international economy and international trade. Lal and Jatav (2024) examine the effects of digital currencies on the development of international trade and economic growth and highlight how digital currencies can redefine international trade and spur economic growth.

While digital currencies can enable international trade, they can also be generate challenges. Dent (2020) argues that China’s new central bank-issued digital currency DCEP (Digital Currency/Electronic Payments), classified as a stablecoin, can violate World Trade Organization (WTO) agreements, like the General Agreement on Tariffs and Trade of 1994 (GATT) and the General Agreement on Trade in Services (GATS). Moreover, China’s domestic banks are mainly state-owned, and “the DCEP grants China incredible authority to manipulate international trade.” (Dent, 2020). Free banking stablecoins can have a dual benefit. First, free banking stablecoins would challenge government monopoly and potential currency manipulation for international trade. At the same time, stablecoins and related services (i.e., payments) can assist in the liberalization, decentralization, and competition in the banking and financial services industry. We discussed the organizational types and ownership in free banking periods as well as stablecoins, which are, in general, private (although in some cases, non-profit). Private corporations and banks issuing notes and offering additional financial services can open government monopolies, but also international trade and services. At the same time, decentralization and DeFi can change financial intermediation and operations in centrally planned economies.

Economic growth and economic development are related to financial intermediation. G. R. King and Levine (1993) discuss the ‘new view of financial intermediation’, in which financial intermediaries are viewed as key determinants of economic development, play a role in the survival of economic organizations, while entrepreneurs will control organizations and determine which types of investment would be made. A decentralized, open, and more accessible financial system would enable entrepreneurs to have more choices and make more investments that can boost economic growth and development.

At this point we should also mention the additional financial innovation and services related to digital currencies and their issuance. Stablecoins are often integrated with a broader payment system. In the case of free banking, there can be further financial innovation in banking and financial services. For example, we already mentioned that JP Morgan created stablecoins related to wholesale payments and token deposit accounts. As more banks, Fintech companies, technology corporations, and other, often big, businesses consider the adoption of stablecoins, there can be more financial innovation and services. There can be such innovations in borrowing.

Wyplosz (2004) examines financial instability and monetary policy in emerging market countries in reference to currency issuance for bonds and notes and underlines the ‘original sin’. The original sin (Eichengreen et al., 2025) refers to the fact that most countries cannot borrow in their own currencies, since international investors will not lend to a country if they believe that the country will then inflate away its currency and therefore its debt. Therefore, monetary policy is key for inflation, but also enables emerging countries to borrow. Free banking stablecoins can provide a solution to sovereign borrowing. Although countries can borrow in stablecoins pegged to the U.S. dollar or other hard currencies, free banking stablecoins can enable more financial engineering and association, at least partially, with their domestic currencies, commodities, or any other assets that might be more appropriate. At the same time, banking and financial institutions can facilitate the borrowing process. It has been argued that stablecoins cannot only affect government borrowing but also businesses and households (Huther & Wang, 2025).

The free banking period in Scotland illustrates that financial institutions have the incentives to create a clearing system, benefit both the banks and the public (Kroszner, 1995). Similar clearing systems can be created for free banking stablecoins in emerging economies. In creating a clearing system so financial institutions can become members of this system, they would have to develop standards for capital, liquidity, and prudential management (Kroszner, 1995). Another lesson from the Scottish free banking period is that competition is compatible with stability and coordination, and it can be concluded system worked well in fulfilling the functions of a central bank. In emerging economies, but also other countries, the introduction of free banking stablecoins and associated financial innovations can improve institutional infrastructure and consequently monetary and financial stability.

7. Summary and Conclusions

Stablecoin has enormous potential to revolutionize the banking system, but the full potential of stablecoins can only be released if it is based on free banking principles. Free banking stablecoin means that not only banks, but also other corporations can issue notes in the form of digital currency. If stablecoins mostly mimic state currencies, they will be bound by government inefficiencies and never realize their full potential, and never have an innovative impact on the global financial system. But, if the issuers and proponents adopt the lessons from successful free banking episodes, have significant competition, convertibility, and implement policies that create price, monetary, and financial stability, stablecoins can become a valuable alternative to fiat currencies.

In this paper we examined free banking periods in Scotland and the U.S. and, through narrative, we extracted some useful lessons from these periods. This is a limitation of our study, examining only two cases of free banking despite their importance. Moreover, we focused on note issuance rather than a broader analysis of competition and regulation concerning free banking, and such issues can be future research directions.

We found that appropriate reserves determine the success of note issuance. Additional factors for successful note issue include coordination and the institutional infrastructure, like note exchanges and clearing organizations. We argue that the banking sector is important in the evolution of alternative digital currencies because it has the expertise in reserve management and other financial operations (i.e., payments), as well as a reputation. These lessons can be applied to stablecoins to improve financial stability, enhance financial innovation, and provide numerous benefits. The freedom for regulated banks and other corporations to issue their own stablecoins should be allowed.

We examined some considerations for free banking note issue, technological exchange rates, and other considerations concerning monetary policy and regulation. These considerations are subject to future research. We analyzed some benefits, particularly for emerging and frontier economies. These benefits include price stability against devaluing fiat currencies, enabling international trade transactions and payments, and enabling innovative financial services as credit provision. Not only do they create the benefits that come from competition in every economy, but they also create ways for entrepreneurs and investors in countries with dysfunctional finance systems an alternative to that dysfunction and allow people to escape poverty despite incompetent and corrupt government policies. Some of these benefits can also apply to developing and developed countries, which experienced significant inflation and other inefficiencies (i.e., Inflation Surge of 2021–2022). The benefits to emerging and developed economies can also constitute future research directions.

The value of proposing free banking stablecoins, stablecoins that both banks and corporations can issue, has numerous implications. It has significant implications for financial innovation and can create value for entrepreneurs and markets. At the same time, it can facilitate efficiency in financial markets. The implications of this study are not only for innovation, banking, financial markets, and the broader industry but also for public policy. Governments can consider a free banking stablecoin and, based on the considerations analyzed above, improve and ensure monetary and financial stability.