Stablecoin Runs and the Centralization of Arbitrage

We analyze the run risk of USD-backed stablecoins and uncover a dilemma between stablecoins' price stability and financial stability. Stablecoin runs bear important financial stability implications through the fire sale of US dollar assets like bank deposits, Treasuries, and corporate bonds. We show that panic runs exist even though general investors only trade stablecoins in secondary markets with flexible prices. Run incentives are reinstated by stablecoin issuers' liquidity transformation and the fixed $1 at which arbitrageurs redeem stablecoins for cash in the primary market. We discover that more efficient arbitrage amplifies run risk. This explains why stablecoin issuers only authorize a small set of arbitragers even though it comes at the expense of maintaining a stable secondary price. In other words, the centralization of arbitrage embeds an inherent tradeoff between run risk and price stability. Our findings are based on a model and a novel dataset on stablecoin redemptions, trading, and reserve assets. Calibrating our model, we find a higher run risk for USDT, the largest stablecoin, compared to USDC, the second-largest stablecoin. However, even USDC bears significant run risk due to its less concentrated arbitrage and more concentrated deposit holdings.