Article authors: Cy Watsky, Jeffrey Allen, Hamzah Daud, Jochen Demuth, Daniel Little, Megan Rodden, Amber Seira, article compilation: Block unicorn< /p>
Stablecoins are becoming increasingly important in decentralized finance (DeFi) and crypto-asset markets, and their prominence has led to interest in Its unique role as a representation of the U.S. dollar running on a blockchain network comes under greater scrutiny. Stablecoins attempt to perform a mechanically complex function – maintaining a peg to the U.S. dollar even during periods of market volatility. However, in recent years, some stablecoins have become decoupled from secondary markets during periods of intense stress. Although each successive market event reveals new and unique risks for different stablecoins, there are still many analyzes that question the inherent stability (or instability) of different stablecoin designs.
The events of March 2023 illustrate these shifts and challenges. On March 10, 2023, Circle, the issuer of the stablecoin USD Coin (USDC), announced that it would be unable to transfer some of the USDC reserves it holds until regulators take control of Silicon Valley Bank. The price of USDC has significantly decoupled from the U.S. dollar, and as the market reacted to the news, the market for other stablecoins also fluctuated significantly. A combination of factors made the events of March particularly intriguing for researchers seeking to understand the complexities of the stablecoin market. This article analyzes many of these factors, focusing on differentiating primary and secondary market dynamics during the stablecoin crisis.
We first outline how stablecoins are collateralized, issued in the primary market, and traded in the secondary market. We then turn to a case study of the March 2023 stablecoin market events that rocked the crypto asset market. We discuss four stablecoins of interest, focusing on their different technical designs and detailing the dynamics of primary issuance points and secondary markets. From this analysis, we draw some general insights about the nature of stablecoin markets in times of stress.
Stablecoins are a class of crypto-assets designed to maintain a stable value relative to a non-crypto reference asset. For the purpose of this note, we focus on USD-denominated stablecoins – the vast majority of stablecoins traded on the crypto market. Unlike cryptoassets, which can fluctuate in value and are often purchased purely for speculation, stablecoins can serve as (ideally) a stable store of value and medium of exchange. The proliferation of stablecoins has led to their widespread use in DeFi markets and services to facilitate trading on cryptocurrency exchanges and serve as an entry point into the cryptocurrency market.
Based on the mortgage and issuance methods, stablecoins can usually be divided into three categories: stablecoins backed by legal currency, cryptocurrency-backed stablecoins Stablecoins and algorithmic (or uncollateralized) stablecoins. The way a stablecoin is designed to maintain a stable value has implications for its utility as a means of exchange or store of value, as well as the level of centralization (or lack thereof) inherent in the product.
Stablecoins backed by fiat currencies are backed by reserves of cash and cash equivalents such as deposits, Treasury bonds, and commercial paper. Most fiat-backed stablecoins are centralized, where a single company is responsible for issuing stablecoins on a public blockchain at a 1:1 ratio to fiat reserves held outside the blockchain. At a high level, stablecoin issuers are responsible for ensuring that the number of tokens issued on the blockchain is no greater than the dollar value of the issuer’s “off-chain” reserves.
Cryptocurrency-collateralized stablecoins are backed by a basket of cryptoassets (such as other stablecoins or cryptoassets, including Bitcoin or Ethereum), so each stablecoin issued holds at least one dollar worth of crypto assets as reserves. They tend to be decentralized in nature, with self-executing smart contracts responsible for the issuance of tokens. A user deposits a certain amount of a crypto asset, and the smart contract mints an appropriate number of stablecoin tokens in return, typically at an overcollateralization ratio. If the value of the collateral falls below a certain level, a series of smart contract-backed processes liquidate the collateral and eliminate excess stablecoins from the supply.
In many ways, algorithmic stablecoins are the hardest category to define. They are often designed to be uncollateralized or uncollateralized at all, instead using smart contracts and various incentive structures to maintain the peg by adjusting the supply of the stablecoin based on demand. Terra, the largest algorithmic stablecoin before its collapse in May 2022, represented a model in which stablecoins were “backed” by cryptoassets and their supply fluctuated directly based on changes in stablecoin demand. As stablecoins are withdrawn from circulation, the supply of the backing crypto-asset increases, thereby reducing the price of the backing crypto-asset, and vice versa, new stablecoins are minted. In this way, the cryptoassets backing algorithmic stablecoins are endogenous to the same system, unlike crypto-collateralized stablecoins, which are theoretically backed by other unrelated cryptoassets. This collateral design resulted in a rapid and significant “death spiral” for several algorithmic stablecoins.
The issuance and collateral design of stablecoins is a way for stablecoin issuers to adjust collateral or supply, a way to guarantee consumers that each stablecoin is worth one dollar. However, secondary markets actually price the asset and help the stablecoin maintain its peg to the U.S. dollar.
Issuers of fiat-backed stablecoins tend to mint and destroy new stablecoins only with institutional clients, meaning retail traders rely on the secondary market to obtain their stablecoins. Therefore, not all stablecoin traders have access to the primary issuance point, and those who do not can only contribute to the stablecoin’s peg through the secondary market. But primary markets for other stablecoins can include a wider range of participants. For example, DAI is a crypto-collateralized stablecoin issued through a decentralized smart contract that allows any user on Ethereum to deposit collateralized tokens in exchange for the stablecoin.
The peg of stablecoins is also maintained through extensive trading in secondary markets, such as DeFi platforms and centralized exchanges. Direct clients of stablecoin issuers can engage in arbitrage transactions to profit from the difference between the exchange rate in the primary market and the exchange rate in the secondary market to maintain the stablecoin peg. Decentralized exchanges and liquidity pools provide additional opportunities for arbitrage trading, such as stablecoin-specific automated market makers.
Market observers typically do not look at primary issuance points to determine whether a stablecoin remains pegged at a specific point, as stablecoin issuers are unlikely to commit to redeeming their stablecoins for less than a dollar. Instead, prices aggregated across exchanges tend to be the most popular source of pricing data, although market inefficiencies can make it difficult to accurately price stablecoins and other cryptoassets.
The literature on the economics behind stablecoin issuance and cryptoasset markets is still grappling with fundamental questions, but several emerging areas of research provide insights into stablecoin stability and the role that stablecoins play in cryptoasset markets. Character insights. Baur and Hoang (2021) and Grobys et al. (2021) provide evidence for the role of stablecoins as a hedge against Bitcoin volatility and argue that, as a result, the prices of stablecoins are not always stable as they are affected by other cryptoassets The impact of market fluctuations. Gorton et al. (2022) argue that stablecoins have the utility of providing loans to leveraged traders in the cryptocurrency market and explain their ability to remain stable. Several papers analyze the impact of the issuance of new stablecoins on other crypto-asset markets, and there is evidence of a correlation between the primary market for stablecoins and the secondary market for stablecoins and other crypto-assets. Ante, Fiedler, and Strehle (2021) argue that on-chain issuance of new stablecoins is associated with abnormal returns for other cryptoassets, while Saggu (2022) argues that investor sentiment in response to the public announcement of a new Tether minting event is contrasting Reasons for Bitcoin’s positive price reaction.
Perhaps the most informative for our analysis is Lyons and Viswanath-Natraj (2023), who explore flows between primary and secondary markets for stablecoins, arguing that stablecoins “ Access to primary markets is critical to the efficiency of arbitrage designs” (p. 8). The authors found that Tether’s design changed in 2019 and 2020, expanding its access to primary markets and reducing peg instability. We draw inspiration from their approach to consider the importance of the relationship between primary and secondary market price dislocations for stablecoins and adopt some of their methods. We extend this analytical approach to stablecoin markets during periods of market stress, highlighting the mechanical differences between the four stablecoin primary markets as well as the activity in decentralized and centralized secondary markets.
On March 10, 2023, Circle, the issuer of the stablecoin USD Coin (USDC), announced , it was unable to transfer the $3.3 billion in USDC reserves held by Silicon Valley Bank (its reserves were about $40 billion) out of the bank until regulators took over. The price of USDC decoupled from the U.S. dollar on the secondary market, and the markets for other stablecoins also saw significant volatility as market traders reacted to the news. In our case study, we looked at four of the largest stablecoins at the time: USDC, Tether (USDT), Binance USD (BUSD), and DAI.
Our analysis and tracking of activity in primary markets, decentralized secondary markets, and centralized secondary markets during market turmoil to tease out the differences between stablecoins and demonstrate the benefits from on-chain and What can be seen in the off-chain data.
USDC is a stablecoin backed by fiat currency issued by Circle. As with many fiat-backed stablecoins, only Circle’s direct customers (cleared through the application process) have access to USDC’s primary market, and these customers tend to be businesses such as crypto asset exchanges, fintech companies, and institutional traders. Most retail investors purchase stablecoins from intermediaries and can buy and sell them on secondary markets such as centralized and decentralized exchanges.
On March 11, Circle announced that USDC’s “issuance and redemption are subject to U.S. banking system business hours” and that such “USDC liquidity operations will resume normal on Monday morning when banks open.” . The announcement suggested that operations in the primary market would be restricted, while later announcements suggested that redemption backlogs had grown. Our analysis in the following sections examines the on-chain activity visible in the USDC primary market, although we cannot infer the extent of the off-chain backlog. Exchanges that typically offer retail investors one-on-one trading of USDC against other stablecoins or USDC against the U.S. dollar then suspend such trading, further cutting off outflows from secondary market participants who want to sell USDC.
BUSD is a stablecoin backed by fiat currency issued by Paxos. While it operates mechanically similarly to the other fiat-backed stablecoins described in this note, it differs significantly in several ways. For one, regulators halted new issuance of BUSD in February 2023, meaning that the primary market for BUSD could only burn tokens and reduce supply during the period we analyzed. Second, although BUSD is only issued on Ethereum, BUSD holdings are highly concentrated in Binance-related wallets—more than 85% of BUSD is on Ethereum. Approximately one-third of BUSD is locked in Binance wallets on Ethereum, and tokens representing the locked BUSD are issued on Binance Smart Chain (another blockchain). As a result, BUSD also plays a much smaller role in transactions on Ethereum-based decentralized markets.
USDT is the largest stablecoin on the market and a fiat-backed stablecoin whose primary market is limited to a set of approved customers, who tend to be companies rather than retail traders. The primary market for USDT is much more restrictive than USDC, with a reported minimum price of $100,000 per mintage on-chain (Ehrlich and Bambysheva 2022). We will delve further into Tether primary market activity later. It is worth noting that although USDC has been restricted in both the primary and secondary markets, and the issuance of BUSD has been suspended by regulatory agencies, USDT was not subject to unusual technical restrictions during the case study period.
Dai is a crypto-collateralized stablecoin whose issuance is managed by a decentralized autonomous organization (DAO) called MakerDao and implemented through smart contracts. Dai is issued only on Ethereum, and any Ethereum user can access the smart contract that issues the token. These smart contracts vary in the various types of collateral provided and the mechanisms used to maintain collateral levels. For example, a user can open a Maker Vault, deposit Ethereum (ETH) or other acceptable volatile cryptoassets, and generate Dai at an overcollateralization ratio, such as $150 of ETH for $100 of Dai. Dai's pegged stability module, on the other hand, allows users to deposit another stablecoin, such as USDC, to receive the exact same amount of Dai in return. Dai is therefore unique among the stablecoins we studied in that its primary market is available to any Ethereum user with access to DeFi and that multiple, mechanically distinct primary markets exist for stablecoins. The nature of the self-executing mechanism that controls the token supply makes its primary market theoretically more active than other stablecoins. Additionally, a portion of Dai is collateralized by USDC, a fact that more directly links the Dai market to changes in the USDC market.
Table 1 shows some descriptive statistics for each stablecoin. Notably, USDC’s market capitalization decreased by approximately $10 billion during March 2023, while USDT’s market capitalization increased by approximately $9 billion. Although DAI’s supply fluctuates over the course of a month, ultimately its market cap changes very little. BUSD lost more than $2 billion in market value. Additionally, USDT is significantly different in that only 45% of its supply is issued on Ethereum as of March 1, 2023, while the majority of non-Ethereum USDT is issued on Tron .
Table 1. Descriptive statistics of stablecoins (2023)
The secondary market for stablecoins provides market observers with a default source of pricing data . Figure 1 shows that the prices of these four stablecoins diverged significantly in the days following SVB’s collapse. USDC and DAI decoupled in a strikingly similar pattern, hitting lows below 90 cents and recovering at a similar pace within three days. Given that the primary responsibility of a stablecoin is to maintain a peg to the U.S. dollar, one might think that a similar price decline would indicate similar overall market conditions for both assets. However, as shown in Table 1, DAI’s market capitalization increased after the events of March, while USDC’s market capitalization fell by nearly $10 billion. On the contrary, although both BUSD and USDT experienced a premium, BUSD's market capitalization shrank while USDT's market capitalization increased by $9 billion. Therefore, pricing data alone cannot explain all market dynamics during the March event.
Figure 2. Hourly stablecoin prices on the secondary market (CryptoCompare)
Centralized exchanges (CEX) remain the most popular way for retail traders to trade crypto assets in the secondary market, but decentralized exchanges ( DEX) has become increasingly popular over the past few years. At a high level, DEXs seek to perform a similar function for users: they act as marketplaces for trading crypto assets. However, they differ significantly in several key ways:
CEX can serve as a gateway for fiat currencies. Users can trade fiat currencies to buy cryptocurrencies and vice versa. On the other hand, users cannot buy or sell stablecoins for fiat currencies on the DEX. This limitation has resulted in stablecoins dominating decentralized exchanges as the only alternative to fiat currencies for dollar-like currency transactions.
CEX operates using traditional market makers and limit order books, while DEX uses automated market makers, which behave differently even though they attempt broadly similar market making functions. May vary.
Users must log into a centralized system to access a CEX, often by sharing identifying information to comply with local "know your customer" regulations. DEXs, on the other hand, run on permissionless smart contracts, which makes them theoretically more open. However, for less experienced cryptocurrency traders, CEXs may resemble more traditional, intuitive systems, while DEXs require users to be familiar with the operation of DeFi applications.
Differences between these categories of exchanges may have contributed to the differences in CEX and DEX activity during the March event. Figure 2 shows that both types of exchanges experienced surges in trading volume during the March event, but to varying degrees. While DEX trading volume increased to an all-time high of over $20 billion on March 11, CEX trading volume reached highs in the first half of 2023 compared to typical trading volumes between $1 billion and $3 billion. Levels in other periods are not significantly different, and they are not record highs. Furthermore, DEX trading volume peaks before CEX trading volume increases and then declines before CEX trading volume peaks. However, these differences in trading volumes do not result in significant gaps in asset pricing between centralized and decentralized markets. Further research teasing out the differences between CEX and DEX during times of stress will help clarify the roles they play in facilitating activity in stablecoin operating scenarios, as well as the mechanical differences between automated market makers and limit order books. Influence.
Figure 2. Daily trading volume of the secondary market in the first half of 2023
The increase in secondary market activity ultimately transmits pressure to the primary market for stablecoins due to excessive selling pressure on decoupled stablecoins and excessive demand for stablecoins trading at a premium. In theory it should lead to issuance or redemption in the primary market. We will examine the data in the next section.
The public nature of data stored on the Ethereum blockchain allows us to directly view the creation and destruction of stablecoins, we conduct Part of the reason for this analysis is to demonstrate how researchers can infer the main markets for stablecoins through blockchain data. We present these data in a variety of ways, but we do not attempt to assert primacy of one or another approach to understanding the nature of the primary market for stablecoins. The descriptive analysis of on-chain issuance provides an illuminating complement to the more widely cited data on stablecoin secondary markets. We hope that future research will question the theoretical underpinnings of the relationship between primary and secondary markets for stablecoins.
We use Amazon Web Services public blockchain data to access on-chain data to track stablecoin supply changes on Ethereum. We track two sets of numbers: the “mint” and “burn” of on-chain tokens, and the movement in and out of treasury wallets associated with each fiat-backed stablecoin issuer. The minting and burning of tokens simply describes the addition or subtraction of tokens from the total supply of Ethereum. We follow Lyons and Viswanath-Natraj (2023) to measure “net flows” from primary to secondary markets. Issuers of BUSD, USDT, and USDC each maintain a treasury wallet that holds the remaining tokens minted on-chain but not yet issued to other parties. By subtracting the net transfers into Treasury wallets from the net amount of tokens minted on-chain, we can track the net flow of new funds from the primary market to the secondary market. Because DAI is issued directly to holders through smart contracts, there is no treasury wallet that acts as an intermediary for the initial distribution of DAI on the chain.
As background, Table 2 provides summary statistics comparing the major markets for each stablecoin in 2022 (well before the relevant event window). This table records the number and average of mints, burns, and treasury wallet transactions over the course of the year. What is immediately apparent are differences in the frequency of primary market activity and the average size of each trade. In terms of transaction volume and unique primary market participants, the primary markets for DAI and USDC are much more active than for BUSD and USDT. Furthermore, on average, BUSD and USDT have higher primary market trading volumes than DAI and USDC. Clearly, tokens that are considered similar in terms of structure and functionality (such as USDC and USDT) may have very different underlying primary market dynamics.
Table 2. Activity in the primary market of stablecoins on Ethereum in 2022
As mentioned before, while the viewing activity on Ethereum accounts for the vast majority of Dai, USDC and BUSD, the majority of USDT tokens are on Tron . Tron blockchain data accessed via Tronscan suggests that Tron’s primary market is not significantly different from Ethereum, and that the dynamics observed on Ethereum are not due to the lack of Tron activity in our analysis.
Turning to major market activity during the decoupling event, Figure 3 plots the total number of tokens minted and burned for DAI and USDC over three comparable windows. March 10 to March 15 was the period between Circle’s announcement of SVB’s stranded funds issues and its announcement of a “significant clearing” of all accumulated backlog redemptions. These dates roughly coincide with a period of unusually high activity in cryptocurrency markets following the collapse of SVB. Two windows of equal length in the months preceding decoupling are depicted for comparison. The figure reveals three noteworthy observations. First, DAI experienced unusual primary market activity during this period compared to normal trading volumes. Second, USDC’s burning activity was not unusual during this window, but its minting activity was sluggish. Finally, DAI saw a net issuance increase during the event window, while USDC saw a net loss. Given that both stablecoins de-pegged during this period, future research could examine the drivers of differences in net issuance during the crisis.
Figure 3. DAI and USDC minting and burning activity within selected window on Ethereum
Looking further into USDC, Figure 4 plots the hourly minting and burning amounts of the token within the event window from March 10 to March 15 , value and average. Here we are interested in observing the main market activity between Friday, March 10, and Monday, March 13, when Circle suspended and resumed redemptions respectively. When examining these trades on an hourly basis, we are able to compare public statements from company employees with detailed primary market dynamics. Although there were a large number of burn transactions during this window, the total value and average size of the transactions were limited.
Figure 4. USDC’s main market activity on Ethereum during the decoupling event
Figure 5 shows the daily “net flow” into the secondary market for all four stablecoins from March 1 to March 20. Prior to the decoupling event window, BUSD experienced a period of significant outflows after the New York Department of Financial Services ordered Paxos to stop issuing BUSD in mid-February. Figure 5 shows that USDC experienced significant negative flows during the March decoupling event compared to other stablecoins. Nearly $2 billion in USDC tokens were delisted from the secondary market on March 10, with net flows decreasing over the weekend before heavy outflows began again on Monday, March 13. During the case study period, Dai also went off the peg and net traffic decreased significantly. Inflows into the secondary market increased on March 11, followed by smaller outflows the following week. Meanwhile, USDT was the only stablecoin to see inflows into the secondary market in the week following the decoupling event, possibly reflecting a shift by investors toward safety. Net inflows into the secondary market complement our observations of secondary market activity during this period. While selling pressure on USDC led to secondary market outflows, surprisingly DAI still saw net inflows into the secondary market despite its price moving at a similar pace.
Figure 5. Net flow from the primary market to the secondary market
Overall, when analyzing on-chain data, we observed significant differences in primary market activity across the four stablecoins during the crisis, and our results indicate that, Relying solely on exchange pricing data does not tell the full story of stablecoin runs. Our analysis raises several research questions and highlights that, based on the technical characteristics of stablecoins, primary market behavior is important for understanding stablecoin crisis dynamics.
After events in the stablecoin market, media reports and analyzes usually focus only on price dislocations in the secondary market. As the literature on how to explain stablecoin market dynamics as a whole remains unresolved, our technical and empirical analysis provides some insights that suggest an area ripe for further exploration:
The main function of stablecoins in the cryptocurrency market is to maintain value stability. As a result, price declines could harm the long-term performance of stablecoins, a dynamic that has historically been the case. However, price declines alone are not enough to explain the long-term performance results of stablecoins. Indeed, during the events of March, USDC experienced a significant price slide and subsequent decline in market cap, while USDT traded at a premium before experiencing a rise in market cap. But BUSD trades at a premium while its market capitalization falls, while DAI fell below its USD peg before emerging from the crisis and increasing its market capitalization. While some obvious factors such as regulators halting issuance of BUSD contributed, more research is needed to assess other contributing factors, but several questions remain. Why is DAI priced so similarly to USDC on the secondary market? How much impact do different primary markets have on these stablecoins?
There are huge differences in the primary market for stablecoins whether in normal times or in times of crisis. Even superficially similar stablecoins, such as fiat-backed stablecoins like USDT and USDC, are distributed through primary markets, which are unique in terms of frequency, number of participants, and response to external shocks Characteristics. The importance of these changes for price stability, operational risks, and price recovery deserves to be explored in further detail.
Our empirical analysis shows that decentralized and centralized exchanges operate differently during times of crisis, even though they price stablecoins very similarly. This leaves several questions: To what extent are mechanical differences between automated market makers and limited order books, the availability of fiat trading pairs, or other factors causing this difference? Which secondary markets are more reliable indicators of stablecoin market stress?
Our study aimed to identify several areas worthy of further exploration, and the results of our analysis raise more questions than answers. As stablecoins continue to play a key role in cryptoasset markets and DeFi, we believe that the findings presented in this article and the questions we raise merit further theoretical and empirical research.
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