What happens when a cryptocurrency ‘shock’ hits? Researchers look at how stablecoin investors react - Federal Reserve Bank of Boston

A working paper by researchers at the Federal Reserve Banks of Boston and New York and UMass Amherst examines how stablecoin investors respond to "shocks," or unexpected events in the crypto market. Co-author Christina Wang, a senior economist and policy advisor in the Boston Fed's Research Department, said understanding these dynamics now, before stablecoins "gain even more scale," is intended to help build a foundation for future regulatory considerations. Mattia Landoni, a senior economist in the Boston Fed's Supervision, Regulation & Credit department, noted that rapid liquidation of very large asset pools is a concern for financial stability regulators.

The paper compares stablecoin investor behavior during recent stress periods with money market fund investor behavior during the 2008 financial crisis and the onset of COVID-19 in 2020. Stablecoins generally aim to maintain a price pegged to the U.S. dollar. Asset-backed stablecoins issued by U.S.-based entities are generally considered less risky than offshore stablecoins, which are often partially backed by riskier assets such as commercial paper, precious metals, and other cryptocurrencies. Co-author Antoine Malfroy-Camine, a senior risk analyst at the Boston Fed, said the two asset classes differ in structure but "experience very similar investor run and flight-to-safety dynamics during periods of stress."

Using daily CoinGecko data on 12 stablecoins from January 1, 2021, to March 15, 2023, the researchers estimated changes in circulating supply, or "flows," for each coin. The period included the collapse of the Terra stablecoin and a run on USDC. The researchers found investors tend to move away from riskier stablecoins after negative shocks toward safer ones. However, the definition of safety varies by shock type. When Silicon Valley Bank failed in March 2023, investors moved funds out of USDC, a U.S.-based stablecoin that held part of its cash at the bank. The outflows likely went to two offshore stablecoins, which Wang said made sense given that the shock originated with a U.S. bank.

The researchers also found that investor shifts occur mostly between stablecoins on the same blockchain, paralleling money market fund movements within the same fund family. Wang said such transfers are faster and less costly than moving assets across platforms, noting that "speed is of paramount importance" for investors seeking to move money. The paper further determined that a stablecoin pegged at $1 that drops to 99 cents reaches its depegging threshold, the level that can spark investor runs. Wang said money market fund depegging thresholds have regulatory roots, whereas the stablecoin threshold had been unclear, making the exercise useful. The full paper is available on bostonfed.org.