Public information and stablecoin runs (2024)

Summary

Focus

Stablecoins are crypto tokens that live on distributed ledgers and promise to always be worth a dollar. To make that promise credible, stablecoin issuers hold a variety of reserve (collateral) assets, including fiat-denominated money market instruments, Treasuries, bank deposits and other cryptoassets (including other stablecoins). For that reason, public information and perceptions regarding the quality, transparency and volatility of reserves are key for stablecoin peg stability, as was evident during the March 2023 US banking turmoil.

Contribution

We analyse the effects of collateral disclosure and transparency as well as the perceived quality and volatility of reserve assets on stablecoins' peg stability. Our approach is general enough to characterise both US dollar stablecoins backed by traditional fiat collateral and those backed by more volatile crypto asset collateral. Our framework allows us to understand the effects and consequences of various public information shocks on stablecoin peg stability.

Findings

Greater reserve transparency can increase run risk when stablecoin holders believe the quality of reserves backing the stablecoin is low or when transaction costs of conversion to fiat are low. However, transparency can lower run risk when beliefs about the quality of reserves are strong or transaction costs are high. When reserve assets are highly volatile, as in the case of many crypto-backed stablecoins, par convertibility is resilient to small shocks but collapses under large negative shocks, even for high initial reserve values. Drawing on several case studies, we find empirical support for the testable implications of the model.

Abstract

We provide a global games framework to study how the promise of par convertibility byvarious types of stablecoins breaks down. Public information disclosure has an ambiguouseffect on run risk: greater transparency can lead to increased (reduced) run risk for sufficientlylow (high) stablecoin holders' priors about reserve quality or transaction costs ofconversion to fiat. If the distribution of reserve assets is fat-tailed (i.e. reserves are volatile),par convertibility is resilient to small shocks but fails with large negative public shocks, evenfor high initial reserve values. We find empirical support for the testable implications of themodel.

JEL classification: C70, D83, D84, E42, G01, G20

Keywords: stablecoins, crypto, global games, bank runs