In our previous post, we discussed the rapid growth of the stablecoin market over the past few years and then discussed the operation of the TerraUSD stablecoin in May 2022. However, TerraUSD’s operations are not the only volatile episode the stablecoin has experienced. Other notable events include the IRON trade in June 2021 and, more recently, the unpegging of the USD coin secondary market price from $1.00 to $0.88 following the Silicon Valley Bank failure in March 2023. There are many things that have happened. This post is based on our recent staff report. Are stablecoin investors reacting to a broader shock in the crypto asset industry? Are investors fleeing the stablecoin industry as a whole, or are they engaging in a flight to safer stablecoins? Is there one? Finally, we present some high-level discussion points regarding potential regulation of stablecoins.
Responding to market-wide shocks
We highlight the significant drop in Bitcoin prices, which, although caused by multiple factors, is sending shockwaves across the cryptocurrency ecosystem, and how disruption in the crypto industry will impact stablecoin flows. We are studying the impact. Specifically, our analysis uses data from January 2021 to March 2023 to show that Bitcoin price declines lead to net capital inflows into stablecoins of different types and risk profiles. We are estimating the impact.
As we did in our previous post, we divide stablecoin issuers into four broad categories. i) US-based asset-backed stablecoins (e.g. USD Coin). This is backed by a (mostly traditional) USD-denominated portfolio. Assets such as U.S. Treasury bills and commercial paper. ii) Offshore asset-backed stablecoins (such as Tether). This is also backed by USD-denominated assets, but is based offshore. iii) Cryptocurrency-backed stablecoins (such as DAI) issued against other cryptoassets such as Ether (which are typically highly volatile in price). iv) Algorithmic stablecoins (such as TerraUSD). It is not backed by collateral and its pegging mechanism relies on a supply-demand matching algorithm that takes advantage of arbitrage between the prices of various crypto tokens.
We then use local predictions to estimate the impulse response of cumulative net flows into stablecoins to Bitcoin price shocks. The results are shown in the graph below. Our estimates show a clear flight-to-safety pattern. After a negative Bitcoin price shock, capital flows out of riskier stablecoins (offshore asset-backed, crypto-backed, algorithm-backed; see panels (b)-(d)); I will. lower risk (backed by US-based assets, see panel (a)); Our results show that if the daily change in Bitcoin’s price is in the bottom 5 percent of its historical distribution, then a risky stablecoin will have a It suggests that it will experience a cumulative runoff of 9 percent. In contrast, lower-risk stablecoins have seen inflows of around 2%. Additionally, outflows are the largest among algorithmic stablecoins, consistent with the safe flight hypothesis.
Impulse response function from various stablecoins to Bitcoin price shock
Source: Coingecko and author calculations.
This flight to safety trend is very similar to that experienced by money market funds (MMFs) during times of stress. In 2008 and 2020, investors made large redemptions from prime MMFs that held risky debt and moved into government-backed MMFs that held debt. Primarily U.S. Treasury and government agency obligations and repurchase agreements secured by these instruments. These MMF runs amplified tensions in the short-term funding market, but tensions have eased after extraordinary actions by government departments. By the same logic, if stablecoins grow larger and become more interconnected with financial markets, stablecoin trading could also cause financial instability and require government intervention.
discussion
Stablecoins are newer products than MMFs and are more diverse both in terms of pricing and trading mechanisms. Furthermore, most jurisdictions do not have strong regulatory frameworks for stablecoins. Therefore, questions abound about how to regulate them.
In a 2021 report, the President’s Task Force on Financial Markets, FDIC, and OCC recommended that stablecoins, particularly stablecoins used for payments, be “subject to appropriate federal prudential oversight.” Recommended. The report also highlights the need for greater transparency in stablecoin arrangements, which could be achieved, for example, by imposing a more uniform disclosure regime on stablecoins. Of course, all regulatory options involve trade-offs and must balance their costs and benefits, primarily those related to investor protection and increased financial stability.
summary
In addition to the peculiar run episodes experienced by algorithmic stablecoins in 2022, stablecoins have also shown systematic flight-to-safety flows during periods of widespread stress in crypto asset markets. That is, investors tend to flee from stablecoins that are perceived to be more risky to stablecoins that are perceived to be less risky during such episodes. These dynamics are very similar to those observed in MMF during periods of stress.
Kenechukwu Anadu is the Vice President of the Supervision, Regulation and Credit Division at the Federal Reserve Bank of Boston.
Pablo Azar is a Financial Research Economist in the Research and Statistics Group at the Federal Reserve Bank of New York in charge of money and payments research.
Marco Cipriani is the Director of Money and Payments Research in the Research and Statistics Group at the Federal Reserve Bank of New York.
Thomas M. Eisenbach is a financial research advisor in the Money and Payments Research in the Research and Statistics Group at the Federal Reserve Bank of New York.
Katherine Huang is a research analyst at the Federal Reserve Bank of New York and holds a Ph.D. candidate in business economics at Harvard University.
Mattia Landoni is a senior financial economist in the Supervisory, Regulation, and Credit Division at the Federal Reserve Bank of Boston.
Gabriele La Spada is a Financial Research Advisor for Money and Payments Research in the Research and Statistics Group at the Federal Reserve Bank of New York.
Marco Machiavelli is an assistant professor of finance at the University of Massachusetts, Amherst.
Antoine Malfroy-Cmine is a risk analyst in the Supervisory, Regulation, and Credit Division at the Federal Reserve Bank of Boston.
J. Christina Wang is a senior economist and policy advisor in the Research Department of the Federal Reserve Bank of Boston.
How to cite this post:
Kenechukwu Anadu, Pablo D. Azar, Marco Cipriani, Thomas Eyesenbach, Catherine Huang, Mattia Landoni, Gabriele La Spada, Marco Macchiavelli, Antoine Malfroy-Cmine, and J. Christina Wang, “Stablecoins and Crypto Shock,” New Federal Reserve Bank of York Liberty Street Economics, March 8, 2024, https://libertystreeteconomics.newyorkfed.org/2024/03/stablecoins-and-crypto-shocks/.
Disclaimer
The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
