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

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

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)

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))