Currency Crises in the Age of Decentralized Finance: An Empirical Study of the Fixed Exchange Rate Vulnerabilities of Stablecoins

Abstract

This study provides an empirical investigation into the vulnerabilities of stablecoins and the impact of reserve disclosure transparency on peg stability. By extending the theoretical frameworks of second generation currency crisis models, traditionally applied to fiat pegged exchange rate regimes, we show the relevance of the multiple equilibria theory to the relatively new field of stablecoins. We use a panel data probit model to empirically show that greater transparency is associated with a reduced stablecoin crisis probability, but its stabilizing effect diminishes as the stablecoin reserve value drops farther away from the desired 1:1 collateral ratio. Transparency’s benefits are particularly pronounced when a stablecoin faces a large shock to Treasury yields, which impacts the value of its portfolio assets. Furthermore, we illustrate that on-chain shocks and external market events are associated with a notably greater crisis likelihood and can push a stablecoin into a state where a speculative run equilibrium becomes viable. The implications of these findings are of particular relevance to academics, policymakers, and stablecoin issuers, as they highlight the vital importance of reserve holdings transparency in protecting investors and the need to develop novel risk management approaches to minimize crisis probability.