In a landmark move, the United States has passed a long-awaited law regulating stablecoins, signalling a turning point for digital assets pegged to the U.S. dollar. The legislation, signed into law this month, aims to provide a clear framework for stablecoin issuers and offer users greater protection and transparency. As stablecoins inch closer to mainstream financial infrastructure, one might assume this increased legitimacy brings greater safety. But a newly accepted paper in Review of Financial Studies raises a surprising possibility: what if making stablecoins more stable on the surface makes them more fragile underneath?
Stablecoins are digital currencies designed to maintain a stable value, typically pegged to a fiat currency, such as the U.S. dollar. Unlike volatile cryptocurrencies such as Bitcoin or Ethereum, stablecoins are often used for payments, remittances, and as a store of value within the crypto ecosystem. They achieve stability by being backed by assets — typically dollar-denominated ones, such as cash, Treasuries, or short-term debt. But not all stablecoins are created equal. Most operate with a two-tiered structure: a small group of approved arbitrageurs can redeem or mint coins directly with the issuer at a fixed $1 price, while the rest of the world trades them on crypto exchanges where prices fluctuate slightly above or below $1 based on demand.
This unique market structure is at the heart of the recent paper by Yiming Ma, Yao Zeng, and Anthony Lee Zhang. The authors explore a critical and underexamined question: does increasing arbitrage efficiency to improve price stability in stablecoins also make them more susceptible to panic-induced runs?
Using transaction-level data from blockchain records and exchange prices, the authors reveal that arbitrage in stablecoins is surprisingly concentrated. For example, Tether (USDT), the largest stablecoin, allows only about six arbitrageurs to redeem coins in an average month. In contrast, USDC, a competitor stablecoin, sees over 500 arbitrageurs actively participating. These figures are based on actual on-chain redemption data, matched with secondary market price activity. The limited set of arbitrageurs isn’t merely a result of market disinterest — access is often governed by institutional arrangements, compliance procedures, and capital requirements, which restrict who can redeem stablecoins directly with the issuer.
This concentration matters. The study shows that stablecoins with more competitive arbitrage see fewer deviations from their $1 peg in the secondary market — a clear sign that arbitrage helps keep prices stable.
But there’s a twist. The same mechanism that keeps prices stable can also increase risk. In their theoretical model, the authors show that more efficient arbitrage reduces the penalty for investors who want to sell during stress — making it easier to exit and therefore more tempting to panic-sell. When redemptions spike, issuers must liquidate their reserves to meet demand, often at unfavourable prices. If enough investors rush to sell, fearing the system may not hold, this can trigger a self-fulfilling run — much like a bank run, but with tokens on a blockchain.
In other words, arbitrage acts as both a stabilizer and a stress amplifier. It keeps prices tight when markets are calm, but can lower the threshold for panic when uncertainty hits. The result is a fundamental tradeoff: improving price stability comes at the cost of financial fragility. Stablecoins that allow broader, more competitive arbitrage are more tightly pegged to $1 — but also more vulnerable to coordinated investor runs. Those that restrict arbitrage may look less stable day-to-day but are more insulated from cascading panic.
This insight has deep implications for regulation. Policies that simply aim to enhance price stability — like mandating open redemptions or enforcing tighter price bands — may inadvertently increase systemic risk if they don’t account for the liquidity of underlying reserves or investor behaviour during stress. For instance, requiring stablecoin issuers to allow all users to redeem at $1 could reduce price volatility, but unless backed by highly liquid and secure assets, this could expose the system to dangerous liquidity spirals. Similarly, restricting redemption access or adding fees may appear inefficient, but could reduce the likelihood of runs by dampening panic incentives.
Through empirical analysis and an elegant model, the authors show that stablecoin design is not a one-dimensional problem. It involves balancing competing goals: liquidity, accessibility, stability, and resilience. The key is understanding that stablecoin markets are more like a hybrid between ETFs and money market funds, where rules governing who can redeem and how easily matter deeply to systemic outcomes.
As stablecoins move further into the regulatory spotlight, this research serves as a timely reminder: in the quest to make money more digital and efficient, we must not forget that the appearance of stability can be deceiving. After all, in the world of crypto, even a dollar that never wobbles can be standing on shaky ground.
Chaoyi Chen
References:
Ma, Y., Zeng, Y. and Zhang, A.L., forthcoming. Stablecoin runs and the centralization of arbitrage. Review of Financial Studies.
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