Stablecoin Runs and the Centralization of Arbitrage

Abstract

We analyze the run risk of USD-backed stablecoins. Stablecoin issuers aim to keep the stablecoin price at $1 by holding a portfolio of US dollar assets like bank deposits, Treasuries, and corporate bonds while promising to exchange stablecoins for $1 in cash with arbitrageurs. We show that asset illiquidity coupled with fixed redemption values reinstates panic runs among investors that only trade stablecoins in secondary markets with flexible prices. Importantly, run risk is exacerbated by more efficient arbitrage, implying a tradeoff between price stability and run risk. This is why stablecoin issuers only authorize a concentrated set of arbitrageurs despite the cost to price stability. Our findings are based on a model calibrated with a novel dataset on stablecoin arbitrage and trading activity. Our model predicts economically significant run risk for Tether (USDT) due to its liquidity transformation. But run risk is also sizeable for Circle (USDC) due to its less concentrated arbitrage. Finally, we show that issuing dividends to investors would effectively reduce run risk at both USDT and USDC, which points to a potential benefit of regulating stablecoins as securities.

Keywords: stablecoin, runs, arbitrage, financial stability, price stability, Tether, Circle