Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking
CESifo, Munich, 2021
CESifo Working Paper No. 9260
![](https://cesifo.org/DocImg/cesifo1_wp9260.jpg?c=1689236940)
Stablecoins rise to meet the demand for safe assets in decentralized finance. Stablecoin issuers transform risky reserve assets into tokens of stable values, deploying a variety of tactics. To address the questions on the viability of stablecoins, regulations, and the initiatives led by large platforms, we develop a dynamic model of optimal stablecoin management and characterize an instability trap. The system is bimodal: stability can last for a long time, but once stablecoins break the buck following negative shocks, volatility persists. Debasement triggers a vicious cycle but is unavoidable as it allows efficient risk sharing between the issuer and stablecoin users.
Monetary Policy and International Finance
Economics of Digitization