The Shadow Banking of Cryptocurrencies: An Analysis Based on Credit Money Theory

April 2025, the Review of International Political Economy published an article titled "A Credit Theory of Anti-Credit Money: How the Cryptocurrency Sphere Turned into a Shadow Banking System." Based on credit money theory, the article systematically demonstrates the logical inevitability of the evolution of the cryptocurrency domain from the original concept of "anti-credit, no banking" to a system highly dependent on credit creation and shadow banking. The author points out that cryptocurrencies like Bitcoin, due to their lack of liquidity, sovereign backing, and the balance between elasticity and discipline, cannot spontaneously acquire monetary functions. The rise of centralized exchanges and stablecoins is precisely the credit arrangements introduced by market participants to compensate for these deficiencies. This evolution explains the essence of the 2022 crypto crisis and reveals how cryptocurrencies have been integrated into the sovereign currency hierarchy centered on the US dollar. The Institute of Financial Technology at Renmin University of China has translated this study.

1. Problem Statement: Why Did Cryptocurrencies Fall into a Banking Crisis?

In 2022, the cryptocurrency sector experienced its most severe systemic crisis since inception. The algorithmic stablecoin project Terra-Luna collapsed in May of that year, followed in November by the bankruptcy of the leading centralized exchange FTX. By June 2023, Bitcoin’s USD price had fallen about 70% from its November 2022 level. Many crypto exchanges and stablecoin issuers entered bankruptcy proceedings one after another. These events exhibit typical features of a classic bank run and systemic financial crisis. However, this fact contradicts the original ideological promise of cryptocurrencies: a technological-political project aimed at escaping the banking, credit, and fiat currency system, how did it ultimately evolve into a credit intermediary system and suffer a bank-like collapse?

Some studies attribute the crisis to fraud and moral hazard by individual actors, but this paper argues that a systemic analysis from the perspective of monetary theory is necessary to understand the endogenous evolution logic of the crypto system. Essentially, cryptocurrencies are a form of “anti-credit money,” attempting to function as money without any debt relationships or intermediary institutions. However, historical experience shows that cryptocurrencies can only achieve monetary qualities within limited scope by introducing credit relationships and establishing institutions functionally equivalent to shadow banks. Although this process makes cryptocurrencies closer to money, it also exposes them to the inherent maturity mismatches, liquidity risks, and bank run risks of traditional financial systems.

2. Literature Positioning and Theoretical Starting Point

In the field of international political economy, systematic research on cryptocurrencies remains relatively weak. Existing literature mainly focuses on ideological history (e.g., Eich’s tracing of Hayek’s “denationalization of money”), technological features (e.g., blockchain governance mechanisms), or regulatory practices (e.g., different national attitudes toward cryptocurrencies). Chey has called for a systematic analysis from monetary theory on how private actors promote cryptocurrencies to become money.

Mainstream views in monetary theory suggest that the Credit Theory of Money (CTM) struggles to explain the asset form of cryptocurrencies that lack issuers and liabilities. This paper argues that CTM not only explains the evolution of cryptocurrencies but is also the most powerful theoretical tool for understanding this process. Accordingly, it is proposed that centralized exchanges and fiat-backed stablecoin issuers are functionally equivalent to shadow banks; the entire crypto system has evolved into a shadow banking subsystem embedded within the sovereign currency system.

3. Credit Money Theory and Its Applicability to Cryptocurrencies

The essence of monetary credit and the three-layered structure of confidence

The core propositions of credit money theory can be summarized as two points. First, money is anything accepted as a means of debt repayment in a specific context. Monetaryness (moneyness) is not a binary attribute (is or isn’t money), but a continuous concept: some tools are more monetary than others, depending on their position within the monetary hierarchy. Second, monetaryness fundamentally depends on social trust (credere). Anyone or any institution can create money—by defining a new accounting unit and issuing debt instruments denominated in it—but the key is acceptance by others.

To systematically analyze the trust structure, Michel Aglietta distinguishes three types of confidence. The first is ethical confidence, referring to the basic recognition of the legitimacy of the monetary system, usually derived from political trust in the state or moral commitments to technical rules. The second is hierarchical confidence, referring to trust in the authority—usually the state—that maintains the stability of the monetary system. The state enforces the use of its accounting unit through taxation and expenditure, regulates private money creation, and provides safety structures like lender-of-last-resort and deposit insurance. The third is methodical confidence, arising from the regularity and predictability of the monetary system’s daily operations—that participants believe payments and settlements can be completed according to established rules under normal conditions.

In modern monetary systems, the core of methodical confidence lies in the dynamic balance between elasticity and discipline. Elasticity means private banks can create or destroy credit as needed by economic activity, making the money supply adaptable; discipline means all private debt must ultimately be settled in sovereign currency, preventing unchecked credit expansion. This balance is achieved through banking systems and state regulation (interest rate policies, reserve requirements, capital adequacy ratios, etc.).

Shadow Banking and Shadow Money Definitions

Building on this theoretical framework, the author introduces the concepts of shadow banking and shadow money. Shadow banking is defined as credit intermediary activities supported by money market financing that fund capital market lending. More specifically, shadow banks perform core functions similar to traditional banks—issuing highly liquid, short-term liabilities to finance less liquid, longer-term, higher-yield assets—but these activities occur outside the regulated banking system and lack public safety nets (such as central bank lender-of-last-resort functions). Typical forms include securitization, repurchase agreements, and money market funds.

Shadow money refers to private debt instruments issued by non-bank entities that can be exchanged at face value for sovereign currency at any time, thus serving as private substitutes for bank deposits. Instruments fitting this definition include money market fund shares and certain repurchase agreements. Shadow money does not carry the same sovereign credit backing as bank deposits, making it more susceptible to runs during crises, and its parity exchangeability depends on the issuer’s asset quality and market confidence.

4. The Internal Contradiction of Anti-Credit Money and the Necessity of Credit Creation

Original Design of Bitcoin: Eliminating Credit and Intermediation

Satoshi Nakamoto’s creation of Bitcoin in 2008, against the backdrop of the global financial crisis, proposed a radical monetary concept: establishing an “trustless” electronic cash system. This concept opposes both the state monopoly on currency issuance and the banking role as credit intermediaries. Bitcoin’s technical design embodies this political philosophy. In this design, there are no liabilities from any issuer, nor any elastic mechanisms that can be unilaterally changed by the state or banks.

From the perspective of credit money theory, Bitcoin’s design has a fundamental flaw. Money becomes money not because it is a scarce commodity, but because it is a socially accepted debt relationship. Since Bitcoin does not constitute liabilities of any actor, it lacks any form of hierarchical confidence. Its price is extremely volatile, unable to reliably perform functions as a unit of account or store of value. As Aglietta stated in 2018, Bitcoin was then “anti-money,” with no internal credit creation.

Why Must Anti-Credit Money Ultimately Become Credit?

The core argument of this paper is: for cryptocurrencies to acquire any meaningful monetary qualities, they must meet three conditions: liquidity, indirect connection to the sovereign currency system (to provide hierarchical confidence), and a balance between elasticity and discipline. These three conditions are precisely what Bitcoin’s original design lacks. As a result, market participants spontaneously created new institutions and tools to provide these conditions, even though this directly contradicts the original promise of cryptocurrencies.

Specifically, Bitcoin’s mining mechanism imposes excessive discipline. The fixed total supply and exponentially increasing mining difficulty make supply completely inelastic; demand shocks lead to extreme price volatility. This extreme discipline, paradoxically, fosters a demand for credit creation: during periods of intensive economic activity, market participants need mechanisms to “temporarily” obtain additional cryptocurrencies or crypto-denominated credit to maintain smooth transactions. Centralized exchanges and stablecoins emerged precisely in this institutional vacuum.

5. Centralized Exchanges as Shadow Banks

From Decentralization to Centralization: Institutional Evolution

In the initial years after Bitcoin’s launch, trading mainly occurred on offline forums or early exchanges with minimal functionality, with very limited liquidity. The rise of Mt. Gox in 2013 marked the first bull-bear cycle, but the exchange soon collapsed due to hacking. A structural turning point occurred in 2017–2018: centralized exchanges began to emerge on a large scale and quickly dominated the crypto trading market. In comparison, decentralized exchanges (DEXs) have long accounted for less than 4% of trading volume compared to CEXs.

The fundamental reason users prefer CEXs over more “crypto-spirited” DEXs is liquidity. CEXs, by holding large inventories of both cryptocurrencies and sovereign currency assets, can ensure stable prices for buy and sell orders under any market conditions. This market-making capacity provides a form of methodical confidence—users can reasonably expect their orders to be executed promptly and without significant price deviations caused by their own trades.

Balance Sheet Perspective on Credit Creation

When users deposit Bitcoin into a CEX account (a “custodial wallet”), they do not actually hold control of the Bitcoin on-chain but hold a claim against the exchange—CEX promises to pay the corresponding amount of Bitcoin upon request. This constitutes a form of credit creation denominated in Bitcoin. The CEX can then lend these deposited Bitcoins to other market participants or invest in other assets, transforming high-liquidity short-term liabilities into longer-term, less-liquid assets.

This business model is functionally equivalent to traditional banking deposit and loan activities. CEXs issue high-liquidity liabilities (user deposits) to finance their holdings of less-liquid assets (various crypto assets, equity investments, proprietary platform tokens, etc.). They engage in maturity transformation and liquidity transformation but are not subject to prudential regulation such as capital adequacy ratios, reserve requirements, or stress testing, nor do they have a central bank as a lender of last resort. Therefore, centralized exchanges should be understood as a new form of shadow bank.

The Collapse of FTX: A Typical Case of Shadow Banking Risk

The collapse of FTX in November 2022 was a concentrated exposure of these risks. According to leaked internal financial documents, FTX had about $9 billion in liabilities before filing for bankruptcy, with less than $1 billion in liquid assets. Its large asset positions included FTT and SOL tokens—both issued by FTX or related entities and lacking deep external markets. This created a self-referential credit cycle: FTX’s promise to pay Bitcoin was backed by its valuation of its own issued tokens, which in turn depended on FTX’s solvency.

When market participants began to doubt FTX’s asset quality, a run quickly ensued. Users withdrew assets en masse, but FTX lacked sufficient liquid assets and a last-resort support from the central bank, making it unable to meet redemption demands, ultimately collapsing. Notably, during the run, users’ “safe assets” were not Bitcoin or other non-stablecoin crypto assets but stablecoins and traditional bank deposits. This indicates that even within the crypto world, the ultimate safe anchor remains the sovereign currency system.

6. Stablecoins as Shadow Money

Types and Functional Positioning of Stablecoins

Stablecoins are crypto assets designed to maintain a 1:1 peg with sovereign currencies (mainly USD). Based on their backing and stabilization mechanisms, they can be categorized into three types: fiat-backed (off-chain collateralized), on-chain collateralized, and algorithmic.

Fiat-backed stablecoins (e.g., Tether, USD Coin) are currently the largest and most influential. Their issuers accept user USD deposits, which are stored in traditional bank accounts or invested in US Treasuries, commercial paper, repurchase agreements, etc., and issue equivalent stablecoins to users. Each fiat-backed stablecoin essentially represents a debt claim on the issuer, who promises to redeem it at face value for sovereign currency. Functionally, fiat-backed stablecoins are equivalent to money market fund shares, fully fitting the definition of shadow money.

Stablecoins as Institutional Bridges Connecting to the Sovereign Currency System

The emergence of stablecoins addresses the fundamental institutional flaw in the crypto system: the lack of a stable connection to the sovereign currency system. Previously, converting Bitcoin to USD required selling crypto assets on exchanges, exposing users to price fluctuations at the transaction point. Stablecoins allow users to hold a relatively stable asset within the crypto ecosystem, which can be used as a medium of exchange on the blockchain or as a store of value to avoid the volatility of non-stablecoin crypto assets.

From a balance sheet perspective, the business model of fiat-backed stablecoin issuers closely resembles that of shadow banks. They issue highly liquid short-term liabilities (stablecoins) while holding longer-term, less-liquid assets (such as government bonds, commercial paper). For example, Tether’s Q1 2024 audit report shows that among its nearly $90 billion in assets, a significant portion consists of US Treasuries and money market fund shares, which are far less liquid than the stablecoins issued.

Hierarchical Confidence and Structural Failures of Algorithmic Stablecoins

The reason fiat-backed stablecoins can maintain parity with USD is fundamentally due to “hierarchical confidence”—users believe these stablecoins are backed by real sovereign currency reserves, which are themselves protected by legal and financial safety nets provided by the state. When users exchange stablecoins for USD, they ultimately receive deposits within the traditional banking system, which benefits from FDIC insurance and central bank liquidity support.

The failure of algorithmic stablecoins confirms this understanding. Take TerraUSD (UST) as an example: its stability mechanism does not rely on any sovereign currency reserves but uses algorithms and arbitrage incentives to maintain the peg: 1 UST can be exchanged at face value for 1 USD worth of Luna tokens, and arbitrageurs can buy undervalued UST, exchange for Luna, and sell to restore the price. To increase demand, the Anchor protocol offered about 20% annualized interest on deposits. When Anchor cut the interest rate in May 2022, a large redemption wave was triggered. UST’s price plummeted below $0.65, and Luna’s value nearly zeroed out. This “platform run” then spread across the entire crypto system and eventually impacted large institutions like FTX.

The collapse of algorithmic stablecoins validates the core proposition of credit money theory: private debt instruments without sovereign currency backing cannot sustain methodical confidence during crises. When panic hits, the only “ultimate fallback” trusted by market participants remains the sovereign currency and its institutional support system.

The Currency Hierarchy within Cryptocurrencies

Based on the above analysis, the author constructs an internal hierarchy of money within the crypto system. Fiat-backed stablecoins occupy the top tier, serving as the final settlement medium for internal transactions; simultaneously, they are at the bottom of the sovereign currency hierarchy (as private substitutes for bank deposits). Bitcoin and other non-stablecoin cryptocurrencies are at lower levels because they cannot guarantee exchange at face value for sovereign currency. Algorithmic stablecoins and various crypto derivatives are at the bottommost layer, with the most fragile monetary qualities, often among the first to be sold off during crises.

7. Conclusions and Theoretical Implications

This paper offers specific insights into four research directions in international political economy regarding cryptocurrencies. First, political economists should incorporate cryptocurrencies into shadow banking research. Second, the relationship between states and crypto shadow banks warrants special attention. Traditional views argue that states have strong reasons to oppose cryptocurrencies because they threaten monetary policy autonomy. However, history shows that states often regulate private monetary innovations and provide indirect support. Third, most fiat-backed stablecoins are actually claims on “offshore dollars,” with reserves stored in offshore financial centers like the Cayman Islands and the Bahamas. Therefore, stablecoins are not only shadow money but also a form of “offshore shadow dollars.” This finding is significant for understanding the distribution of international monetary power. Fourth, cryptocurrencies do not offer a feasible path for countries at the bottom of the monetary hierarchy to escape dollar dominance. Most stablecoins are dollar-denominated, and Bitcoin’s price is highly correlated with dollar liquidity. The actual effect of cryptocurrencies is to reinforce rather than weaken the dollar’s dominance in the global monetary system.

Theoretically, this paper demonstrates that credit money theory can explain its “least likely case”—a form of money designed to eliminate credit. The development of cryptocurrencies confirms a long-standing insight of monetary theory: any private currency seeking widespread acceptance must ultimately establish some form of connection with the sovereign currency system. Whether it was 19th-century bills of exchange, 20th-century Eurodollars, or early 21st-century repo agreements and money market funds, private monetary innovations have always followed this pattern.

Policy-wise, the 2022 crisis can be viewed as a “white-horse moment” for the crypto system—its first encounter with systemic risk, prompting the question of whether the state should intervene as a lender of last resort. The policy orientation during the second term of Trump’s presidency might encourage technological innovation while amplifying systemic financial risks. The “anti-bank, anti-state” halo of cryptocurrencies may instead motivate their further integration into banking and state systems. It is crucial to carefully examine whether this development aligns with financial stability, consumer protection, and public interest.

The ultimate conclusion of this paper is that cryptocurrencies have not created an independent monetary system detached from sovereign currencies. Instead, through centralized exchanges and fiat-backed stablecoins—these shadow banking institutions—they are systematically integrated into the dollar-based global monetary hierarchy. This evolution not only validates credit money theory but also represents the latest chapter in private monetary innovation within contemporary capitalism.