NY Fed on "Runs on Stablecoins"
The Federal Reserve Bank of New York recently posted a paper to its "Liberty Street Economics" blog entitled, "Runs on Stablecoins." They write, "Stablecoins are digital assets whose value is pegged to that of fiat currencies, usually the U.S. dollar, with a typical exchange rate of one dollar per unit. Their market capitalization has grown exponentially over the last couple of years, from $5 billion in 2019 to around $180 billion in 2022. Notwithstanding their name, however, stablecoins can be very unstable: between May 1 and May 16, 2022, there was a run on stablecoins, with their circulation decreasing by 15.58 billion and their market capitalization dropping by $25.63 billion.... In this post, we describe the different types of stablecoins and how they keep their peg, compare them with money market funds -- a similar but much older and more regulated financial product, and discuss the stablecoin run of May 2022." The piece explains, "Stablecoins use different mechanisms to peg their value. The top four stablecoins by market capitalization are Tether (USDT), USD Coin (USDC), Dai (DAI), and Binance USD (BUSD). Among these, USDT, USDC, and BUSD are ostensibly backed by traditional financial assets. Part of the backing of USDT is comprised of U.S. Treasury bills and corporate bonds, but also consists of relatively risky assets such as precious metals. In contrast, USDC and BUSD are backed by cash deposited in U.S. banks, short-term U.S. Treasury bills, and other relatively low-risk assets such as reverse repo contracts collateralized by U.S. treasuries. Moreover, the issuers of USDC and BUSD are based in the United States and regulated by U.S. authorities, unlike the issuer of USDT, which is not based in the United States." The post continues, "Stablecoins backed by traditional financial assets resemble the structure of money market mutual funds (MMFs). Users can mint new coins by depositing dollars with the issuer. When users want to withdraw their dollars, they send their stablecoins back to the issuer, who returns dollars to users' bank accounts. To be sure, there are important differences. First, MMFs are regulated by the Securities and Exchange Commission under Rule 2a-7, which sets minimum portfolio liquidity and maturity standards, among other things, while stablecoins are not. Second, stablecoins are traded on multiple exchanges, whereas MMF shares are not traded on exchanges. Finally, stablecoin units can be used as collateral in decentralized finance protocols, increasing the interconnection between different blockchain applications, whereas tokenization of MMF shares is nascent." Discussing the meltdown of the Terra stablecoin, the blog adds, "This dynamic is similar to what we have observed in recent runs on the MMF industry, when investments flowed from riskier prime funds to less risky government funds. And as with MMF runs, stablecoin runs can propagate to broader asset classes; the May 2022 stablecoin run, for instance, affected the broader crypto market, with approximately $200 billion in crypto market value (beyond stablecoins) being wiped out over eight days.... In May 2022, there was a run on Terra, an algorithmic stablecoin whose price broke its peg of $1 and crashed to zero. The run spilled over to the entire stablecoin sector, with stablecoins backed by riskier assets heavily affected and investors fleeing to less risky U.S.-based stablecoins regulated by U.S. authorities. As the digital asset ecosystem continues to grow, its potential to affect traditional financial markets and a broader section of households and firms could grow accordingly."
