Stablecoins and credit risk: when do they stop being stable?

Korobova, Elena and Fantazzini, Dean (2024): Stablecoins and credit risk: when do they stop being stable? Forthcoming in: Applied Econometrics (2025): pp. 1-30.

Abstract

Stablecoins are a pivotal and debated topic within decentralized finance (DeFi), attracting significant interest from researchers, investors, and crypto-enthusiasts. These digital assets are designed to offer stability in the volatile cryptocurrency market, addressing key challenges in traditional financial systems and DeFi, such as price volatility, transparency, and transaction efficiency. This paper contributes to the existing literature by estimating the credit risk associated with stablecoins, marking the first study to focus exclusively on this market. Our findings reveal that a substantial portion of stablecoins have failed, aligning with existing literature. Using Feder et al.'s (2018) methodology, we observed that 21% of stablecoins were "abandoned" at least once, with only 36% being later "resurrected," and just 11% maintaining their "resurrected" status. These results support the hypothesis that stablecoins rarely recover once they break their peg, often due to technical issues or loss of user trust. We also found that the time between a statistically significant break in the stablecoin's peg and its subsequent collapse or stabilization averages approximately 10 days. We estimated probabilities of default (PDs) for stablecoins based on market capitalization using various forecasting models. A robustness check further indicated that stablecoins on the Ethereum blockchain are less prone to default, likely due to Ethereum's robust ecosystem and the established presence of older stablecoins. Despite the study's limitations, including a limited dataset of 121 stablecoins and missing market capitalization data, the findings offer practical applications for investors and traders. The techniques and models applied in this research provide tools for evaluating credit risks in the stable-coins market, aiding in portfolio management and investment strategies.

• Item Type: MPRA Paper
• Language: English
• Keywords: stablecoins; crypto-assets; cryptocurrencies; credit risk; default probability; probability of death; ZPP; Cox Proportional Hazards Model.
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C35 - Discrete Regression and Qualitative Choice Models ; Discrete Regressors ; Proportions; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C38 - Classification Methods ; Cluster Analysis ; Principal Components ; Factor Models; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C51 - Model Construction and Estimation; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G17 - Financial Forecasting and Simulation; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill; G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy ; Liquidation

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