One Asset, Two Financial Systems: Stablecoins and the Transmission of Runs between Decentralized and Traditional Finance

Abstract

A stablecoin is two things at once, a claim on U.S. Treasury bonds and the money of decentralized finance. That dual role makes the coin a conduit that carries runs in both directions. We build a model in which the coin is fully backed by Treasuries, pays no interest, and is the gateway to DeFi lending, so that the peg, the liquidation value of the issuer's reserves, and the run on a DeFi protocol are determined jointly rather than fixed in advance. Contagion then runs both ways. A shock that begins in crypto sets off withdrawals, redemptions, and reserve sales, fire-selling Treasuries that would otherwise have stayed calm. A shock to Treasury values runs the other way. It weakens the peg, strips the dollar value from DeFi claims denominated in the coin, and pulls lenders out of a protocol that was never in trouble. The mechanism is a no-interest paradox. Promising only par and paying no interest is what makes a stablecoin look safe on its own; it is also what forces it to depend on DeFi returns, and that dependence carries the shock in both directions. Full backing does not buy safety, because the threshold at which the peg breaks is set by a market the issuer does not control.