When Silicon Valley Bank collapsed last March, the USDC stablecoin lost its peg because $3.3 billion of its reserves were deposited at the bank. Last week the Federal Reserve published a thought provoking note exploring the USDC stablecoin depeg event as a means to learn more about stablecoins.
Each stablecoin has distinctive issuance and redemption processes (primary markets), even for similar stablecoins. The ease and accessibility of minting and redemption could impact events during a stablecoin de-peg. Additionally, there were significant differences between activity on centralized and decentralized exchanges during the depeg event.
De-peg activity: price versus minting/burning
Perhaps the most significant finding is that price activity during a depeg event doesn’t tell the whole story. Two stablecoins, USDC and DAI, showed very similar price activity but behaved differently in other ways.
The DAI stablecoin is backed by crypto-assets rather than using cash and Treasuries in its reserves, with some of its assets in USDC. Having USDC in its reserves partially explains the similarity in price action.
Even though the DAI price de-pegged in a similar manner to USDC, the net flows in and out of the stablecoins were very different. During the early stages, the DAI saw positive net inflows of around $800 million, which was unexpected. That was followed by relatively small outflows.
In contrast, the USDC stablecoin experienced net requests for stablecoin redemptions reaching $2 billion on March 10.
Hence, the researchers suggest this needs more investigation.
They highlight that the DAI is different from the other major stablecoins (USDC, Tether, BUSD) which are centralized, whereas the DAI is decentralized. Without intermediaries, the minting and redemption process is automated. Users can deposit ETH or other collateral and mint DAI. They can also trade directly between DAI and USDC.
The question is whether these design features contributed to the net inflow. The authors didn’t draw conclusions. However, one potential hypothesis we’d make is that DeFi users may have used the ability to trade directly between DAI and USDC to off-ramp from USDC to DAI. While it’s not a perfect off-ramp, DAI is only partially backed by USDC. However, if users were rational, given the partial USDC backing, the DAI depeg should have been shallower than USDC’s but wasn’t significantly. Hence, it’s certainly worth further investigation.
Does greater accessibility make for more stability?
A 2023 research paper by different authors explored Tether, concluding that improving the accessibility of a stablecoin makes its price more stable (Tether moved from the Omni blockchain to Ethereum in 2019).
Hence, the Fed researchers explored the primary market – how users can issue and redeem stablecoins. We’ve already established that it’s easier for DAI users to mint and redeem. For the USDC stablecoin, only those with USDC accounts can issue and redeem. That’s mainly corporates and exchanges, but historically it has included individuals. During 2022 USDC had more than 88,000 unique primary market participants, compared to just 79 for Tether. Because Tether’s issuance and redemption is so concentrated, primary market transaction size is large compared to DAI and USDC.
The paper’s authors believe this topic of more access to minting and redemption is worth exploring further regarding what happens when there’s a shock.
Decentralized exchange activity leads?
The third point concerns key differences between centralized (CEX) and decentralized exchanges (DEX). The prices for stablecoins were not significantly different, but activity was.
Spikes in DEX trading volumes preceded increased activity on CEXs. The DEX volumes declined before CEX trading dropped. The authors simply suggest further research. However, we’d note that DEX users are more likely to be professional and semi professionals. So, one might expect DEX users to react faster than CEXs, which have more mixed user profiles.
The other difference is DEX volumes hit all-time highs on March 11 at $20 billion compared to average volumes of $1 to $3 billion. Volumes on CEXs also spiked, but not dramatically. CEX volumes rose by around 60% compared to the runup period, whereas DEX volumes were up close to 1000%. Again, we’d hypothesize that DEX users are far more likely to participate in arbitrage, hence the significant activity spike.
Meanwhile, the United States is apparently close to agreeing bipartisan stablecoin legislation, after acrimonious debates last year.
