Stablecoin Devaluation Risk

Abstract

We construct market-based measures of stablecoin devaluation risk using spot and futures prices for Tether. We estimate an average probability of devaluation over one year of 60 basis points, rising to 200 basis points during the March 2020 "Black Thursday" Crypto crash and the March 2022 Terra-Luna crash. One might expect devaluation probabilities to be connected to interest rates on stablecoins at DeFi lending protocols via covered interest parity; contrary to this expectation, we find that deviations from covered interest parity are pervasive. Nor do stablecoin interest rates respond to Federal Reserve policy announcements in the manner of conventional market interest rates. We suggest explanations for these disconnects, including market segmentation, lack of term structure in DeFi interest rates, lack of arbitrage capital in cryptocurrency markets, and transaction costs of arbitrage.

Keywords: Cryptocurrency, stablecoins, futures, bank runs, Tether, Bitcoin

JEL Classification: E5, F3, F4, G15, G18