Review of Finance 2026
Making stablecoins stable(r): can regulation help?
Abstract
Rapid growth of stablecoins has raised concerns about issuer default and spillover risks. To assess these risks, we model a stablecoin issuer facing persistent demand shocks. Absent regulation, the issuer holds little capital and favours interest-bearing but illiquid bonds over cash. This exposes coin-holders to default risk and poses spillovers via bond fire-sales. How can regulation mitigate these risks? Capital and liquidity thresholds can help, especially when introduced as usable buffers. The thresholds can be breached, providing flexibility. However, breaches trigger additional redemptions that discipline the issuer. The thresholds operate through asymmetric channels: the liquidity threshold raises only cash, whereas the capital threshold increases both capital and cash. Both thresholds mitigate default and spillover risks, making them substitutes when either risk is targeted separately but complements when both risks are targeted jointly. We provide a two-way mapping that helps derive capital-liquidity threshold combinations implied by chosen risk targets (and vice-versa).
- DOI
- 10.1093/rof/rfag040
- Language
- en
- Sources
- crossref