On Par: A Money View of Stablecoins

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. However, how do stablecoins hold up from the vantage point of 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?

In a new working paper for the Bank of International Settlements, Iñaki Aldasoro, Perry Mehrling and Daniel H. Neilson present 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, the authors reveal that liquidity, not solvency, is the issue confronted by par settlement.

During the 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 as a result, relatively easy maintenance of par settlement.

However, 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, the authors emphasize the extremely primitive character of the on-chain forward market and find that there is a continuing vulnerability of existing on-chain stablecoins to liquidity failure.