Pete Ryan
Stablecoins may not be as stable as intended, suggests research by Columbia’s Yiming Ma, University of Pennsylvania’s Yao Zeng, and Chicago Booth’s Anthony Lee Zhang. They identified the risk of runs in the two biggest dollar-backed stablecoins as “economically significant” in an analysis of data covering two recent years.
Stablecoins, a form of cryptocurrency, are pegged to the US dollar and backed by assets such as US Treasury securities and corporate bonds. But like money market funds, stablecoins can fall below $1 and force their sponsors to sell assets in a potentially market-destabilizing fire sale.
In the United States, Federal Reserve chair Jerome Powell urged Congress last year to impose robust federal regulation of stablecoins. (It hasn’t done so; stablecoins remain unregulated.) The value of stablecoins worldwide surged to more than $130 billion by the beginning of 2022 from $5.6 billion two years earlier, the researchers report.
Ma, Zeng, and Zhang analyzed the role of arbitrageurs, who buy and sell stablecoins in response to fluctuating market demand to keep their value constant.
They collected transaction-level data on each stablecoin creation and redemption for the six largest dollar-backed stablecoins: Binance USD, Circle USD Coin, Gemini dollar, Paxos, Tether, and TrueUSD. The amount of data collected varied by coin. The researchers also obtained trading prices from the main crypto exchanges and data on the reserve assets of the two top stablecoins in terms of transaction volume, Tether and Circle, at various points in 2021 and 2022.
Pegging the value of stablecoins to traditional currencies sounds good, but in practice it doesn’t always work.
How to Make Cryptocurrencies More StableTheir analysis reveals that only a handful of arbitrageurs were able to redeem stablecoins for $1 in primary markets. The small number of such market players surprised the researchers because more participants would improve market efficiency.
However, they find that issuers face a tradeoff: while efficiency is generally desirable, more competitive arbitrage could increase the risk of runs. “Stablecoins are subject to panic runs because of illiquidity in their assets and the fixed $1 redemption value,” they write. Yet more arbitrage would just make it easier for investors to sell, according to their results.
The researchers also demonstrate that market prices frequently deviate from $1, and that doesn’t necessarily trigger a run.
The researchers plugged data on the Tether and Circle reserve assets into their model to put a figure on the probability of a run on either of those. They find that Tether’s assets were less liquid than those of Circle. As of September 2021, the risk of a run amounted to 2.5 percent for Tether and 2.1 percent for Circle, the researchers calculate. There are no good comparative estimates for the risk of bank runs, says Zhang.
But much in the way a bank run can destabilize financial markets, a run on a major stablecoin could have negative implications for debt markets, the study suggests. If Tether had to sell its Treasury positions in a run, the researchers write, that would amount to one-sixth of the amount of Treasury securities that mutual funds liquidated in the March 2020 COVID-inspired global dash for cash.
Ma, Zeng, and Zhang note several policy implications of their findings, including that regulators should pay close attention to stablecoin arbitrage capacity, and coin issuers and regulators could reduce the risk of runs by imposing redemption fees on arbitrageurs. The model suggests that “moderate redemption fees can have fairly large effects on stablecoin run risk,” the researchers write. In addition, their model predicts that Tether and Circle could meaningfully reduce their run risks and increase stability by paying dividends to investors.
Yiming Ma, Yao Zeng, and Anthony Lee Zhang, “Stablecoin Runs and the Centralization of Arbitrage,” Working paper, March 2024.
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