Leverage and Stablecoin Pegs
Money is debt that circulates with no questions asked. Stablecoins are a new form of private money that circulate with many questions asked. We show how stablecoins can maintain a constant price even though they face run risk and pay no interest. Stablecoin holders are indirectly compensated for stablecoin run risk because they can lend the coins to levered traders. Levered traders are willing to pay a premium to borrow stablecoins when speculative demand is strong. Therefore, the stablecoin can support a $1 peg even with higher levels of run risk.
Gorton has nothing to currently disclose. He was a consultant to AIG Financial Products from 1996-2008. For comments and suggestions, thanks to Joseph Abadi, Todd Keister, Michael Palumbo, Greg Phelan, K. Sudhir, Chris Waller, and seminar participants at the Office of Financial Research, the Fed Board 2022 Summer Workshop on Money, Banking, Payments, and Finance, and the Fed System Committee on Financial Institutions, Regulation, and Markets. The analysis and conclusions set forth are those of the authors and do not indicate concurrency by members of the Board of Governors of the Federal Reserve System, the Office of Financial Research, or their staffs. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research or the Federal Reserve System.