Liquidity dilemma of non-USD stablecoins: the core issue is not demand, but the heavy burden of banking regulatory systems

Many people believe that the stagnation in non-USD stablecoin growth is due to insufficient market demand. This judgment is actually completely wrong.

Data shows that the daily volume of non-USD foreign exchange trading exceeds $3.2 trillion, indicating how enormous the cross-border settlement demand for multiple currencies is. The real source of the problem lies on the supply side—the global banking system’s incentive mechanisms have completely failed.

Why Banks Are Escaping Non-USD Channels

When a bank wants to support trading in emerging market currencies like the Brazilian Real or the Mexican Peso, it faces not just a single constraint but a multi-dimensional regulatory squeeze. This mechanism is built upon Basel III, introduced after the 2008 financial crisis, which includes three layers of capital and liquidity requirements.

First is the liquidity crisis. Under Basel III, banks must hold enough “High-Quality Liquid Assets” (HQLA) to survive a 30-day stress scenario. Seems reasonable, right? But the question is: what is defined as “high quality”?

Reserve currencies like USD, JPY, EUR naturally meet this standard—they have deep repo markets, central bank guarantees, and ample global trading liquidity. But for currencies like BRL or MXN, the situation is different. Although liquidity assets exist for these currencies, under the strict HQLA definition, they are considered “substandard assets.”

What are the consequences? If a bank wants to trade BRL/MXN, it must not only hold inventories of these currencies but also hold additional USD assets as a buffer. In other words, the regulatory framework structurally incentivizes banks to use USD as an intermediary rather than establishing direct non-USD currency pairs.

Trapped in the “Dual Financing” Liquidity Trap

Things get worse. When banks set up local entities in emerging markets to provide settlement services, these local liquidity assets—due to capital controls, asset segregation rules, etc.—often cannot be freely transferred to the global headquarters.

The regulators’ logic is: “If this money is trapped in Brazil, we can’t count it as part of the group’s liquidity buffer.” The result? Banks must finance in two places simultaneously—they need to hold trapped liquidity locally and also maintain redundant liquidity in London or New York.

This effectively imposes an invisible tax on each non-USD channel. In contrast, USD-centric trading models do not have this problem—USD liquidity can flow freely worldwide, unrestricted by geography.

The “Time Tax” and “Cartel Effect” in Market Risk

Even if banks can handle liquidity constraints, they face a second blow: market risk capital.

Under the FRTB (Fundamental Review of the Trading Book) framework, banks need to allocate sufficient capital to cover market fluctuations for their positions. The key metric is “liquidity horizon”—regulators assume how long it takes for a bank to safely exit a position during a market crisis.

For major currency pairs like USD/EUR, the default liquidity horizon is 10 days. But for non-designated currency pairs (including many emerging market pairs), this horizon doubles to 20 days. What does this mean?

When a bank uses a risk model to calculate the capital needed for a BRL/MXN position, the model assumes it takes 20 days to exit during a crisis, doubling the capital buffer requirement. This is not just a numerical issue—it directly alters the cost structure.

Worse, these 20 days are only the statutory minimum. If regulators consider a channel riskier or less liquid, they can arbitrarily extend this horizon to 40 or even 60 days. For niche pairs like NGN/ZAR (Nigerian Naira to South African Rand), regulators might set extremely long horizons.

What incentives does this create? Banks simply dare not enter these channels—because the capital costs become prohibitively high. Even if a niche channel could generate profits, the high capital costs would swallow the gains.

The Vicious Cycle of Insufficient Liquidity

If a currency pair’s trading volume is too infrequent to meet the regulator’s “risk factor qualification test” (which requires at least 24 real price observations per year), it is classified as an “Unmodelable Risk Factor” (NMRF).

This is disastrous. The capital penalty for NMRFs is extremely severe—banks cannot use capital-efficient models and must base calculations on worst-case stress scenarios. For each NMRF, the liquidity horizon must be the larger of the specified horizon and 20 days—effectively infinite.

This creates a deadlock:

1. Low trading volume → 2. Cannot pass the test, classified as NMRF → 3. Capital requirements skyrocket, profits vanish → 4. Banks withdraw, stop quoting → 5. Trading volume drops further

Banks are caught in a paradox: “You need sufficient liquidity to make a market, but market-making itself consumes liquidity.” The only solution to this paradox is: stop market-making.

The “Unbearable Burden” on G-SIBs

The final layer comes from the G-SIB (Global Systemically Important Bank) score. This system imposes additional capital requirements based on five factors: size, cross-jurisdictional activity, interconnectedness, substitutability, and complexity.

Each factor has a weight of 20%, which sounds balanced. But for non-USD channels, this is a “triple blow.”

First is the cross-jurisdictional cost. To support BRL/MXN channels, banks need to hold local balances and settle locally in both Brazil and Mexico. Each new emerging market channel requires establishing new local balance sheets, significantly increasing the “cross-jurisdictional activity” score and triggering higher capital requirements.

In contrast, a bank that only trades USD/EUR in New York and uses USD triangular arbitrage to meet all needs will have a much lower score.

Second is the substitutability penalty. If a bank becomes the sole liquidity provider for BRL/MXN, regulators see it as a “critical infrastructure.” If that bank fails, trade between the two countries could freeze. So regulators assign higher scores—effectively higher capital costs.

This creates absurd incentives: in normal business logic, being a sole provider is an advantage; but in the G-SIB framework, it becomes a liability. A bank might think: “We dominate this niche channel, but being a ‘sole provider’ raises our G-SIB score and pushes us toward higher capital tiers. Better to shut it down and just trade USD.”

Finally, the complexity penalty. Non-USD channels, due to insufficient spot liquidity, force banks to use OTC derivatives (FX swaps, cross-currency swaps) to “manufacture” liquidity. The G-SIB model assigns high weights to OTC derivatives’ notional amounts, further increasing the complexity score.

The Real Cost Behind the Numbers

Why are these scores important? Because they directly translate into CET1 (Common Equity Tier 1) capital requirements.

Moving from one G-SIB bucket to the next can increase the required capital buffer by 0.5% of risk-weighted assets. For a bank with $1 trillion in RWA, that’s a $5 billion capital requirement.

Even if the BRL/MXN trading desk earns $50 million annually, if its activities push the bank into a higher bucket due to cross-jurisdictional and complexity scores, it could trigger tens of billions in capital costs. For a trading desk with annual profits of only a few hundred million dollars, that is a fatal cost.

Banks are not “ignoring” these channels’ profits; they are calculating that, after regulatory capital costs, the risk-adjusted return is negative.

The Conclusion: Liquidity Vacuum and the Fate of USD Centralization

What is the result of these three layers of constraints (LCR liquidity, FRTB market risk, G-SIB capital)?

The global FX market outside the G7 has become structurally dysfunctional. Direct bilateral liquidity between emerging market currencies is nearly nonexistent. Banks are incentivized to flow back into USD-centric models—radiating out: all liquidity concentrates in USD, and other currency pairs are traded via USD as an intermediary.

The advantage of this model is standardization, substitutability, and efficient netting. From a regulatory perspective, it meets all capital requirements at the lowest cost. But from a global trade perspective, it artificially restricts non-USD cross-border settlement.

Trade between currencies like MXN, BRL, ZAR must all pass through USD. Each intermediary step adds cost, delays settlement, and increases risk.

The Future of Non-USD Stablecoins

In the on-chain world, some are attempting to solve this problem by building “on-chain FX platforms”—essentially replicating the traditional FX market structure on blockchain.

But this is doomed to fail. The core issue is not technological but infrastructural cost. As long as liquidity for non-USD stablecoins depends on traditional banking systems to hold inventories and provide settlement, they will remain trapped by this regulatory “tax” system.

A true breakthrough requires DeFi-native solutions—innovations that do not rely on bank balance sheets, are not constrained by G-SIB regulations, and do not depend on traditional FX markets.

This could mean:

• Fully on-chain liquidity aggregation and market-making mechanisms
• Direct pairing and trading between non-USD stablecoins
• Protocol-managed cross-currency liquidity instead of institutions

Only then can the “liquidity vacuum” in non-USD cross-border settlement truly be addressed. Any attempt to improve within the old system framework is merely patching a fundamentally broken structure.

The real reason for the stagnation of non-USD stablecoin growth is not “lack of demand,” but “banking systems are incentivized to abandon this market.” Breaking this deadlock must involve bypassing the existing system.