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Intelligent design: stablecoins (in)stability and collateral during market turbulence
Riccardo De Blasis1, Luca Galati2,3,4, Alexander Webb2
1Department of Management, Marche Polytechnic University, Via Lodovico Menicucci 6, 60121 Ancona, AN Italy.
Financial Innovation
|May 16, 2023
Summary
Stablecoin design significantly impacts market reactions to shocks, as seen after the TerraUSD (UST) collapse. Different structural designs influence contagion effects and trading behavior during turbulent periods.
Area of Science:
- Financial Economics
- Cryptocurrency Markets
- Market Stability
Background:
- Stablecoins aim to maintain a fixed value, typically pegged to a fiat currency like the US dollar.
- Varying structural designs exist among stablecoins, leading to different risk profiles and market behaviors.
- The May 2022 collapse of TerraUSD (UST) and Terra (LUNA) created a significant exogenous shock to the stablecoin market.
Purpose of the Study:
- To investigate how stablecoin design influences market behavior during periods of turbulence.
- To analyze the contagion effects stemming from the TerraUSD collapse on other major stablecoins.
- To understand the role of herding behavior in stablecoin market reactions.
Main Methods:
- Econometric analysis using the Baba, Engle, Kraft and Kroner (BEKK) model.
- Examining the reaction of various stablecoins to the exogenous shock of the UST collapse.
- Testing hypotheses on the differential impact of stablecoin design features on market responses.
Main Results:
- Significant contagion effects were observed following the UST collapse, indicating interconnectedness within the stablecoin market.
- Herding behavior among traders likely contributed to the observed contagion effects.
- Differences in stablecoin design were found to affect the direction, magnitude, and duration of market responses to shocks.
Conclusions:
- Stablecoin structural design is a critical determinant of market behavior and resilience during crises.
- Understanding these design implications is crucial for developers, exchanges, traders, and regulators.
- Further research into stablecoin architecture can enhance market stability and mitigate systemic risks.
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