digital representation of a unit of a fiat currency on a blockchain

pulled from Nick Carter's talk on "Will stablecoins serve or subvert U.S. interests?"

stablecoins are crypto's/blockchain's first "killer" use case

JPM coin

USDC

USDT

UST, Basis, Neutrino

DAI, FEI

What makes a Stablecoin stable?

• stablecoins are issued 
  • by a single entity or
  • a blockchain-based algorithm (smart contract)

• they trade in a secondary market
  • on crypto-exchanges against fiat
  • on crypto-exchanges against cryptos
  • on-chain against other tokens
• \(\Rightarrow\) stablecoin price fluctuates

arbitrageur

issuer/ primary market

secondary market

What makes a Stablecoin stable?

Arbitrage when price(stablecoin)<$1

arbitrageur

issuer/ primary market

secondary market

This paper: Runs!

Key Model Ingredients and what they do

• primary assets subject to fundamental risk
• global games creates unique equilibrium for run
• run threshold is the key variable of interest

What's the Key Tension

What's the Key Tension

What's the Key Mechanism

1. price drop stablecoin to USD prompts arbitrageurs to
   • buy stablecoins for USD in secondary market
   • sell stablecoins for USD at parity in primary market
     
      

2. to exchange stablecoins for USD at parity issuer needs to

   • find cash or

   • sell illiquid assets

Issues in the Secondary Market 

Issues in the Primary Market 

Intuition for Key Result

key implication:


more liquidity \(\to\) less price impact

less price impact \(\to\) more run risk

Model Implications

1. less liquid backing \(\to\) more run risk
2. more arbitrageurs \(\to\) more run risk
3. less liquid backing \(\to\) choose fewer arbitrageurs
4. more liquid backing \(\to\) may have higher run risk (than expected)

Comments

Comment 0: all OK with the theory?

• theory model is fine (and well thought out)
   
• big question: is it true and does it capture what's going on?

Comment 1: What brings prices back to parity?

1. primary market arbitrage

Arbitrage when price(stablecoin)<$1

arbitrageur

issuer/ primary market

secondary market

arbitrageur

issuer/ primary market

secondary market

Source: Liao (2023) "How to preserve the singleness of money for tokenised forms of money? "

Does secondary market activity justify primary market flows?

Comment 2: Price impact argument for infinitesimal investors

• secondary market liquidity does a lot of heavy lifting in the model
• concern about price impact is the cited reason for run aversion
• but: investors (prospective runners) are infinitesimal and have no price impact.
• So ... ?

Comment 3: cranky referee #2

Comment 4: issuers optimize over #of arbitrageurs?

• key variable: # of arbitrageurs for primary market.
  • Tether: 6
  • Circle: 500+

• In the grand scheme of things, the choice of \(\phi\), the assets to back with seems much more salient.
• Appendix D is not convincing.

• alternative explanation: Tether has bad access to banking network
   
• \(\to\) cannot enable more arbitrageurs

Comments 5: odds and ends

• concentration measure for arbitrage
  • fraction of top 5?
  • why not  Hirshman-Herfindahl Index (or 1/HHI) 
• institutions of Tether and Circle operations
  • Tether:
    • large discrete chunks traditionally issued via Bitfinex
    • banking connection in the Carribean \(\to\) cannot redeem for \(r\)
  • Circle:
    • strong connection banking network
    • high redeem-issuance frequency \(\to\) redeem USDC for \(r\)
• Calibration
  • CDS spread \(\not=\) CDS price (since 2009), so Appendix G requires some work (see ISDA's pricing model or Augustin, Saleh, Xu (JEDC 2020))