Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking

Fisher College of Business Working Paper No. 2020-03-030

Charles A. Dice Center Working Paper No. 2020-30

78 Pages Posted: 30 Dec 2020 Last revised: 8 Apr 2022

See all articles by Ye Li

Ye Li

University of Washington - Foster School of Business

Simon Mayer

Carnegie Mellon University

Multiple version iconThere are 2 versions of this paper

Date Written: April 2, 2022

Abstract

Stablecoins are at the center of debate surrounding decentralized finance. We develop a dynamic model to analyze the instability mechanism of stablecoins, the complex incentives of stablecoin issuers, and regulatory proposals. The model rationalizes a variety of stablecoin management strategies commonly observed in practice, and we characterize an instability trap: Stability can last for a long time, but once debasement happens, price volatility persists. Capital requirement improves price stability but fails to eliminate debasement. Restricting the riskiness of reserve assets can surprisingly destabilize price. Finally, data privacy regulation has an unintended benefit of reducing price volatility of stablecoins issued by data-driven platforms.

Keywords: Stablecoin, platforms, regulation, decentralized finance, financial instability

JEL Classification: E41, E42, E51, E52, F31, G12, G18, G21, G31, G32, G35, L14, L86

Suggested Citation

Li, Ye and Mayer, Simon, Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking (April 2, 2022). Fisher College of Business Working Paper No. 2020-03-030, Charles A. Dice Center Working Paper No. 2020-30, Available at SSRN: https://ssrn.com/abstract=3757083 or http://dx.doi.org/10.2139/ssrn.3757083

Ye Li (Contact Author)

University of Washington - Foster School of Business ( email )

Box 353200
Seattle, WA 98195
United States

HOME PAGE: http://https://yeli-macrofinance.com/

Simon Mayer

Carnegie Mellon University ( email )

Pittsburgh, PA 15213-3890
United States

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