On par: A Money View of stablecoins

BIS Working Papers  |  No 1146  | 
17 November 2023
by Iñaki Aldasoro, Perry Mehrling and Daniel H. Neilson
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Summary

Focus

The rapid growth in stablecoin issuance, and the recent testing of stablecoins' par settlement promises, has provoked a flurry of papers proposing various forms of regulation and alternatives, from various vantage points. Our vantage point is the money view, which focuses attention on the mechanism of settlement, and the role of forward markets in absorbing price pressure in times of adverse settlement flows.

Contribution

The problem of sustaining par settlement has a long history in the relationship between the offshore and onshore dollar systems, where the spread between the offshore eurodollar interest rate and the onshore federal funds rate plays a crucial role. We apply this analytical frame directly to the relationship between the on-chain (stablecoin) and the off-chain (fiat) dollar system.

Findings

During the spectacular rise of stablecoins, inefficiencies in pricing in the on-chain world offered substantial arbitrage profits which allowed stablecoins to offer rates of interest well above those available in the off-chain world. The result was substantial inflows, and so relatively easy maintenance of par settlement. But increasing efficiency in the on-chain world, coupled with rising interest rates off-chain, has shifted those flows in reverse, testing the mechanisms that various stablecoins had devised for maintaining their par settlement promises. Compared with the eurodollar system, we emphasise the extremely primitive character of the on-chain forward market, and hence the continuing vulnerability of existing on-chain stablecoins to liquidity failure.

Abstract

This paper presents a money view analysis of the recent crypto innovation of stablecoins, which have seen a remarkable rise and more recently some spectacular collapses. By analogizing on-chain with offshore, and developing an extended analogy of stablecoins with Eurodollars, we reveal the primitive character of the existing on-chain liquidity mechanism which supports the promise of par settlement by existing on-chain stablecoin models. Liquidity, not solvency, is the issue confronted by par settlement.

JEL classification: E42, F33, G21, G23

Keywords: stablecoins, Eurodollar, forward market, dealer function, liquidity