Abstract
We develop a dynamic model of stablecoins and crypto shadow banking, where the stablecoin issuer transforms risky assets—including cryptocurrencies—into digital tokens of stable value. Key features include:
Dual-Backing Mechanism:
- The stablecoin is backed by both the issuer’s reserve assets and users’ collateral.
- Despite over-collateralization, the pledge of 1:1 convertibility to a reference currency remains fragile.
Bimodal State Distribution:
- A fixed exchange rate may persist, but once the stablecoin "breaks the buck," recovery is slow.
Debasement Risks:
- Negative shocks deplete reserves, forcing the issuer to debase the stablecoin (sharing risk with users).
Triggers a vicious cycle:
- ↓ Stablecoin demand → ↓ Transaction volume/fees → Slow reserve rebuild → Persistent debasement.
Management Strategies:
Optimal stability requires combining:- Open market operations
- Dynamic collateral requirements
- Transaction fees/subsidies
- Re-pegging
- Issuance of "secondary units" (functioning as equity).
Regulatory & Incentive Insights:
- Evaluates proposals like capital requirements.
- Explores incentives behind stablecoin initiatives by network companies (e.g., Facebook).
Key Takeaways
👉 Why Stablecoins Matter
Stablecoins bridge traditional finance and decentralized ecosystems, but their stability hinges on complex reserve dynamics and user confidence.
👉 Crypto Shadow Banking Risks
The model highlights parallels to traditional shadow banking, where liquidity mismatches can amplify systemic fragility.
FAQs
1. What makes stablecoins vulnerable to breaking the buck?
Even with over-collateralization, sudden withdrawals or asset volatility can drain reserves, breaking the 1:1 peg. Recovery is slow due to eroded trust.
2. How does debasement worsen stability?
Debasing the stablecoin (reducing its value) shares risk with users but reduces demand, creating a feedback loop that prolongs instability.
3. Are stablecoins regulated like banks?
Not uniformly. Some proposals advocate capital requirements, but decentralized models complicate oversight.
4. Why do companies like Facebook enter stablecoins?
Network effects and transaction fee revenue drive interest, but regulatory scrutiny remains high.