Stablecoin Runs and the Centralization of Arbitrage

74 Pages Posted: 5 Apr 2023 Last revised: 12 Mar 2024

See all articles by Yiming Ma

Yiming Ma

Columbia University - Columbia Business School

Yao Zeng

University of Pennsylvania - The Wharton School

Anthony Lee Zhang

University of Chicago - Booth School of Business

Date Written: March 22, 2023

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

Suggested Citation

Ma, Yiming and Zeng, Yao and Zhang, Anthony Lee, Stablecoin Runs and the Centralization of Arbitrage (March 22, 2023). Available at SSRN: https://ssrn.com/abstract=4398546 or http://dx.doi.org/10.2139/ssrn.4398546

Yiming Ma

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Yao Zeng (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Anthony Lee Zhang

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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