Working Papers

What Keeps Stablecoins Stable? (with R. Lyons) [Updated July 2020]

Abstract

_{We take this question to be isomorphic to, “What Keeps Fixed Exchange Rates Fixed?” and address it with analysis familiar in exchange rate economics. Using a rich dataset of trades between the stablecoin Treasury and private investors, we examine how peg-sustaining arbitrage stabilizes the price of the dominant stablecoin, Tether. In conventional fixed-rate regimes, the central bank stabilizes the peg through management of foreign reserves. In contrast, stablecoin pegs are managed through the actions of private investors, who deposit (withdraw) dollars with the Tether Treasury when the stablecoin trades at a premium (discount), a change in the relative supply that drives peg prices back toward one. We identify the arbitrage mechanism through a unique natural experiment: the migration of Tether from the Omni to the Ethereum blockchain. This event led to an increase in investor access to arbitrage trades with the Tether Treasury. Consistent with our mechanism, this reduced the absolute size of peg deviations by more than half. We also pin down which fundamentals drive the two-sided distribution of peg-price deviations: Premiums are due to stablecoins’ role as a safe haven, exhibiting, for example, premiums greater than 100 basis points during the COVID-19 crisis of March 2020; discounts derive from liquidity effects and collateral concerns.}

VoxEU articles

Do Stablecoins Inflate Crypto Markets? with R. Lyons
Libra still needs more Baking with B. Eichengreen

Podcasts

Chilling With Charlie Podcast: Cryptocurrencies
On the Brink with Castle Island Podcast: What Keeps Stablecoins Stable?
Stablecoins are Killing it:CryptoZTV

Unconventional Monetary Policy and Covered Interest Rate Parity Deviations: is there a Link?

Abstract

_{A fundamental puzzle in international finance is the persistence of covered interest rate parity (CIP) deviations. Since 2008, these deviations have implied a persistent dollar financing premium for banks in the Euro area, Japan and Switzerland. Using a model of the microstructure of the foreign exchange swap market, I explore two channels through which the unconventional monetary policies of the European Central Bank, Bank of Japan and Swiss National Bank can create an excess demand for dollar funding. In the first, quantitative easing leads to a relative decline in domestic funding costs, making it cheaper for banks to source dollars via forex swaps, relative to direct dollar borrowing. In the second, negative interest rates cause a decline in domestic interest rate margins, as loan rates fall and deposit rates are bound at zero. This induces banks to rebalance their portfolio toward dollar assets, again creating a demand for dollars via forex swaps. Both policies thus lead to an increase in the excess demand for dollars in the forex swap market. To absorb the excess demand, financially constrained dealers increase the premium that banks must pay to swap domestic currency into dollars. I show empirically that CIP deviations have tended to widen around negative rate announcements. I also document a rising share of dollar funding via the forex swap market for U.S. subsidiaries of Eurozone, Japanese and Swiss banks in response to a decline in domestic credit spreads.}

Price-Setting in the Foreign Exchange Swap Market: Evidence from Order Flow (with O. Syrstad)

Abstract

_{The Foreign Exchange (FX) swap market is the most traded financial market in the world with over 3 Trillion USD daily turnover (BIS Triennial Survey, 2019). Pricing in the FX swap market has been subject to considerable scrutiny since the global financial crisis in 2008, with non-US banks paying significant premiums to swap euros, swiss francs and yen into dollars. Since the financial crisis, dealers set the forward price by learning from order flow. We define order flow as net demand changes that are publicly observable and manifest themselves in FX trading. Using a proprietary dataset on inter-dealer trades, we estimate the price impact of order flow. A 1 standard deviation increase in order flow widens Covered Interest Rate Parity (CIP) deviations for the euro/$, chf/$ and yen/$ by up to 5 basis points. The price impact of order flow is more sensitive to increased dispersion in dollar funding spreads. We then differentiate between shocks to public information, such as quarter-end regulations and monetary announcements, and shocks to private information, such as central bank swap lines. We find evidence of forward prices being set contemporaneously in response to public information. In contrast, forward prices are set based on the arrival of order flow in response to private information.}

Work in Progress

“International Monetary Policy Spillovers: A High Frequency Approach” (with C. Jauregui).

“Commodity Currency Excess Returns, Disaster Risk and Recursive Preferences” (with D. Murakami and R. Nguyen)