Making Stablecoins Stable(r): Can Regulation Help? - DC Fintech Week 2025 Research Spotlight

Ladies and gentlemen, it's time. [Music] Fiatbacked stable coins have grown rapidly in recent years. Some projections suggest that their market capitalization could reach several trillion US in the next 3 years. This growth has triggered significant regulatory interest and activity. Our research provides a framework to guide these regulatory efforts.

But what risks justify regulating stable coins in the first place? Stable coin issuers engage in liquidity mismatch. They issue coins that can be redeemed at any time. These coins are backed by reserve assets, typically cash and bonds. These bonds are liquid most of the time.

However, during market stress, some bonds could prove costly to liquidate. Liquidity mismatch therefore creates risks. Issuers may not have enough capital to cover liquidation costs. This depletion of capital can then lead to stable coin failure. Such failure obviously harms coin holders, but it can also affect the broader financial system.

For example, a run on a stable coin can force the issuer to sell a significant share of its reserve assets, which can depress asset prices and cause losses for others holding similar assets. Our model shows how issuers manage reserves in light of these risks. In the absence of regulation, issuers hold to choose little cash in comp periods. Instead, they prefer holding bonds because bonds pay interest. As such, issuers expose themselves to the risk of failure and they expose the market to the risk of spillovers from forced bond sales.

Stable coins may never be perfectly stable, but regulation can help make them stabler. Guided by recent policy discussions, in our paper, we considered two types of regulatory requirements that relate to cash and capital. Flexibility in how these requirements are imposed is key. Some refer to this feature as buffer usability. Take cash for instance.

It is meant to serve as an insurance during times of stress. However, if a regulator imposes a hard minima on cash holdings at all times, then it defeats the purpose of having cash in the first place. Therefore, any cash requirement must be combined with the ability that the issuer is able to use cash when needed. A similar logic applies in the case of capital. Our model incorporates this flexibility feature.

It allows the issuer to maintain a buffer above the requirement or dip below the requirement during times of stress. This however attracts a cost. It unleashes coinholder discipline which is basically a higher risk of redemptions. What this means for the issuer is that it needs to trade off the creation of buffers versus using them when needed. We show that both cash and capital requirements help make stable coins safer and meet policy targets.

However, they work differently. Cash helps reduce forced bond sales whereas capital helps absorb any losses associated with forced bond sales. Are these two requirements necessary at the same time? We show that the answer is yes if the regulator has a dual objective that is making the stable coin arrangement safe as well as reducing spillovers to the broader financial market. Crucially our paper provides a framework a two-way mapping between policy objectives and the regulatory requirements.

The mapping implies that a regulator can either start with the requirements and see what policy objectives they can achieve and this is shown by the red dot. Conversely, the regulator could start with the dual objective and our framework will help them derive the cash and capital requirements that can deliver on the objective and this is shown by the blue dots. To sum up, our paper has two main contributions. It provides a model of how a stable coin reacts to redemptions and at the same time it offers policy makers a framework to calibrate regulatory requirements.

Ladies and gentlemen, it's time. Come on. Let me hear you say, "Hey, rocks like this." Scratch. Got to hear it twice.