Money Creation in Decentralized Finance: A Dynamic Model of Stablecoins and Crypto Shadow Banking
Abstract/Contents
- Abstract
- We develop a dynamic model of stablecoins and crypto shadow banking, where the stablecoin issuer transforms risky assets, including cryptocurrencies, into digital tokens of stable values. Both the stablecoin issuer’s reserve assets and users’ collateral back the stablecoin. However, even under over-collateralization, a pledge of one-to-one convertibility to a reference currency can be fragile. The distribution of states is bimodal: A fixed exchange rate may persist, but once the stablecoin breaks the buck, the recovery is slow. When negative shocks drain the issuer’s reserves, debasement allows the issuer to share risk with users, but it triggers a vicious cycle of depressed stablecoin demand, lower transaction volume and transaction fees, slow rebuild of reserves, and a persistent need for debasement. Stablecoin management requires the optimal combination of strategies commonly observed in practice, such as open market operations, dynamic requirement of users’ collateral, transaction fees or subsidies, re-pegging, and issuances of “secondary units” that function as the stablecoin issuer’s equity. Our model lends itself to an evaluation of regulatory proposals (e.g., capital requirement) and sheds light on the complex incentives behind the stablecoin initiatives led by the network companies (e.g., Facebook).
Description
| Type of resource | text |
|---|---|
| Date created | July 30, 2021 |
Creators/Contributors
| Author | Li, Ye |
|---|---|
| Author | Mayer, Simon |
| Organizer of meeting | Judd, Kenneth |
| Organizer of meeting | Pohl, Walter |
| Organizer of meeting | Schmedders, Karl |
| Organizer of meeting | Wilms, Ole |
Subjects
| Subject | economics |
|---|---|
| Genre | Text |
| Genre | Working paper |
| Genre | Grey literature |
Bibliographic information
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- License
- This work is licensed under a Creative Commons Attribution 4.0 International license (CC BY).
Preferred citation
- Preferred citation
- Li , Y. and Mayer, S. (2022). Money Creation in Decentralized Finance: A Dynamic Model of Stablecoins and Crypto Shadow Banking. Stanford Digital Repository. Available at https://purl.stanford.edu/kb917bq1515
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SITE Conference 2021
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