Riksbank WP No. 423 on Stablecoins

“Stablecoins: Adoption and Fragility”

  • Abstract: Stablecoins promise a stable and secure way to park funds in the crypto universe. However, stablecoin issuers are vulnerable to runs triggered by negative information about the quality and liquidity of their reserves, as well as custodial, operational, and technological risks. I propose a framework for analyzing the factors influencing stablecoin adoption and fragility, which offers insights for risk assessment and appropriate regulation, as well as new testable implications. Under the premise that payment preferences are heterogeneous across potential stablecoin holders, a wider adoption of stablecoins is associated with a destabilizing composition effect. Positive network effects mitigate the destabilizing composition effect, but they may also undermine the role of bank deposits as a means of payment. The marginal stablecoin adopter does not internalize these effects. Consequently, adoption is likely to be excessive. Factors that increase the issuer’s income from fees and seigniorage promote stability, as do congestion effects. A stablecoin lending market promotes both stability and adoption, if it is not undermined by speculation. The introduction of a moral hazard problem provides additional insights into reserve management and disclosure. (D83, E4, G01, G28)
End of month market capitalization of top stablecoins over the period from January 2020 to November 2022. Source: coingecko.com.
  • Keywords: Stablecoins, money, payment preferences, financial stability, global games.

New Riksbank Working Paper version of “A wake-up call theory of contagion”

“A wake-up call theory or contagion” with Toni Ahnert (This version: 03/2020; First version: 06/2012)

  • Abstract: We offer a theory of contagion based on the information choice of investors after observing a financial crisis elsewhere. We study global coordination games of regime change in two regions with an unobserved common macro shock as the only link between regions. A crisis in the first region is a wake-up call to investors in the second region. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can occur even after investors learn that regions are unrelated (zero macro shock). Our results rationalize empirical evidence about contagious bank runs and currency crises after wake-up calls. We also derive other testable implications of the model. (D83, F3, G01, G21)
The value of information v and the proportion of informed investors n2 with and without a wake-up call, f ∈ {1, 0}. The figure shows (1) the strategic complementarity in information choices and (2) the effect of a higher level of s that increases the skewness of the macro shock and leads to an expansion of the intermediate range of information costs for which we establish the wake-up call contagion effect.