Intelligent design: stablecoins (in)stability and collateral during market turbulence

Abstract

How does stablecoin design affect market behavior during turbulent periods? Stablecoins attempt to maintain a “stable” peg to the US dollar, but do so with widely varying structural designs. The spectacular collapse of the TerraUSD (UST) stablecoin and the linked Terra (LUNA) token in May 2022 precipitated a series of reactions across major stablecoins, with some experiencing a fall in value and others gaining value. Using a Baba, Engle, Kraft and Kroner (1990) (BEKK) model, we examine the reaction to this exogenous shock and find significant contagion effects from the UST collapse, likely partially due to herding behavior among traders. We test the varying reactions among stablecoins and find that stablecoin design differences affect the direction, magnitude, and duration of the response to shocks. We discuss the implications for stablecoin developers, exchanges, traders, and regulators.

Silicon Valley Bank Bankruptcy and Stablecoins Stability

“…Galati et al (2023), on the other hand, investigate financial contagion across cryptocurrency exchanges, but do so with regards to blockchain technology (FTX) collapse. As such, this study extends both De Blasis et al (2023) and Galati et al (2023) as it enables us to test whether a new dimension of failure (that of a commercial bank) has an impact on cryptocurrency markets.…”

“…However, their inherent volatility continues to hinder their broader acceptance. Among cryptocurrencies, a subset known as stablecoins, which is intended to maintain a ''stable'' peg to a reference currency, is crucial to the market as it allows traders to work around the volatility issue and keep money in a form equal to US dollars (De Blasis et al, 2023). Access to those digital assets is typically given by new financial technologies (also called Fintech) such as digital wallets or Centralized cryptocurrency Exchanges (CEXs), with the aim of decentralizing finance through innovative offers of financial services.…”

“…Access to those digital assets is typically given by new financial technologies (also called Fintech) such as digital wallets or Centralized cryptocurrency Exchanges (CEXs), with the aim of decentralizing finance through innovative offers of financial services. However, due to the high costs associated with the trading of cryptocurrencies in US dollars, the impossibility of using US dollars on cryptocurrency exchanges, 1 and the simplicity and speed of transferring those virtual assets between exchanges, stablecoins occasionally trade at a premium 2 to the underlying asset they imitate (De Blasis et al, 2023). The recent bankruptcy of Silicon Valley Bank (SVB), the largest commercial bank for nearly half of all venture-backed tech startups in Silicon Valley, 3 in March 2023 tied up $3.3 out of $40 billions of stablecoins in its financial statement, making this exogenous shock a significant event to study.…”

“…These include works that focus solely on cryptocurrencies (Ampountolas, 2022;Moratis, 2021), on cryptocurrencies and foreign exchange markets (Hsu, 2022;Wang, 2022), on markets for non-fungible tokens (NFTs), on alternative coins (altcoins) (Nguyen et al, 2019), on Bitcoin, gold, and the US dollar (Dyhrberg, 2016), and on stablecoins (De Blasis & Webb, 2022). In particular, De Blasis et al (2023) similarly analyze the issue of contagion effects in stablecoin markets, albeit it looks at a stablecoin (UST) crash within the market itself. Galati et al (2023), on the other hand, investigate financial contagion across cryptocurrency exchanges, but do so with regards to blockchain technology (FTX) collapse.…”

“…(2023). Since paying $1.01 or 87 cents for a $1 asset is uneconomic for investors balancing their portfolios and savings, suggesting also major concerns about the stability and potentially even the survival of stablecoins (De Blasis et al, 2023), it is thus important to shed light on the impact of bank failures on the stability of stablecoin markets.…”