HOLDING COURSE

Why stablecoins maintain their dollar peg despite run risk

Despite years of scrutiny, stablecoins backed by real world assets have avoided a run.
Why stablecoins maintain their dollar peg despite run risk
Photo: Dado Ruvic (Reuters)
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Despite the worst crypto crash in history, there has yet to be a run on so-called stablecoins, a form of cryptocurrency backed by real world assets. (Not to be confused with algorithmic stablecoins).

In a new paper (pdf) published by the National Bureau of Economic Research, five economists from Yale, the Federal Reserve, and the US Treasury explain why they think stablecoins backed by non-cryptocurrencies have been able to keep their peg despite all the scrutiny.

The economists studied the margin lending rates across multiple exchanges and found that stablecoins had the smallest haircuts, the term for how much lower the asset is valued as collateral versus when it’s on the market. They also found that stablecoin demand increases when crypto is more volatile and traders can take advantage of more leverage.

Based on the favored status that stablecoins have in margin trading, the economists predicted that most traders will maintain the peg during good times in the crypto industry, regardless of the scrutiny. But when times are bad, run risks are more likely, and stablecoins will move toward safer asset backings, the economists found.

Leverage from stablecoins

For investors to be willing to take on the risk of holding a stablecoin, they have to be rewarded in some fashion. But because of how they’re structured, stablecoins don’t tend to offer holders big returns on price. Instead, they offer access to leveraged trading in the crypto financial system.

Stablecoin holders can lend out their stablecoins to traders who need collateral to take on trades in more volatile cryptocurrencies. Often, holders lend out their stablecoins at rates over 20%, enough to compensate them for the risk of holding the asset, the economists wrote.

Stablecoins are the most popular asset for leveraged crypto trading because other, more volatile digital assets have higher collateral requirements when they are used as margin.

But if trading activity drops quickly because of a crash in crypto prices, traders may find stablecoins less useful—and might sell any stablecoins they were holding as margin.

Where stablecoins meet the “real economy”

Because stablecoin issuers want to make money too, they sometimes invest in riskier assets and then switch back to safer assets (like US Treasury notes) in times when lots of investors are looking to redeem their stablecoins.

This is where speculation in the crypto economy reaches the real economy. In June 2021, JPMorgan estimated that stablecoin issuer Tether was one of the largest investors in the US market for commercial paper, a typically (but not always (pdf)) stable form of very short-term debt issued by big corporations.

But if there’s a shock to the assets backing stablecoins, then the run risk for stablecoins also increases.