Stablecoin devaluation risk

Abstract

Reliance of stablecoin issuers on centralized custodians introduces devaluation risk similar to that observed in traditional currencies under pegged exchange rate regimes. We construct market-based measures of stablecoin devaluation risk using spot and futures prices for Tether. Conditional on full default, our estimates suggest an average devaluation probability of 60 basis points annually, rising to over 200 basis points during the 2022 Terra-Luna crash. In contrast, the probability of a partial default, defined as a 5% devaluation (trading at 95 cents), is approximately 12 percentage points on an annualized basis. Key risk factors include market volatility and transaction velocity. While elevated interest rates suggest heightened devaluation risk, deviations from covered interest parity indicate segmentation between traditional and stablecoin markets, reflecting the effects of leverage trading and arbitrage costs. To mitigate these risks, our findings suggest the importance of greater transparency and regulatory oversight.