We learned from Yahoo Finance, which wrote a piece entitled, "Why stablecoins maintain their dollar peg despite run risk," about an academic paper entitled, "Leverage and Stablecoin Pegs." Yahoo's article says, "Despite the worst crypto crash in history, there has yet to be a run on so-called stablecoins, a form of cryptocurrency backed by real world assets. (Not to be confused with algorithmic stablecoins). In a new paper (pdf) published by the National Bureau of Economic Research, five economists from Yale, the Federal Reserve, and the US Treasury explain why they think stablecoins backed by non-cryptocurrencies have been able to keep their peg despite all the scrutiny."
It adds, "The economists studied the margin lending rates across multiple exchanges and found that stablecoins had the smallest haircuts, the term for how much lower the asset is valued as collateral versus when it's on the market. They also found that stablecoin demand increases when crypto is more volatile and traders can take advantage of more leverage."
The NBER Working Paper's Abstract says, "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."
It explains, "Unlike fiat currency, stablecoins are economically equivalent to deposits and subject to runs. The same strategic complementarities for fragile banks and money market funds apply to stablecoin issuers. Stablecoin holders should demand compensation for run risk if they anticipate stablecoin reserves may prove too illiquid to maintain a $1 peg in bad states. But stablecoins do not pay interest, unlike bank deposits and money-market funds. Thus, it is unclear how stablecoins issuers can compensate their borrowers for run risk enough to keep the price fixed at $1."
The paper tells us, "The funding structure of stablecoin issuers is fragile because the liquidation value of its reserves may not be enough to fully cover potential redemptions by all token holders. As such, the stablecoin issuer is exposed to run risk from self-fulfilling beliefs giving rise to multiple equilibria described in the bank run literature."
It continues, "Such a feature is realistic, and several papers empirically study strategic complementarities in money market mutual funds during the Global Financial Crisis and Covid-19 crisis. Chen et al. (2010) and Schmidt et al. (2016) show that outflow behavior and strategic complementarities in open-ended mutual funds and money market funds are consistent with incomplete information games where agents receive private noise signals. Cipriani and La Spada (2020) show how investors produce private information about the money funds' run risks stemming from the illiquidity of the reserve assets, and they bifurcate investors into sophisticated and unsophisticated types."
Finally, the paper concludes, "Privately-produced money can maintain a $1 peg even if it is not no questions asked, but agents will not hold private money unless they are compensated for their risks. Speculative investors will provide that compensation if their expectations are bullish enough. Our model reconciles two important facts: first, stablecoins are not useful as money under their current regulatory regime despite their relative success in maintaining their peg, at least for the most salient coins. Second, stablecoin lending rates are high and tightly correlated with measures of speculative demand."
It adds, "Stablecoins can provide a direct link between speculation and the real economy. Stablecoin issuers invest their reserves to earn profits but must adjust their reserves -- possibly quickly -- to keep their debt trading at par. When speculative demand falls, they can keep their debt trading at par only by moving to a safer portfolio or allowing redemptions. Such reallocation or change in stablecoin supply can cause disruptions in the real economy. Stablecoin issuers will need to adjust quickly if expected returns for cryptocurrencies fall; otherwise, they face the risk of collapse. These adjustments can cause disruptions in the markets they invest in, like the commercial paper market that provides financing to the real economy."
In other news, The Wall Street Journal writes that, "Cash Cushions Dwindle at U.S. Pension Funds." They comment, "Cash holdings are the lowest since the financial crisis at U.S. government pension funds and just above last year's 13-year low for U.S. corporate pensions, heading into a year that many on Wall Street expect to test investors. Cash holdings hit 1.9% of assets at state and local government pension funds and 1.7% of assets at corporate pension funds as of June 30, according to an annual snapshot from Wilshire Trust Universe Comparison Service. Those figures compare with the 15-year average of 2.45% at public pensions and 2.07% at corporate pensions. The recent figures are lower than in 2008, when some retirement funds had to sell whatever they could to pay benefits during the financial crisis."
The article states, "Pension cash might already be rising from June 30 levels. That snapshot came at the end of a brutal two quarters for stocks, when extra cash might have gone to paying benefits or topping up equity portfolios, pension officials and advisers said. Also, holding cash becomes slightly more attractive as rates rise."
It also says, "Calpers reduced its cash allocation target to 1% from 2% in 2017 and eliminated it in July, as part of a revamp that added leverage and private equity. Deputy Chief Investment Officer Dan Bienvenue said Calpers's access to cash has improved since 2008. Then, he said, 'we not only had to sell at the time we didn't want to sell, we also had to sell things that we didn't want to sell.' We are in a much, much, much better place than we were,' Mr. Bienvenue said."
