Stablecoins Face Liquidity Risks: Concerns About Asset Backing Can Lead to Mass Redemptions

Key Takeaways

• Stablecoins face liquidity mismatch risks, where concerns about asset backing can lead to mass redemptions and liquidity shortfalls.
• Researchers suggest that issuers should sell more liquid assets for small redemption shocks.
• Regulators aim to reduce the issuer’s default risk and minimize the price impact of redemption-driven asset sales.

Stablecoins face liquidity mismatch risks, where concerns about inadequate asset backing can lead to mass redemptions and liquidity shortages.

In light of this, how should issuers manage redemption pressures, and how should regulators oversee stablecoins?

Stablecoins Liquidity Risks

Issuers and Regulators Roles

The regulator pursues both micro and macro-prudential objectives. It aims to reduce the issuer’s probability of default while also minimizing the negative price effects of redemption pressures, regardless of whether the issuer defaults.

The first goal enhances the stability of the stablecoin system, while the second helps contain spillover risks to the broader financial market. These dual objectives justify the implementation of both capital and liquidity requirements, aligning with the Tinbergen Principle .

The probability of default in the next period depends on the issuer’s current financial position and regulatory requirements. It is determined by an indicator function that signals default—defined as the inability to distribute positive dividends.

Meanwhile, the expected price impact reflects the anticipated decline in asset prices due to redemption-driven sales, which can occur even if the issuer remains solvent.

The model establishes a relationship between regulatory parameters and the issuer’s PD and EPI in the following period. These outcomes depend on the issuer’s balance sheet composition and redemption demand.

By considering global benchmarks used for banks and money-market funds, regulators can calibrate capital and liquidity requirements to achieve desired PD and EPI levels while accounting for stablecoin issuers’ balance sheet management strategies and risk buffers.

GENIUS Act May Change Regulatory Environment

As demand grows, Tether (USDT) and USD Coin (USDC) dominate the market with capitalizations of $141 billion and $55 billion, respectively, creating a near-duopoly.

Despite their rising importance, regulatory uncertainty in the U.S. has hindered innovation, potentially weakening the country’s leadership in digital finance. The GENIUS Act, introduced by Senator Bill Hagerty, aims to address this by providing clear oversight.

According to David Krause, Emeritus Professor at the Finance Department at Marquette University, it mandates that stablecoin issuers with over $10 billion in assets comply with Federal Reserve guidelines, while smaller issuers remain under state jurisdiction.

“The bill also requires monthly audited reports to ensure sufficient reserves, with penalties for fraudulent reporting,” the expert said.

By establishing a structured regulatory framework, the GENIUS Act seeks to balance innovation with financial stability. It reinforces confidence in the U.S. dollar by mandating stablecoin backing with Treasury bills and Federal Reserve notes.

Its bipartisan support increases its likelihood of passage, positioning the U.S. as a leader in digital finance.

“Additionally, the Act could reshape credit markets by enabling stablecoin-backed lending, expanding liquidity while introducing new financial risks,” Krause said.