What Keeps Stablecoins Stable?

Abstract

We take this question to be isomorphic to, "What Keeps Fixed Exchange Rates Fixed?" and address it with analysis familiar in exchange-rate economics. Stablecoins solve the volatility problem by pegging to a national currency, typically the US dollar, and are used as vehicles for exchanging national currencies into non-stable cryptocurrencies, with some stablecoins having a ratio of trading volume to outstanding supply exceeding one daily. Using a rich dataset of signed trades and order books on multiple exchanges, we examine how peg-sustaining arbitrage stabilizes the price of the largest stablecoin, Tether. We find that stablecoin issuance, the closest analogue to central-bank intervention, plays only a limited role in stabilization, pointing instead to stabilizing forces on the demand side. Following Tether's introduction to the Ethereum blockchain in 2019, we find increased investor access to arbitrage trades, and a decline in arbitrage spreads from 70 to 30 basis points. We also pin down which fundamentals drive the two-sided distribution of peg-price deviations: Premiums are due to stablecoins' role as a safe haven, exhibiting, for example, premiums greater than 100 basis points during the COVID-19 crisis of March 2020; discounts derive from liquidity effects and collateral concerns.

Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking

“…3 Our paper addresses the key questions on the credibility and sustainability of a fixed exchange rate. Different from Routledge and Zetlin-Jones (2021) who study speculative attacks on undercollateralized stablecoins and coordination failure (Morris and Shin, 1998;Goldstein and Pauzner, 2005), we characterize a novel mechanism of risk amplification and show that in line with evidence (Lyons and Viswanath-Natraj, 2020), even over-collateralized stablecoins can break the buck when the issuer's reserves fall below a critical threshold. What drives debasement is the issuer's trade-off between sustaining a stable value that stimulates demand and sharing risk with users to avoid liquidation.…”

World monies or money-worlds: A new perspective on cryptocurrencies and their moneyness

“…These largely take on two forms: Stablecoins and central-bank-issued cryptocurrencies. Stablecoins are blockchain-based tokens that are pegged to the value of some external reference currency, such as US dollars or the dollar price of an ounce of gold (Lyons and Viswanath-Natraj, 2020). The stablecoin Tether, for instance, is pegged to the US dollar but, just like Bitcoin is issued onto a decentralised blockchain, transactions occurring in Tether are confirmed by its network of miners.…”

Blockchain-Based Address Alias System

“…Stablecoins [12,13] are an excellent use case of blockchain technology, allowing for almost instant transfers with minimal fees. They guarantee that the transaction's value will not change, as is the case in other cryptocurrencies.…”