Authors: Oksana Anatolyevna Malysheva
Abstract: The emergence of decentralized finance (DeFi) has prompted a new, highly interwoven financial system in which the stability of the financial system is fundamentally dependent upon the existence of digital assets, in particular stablecoins, that serve as both a method of conducting transactions, collateral, and a source of liquidity. Although DeFi is said to be efficient, programmable, and disintermediated, the structural complexity and composability of the DeFi system also create new systemic-risk channels that are similar to the impact of fragilities in conventional finance (Auer et al., 2024; Xu et al., 2024). The role of stablecoins in this architecture is to facilitate trading, leverage, and settlement of protocols, though the design and collateralization process puts them at risk of derailing the stablecoin and liquidity shocks and runs (Catalini et al., 2022; Hoang and Baur, 2024). These dynamics are similar to traditional bank run and liquidity crisis theories, in which the lack of coordination and redemption could cause damaging withdrawal effects (Diamond and Dybvig, 1983; Bernardo and Welch, 2004). In the case of the elements of DeFi, the volatility can spread very quickly between lending pools, automated market makers, and cross-chain bridges, facilitating the transfer of stress and volatility across platforms and asset classes (Zieba et al., 2019; Pagnottoni, 2023). The lack of centralized backstops, along with the algorithmic governance and large leverage, also serves to further enhance the risk of local perturbations developing into system-wide contagion. Such vulnerabilities have increased the arguments for risk-sensitive system design, greater transparency, and regulatory coordination to reduce spillovers to the financial system more generally (FSB, 2018; Manaa et al., 2021; Fantacci and Gobbi, 2024). Altogether, the discussion shows that the concept of stablecoins is an important crossroads in the stability environment of DeFi: not only do they allow markets to operate, but also they are a primary medium through which runs and shocks are propagated. The knowledge of these mechanisms is paramount in the formation of the resilient protocol design, supervisory systems, and eventual research on systemic risk of programmable financial systems.
