Demand for Safety in the Crypto Ecosystem

Abstract

We study the demand for safety and liquidity in the crypto ecosystem. In an environment lacking frictionless access to traditional safe assets, we examine whether stablecoin lending pools provide liquidity services to investors. To do so, we develop a model in which a representative investor allocates liquidity between stablecoin lending pool deposits and traditional safe assets (e.g., MMF shares). The model delivers three predictions: (i) the stablecoin premium co-moves positively with the Treasury premium when investors value liquidity services of stablecoin pools, (ii) Treasury supply decreases the stablecoin premium, and (iii) declines in the perceived liquidity of stablecoin pools --- e.g., due to de-pegs or hacker attacks --- reduce their premium. Our empirical results provide evidence consistent with these predictions. They suggest that investors treat stablecoin lending pools as money-like instruments and that shocks to traditional safe assets transmit to crypto markets. Our findings contribute to the literature on safe assets by showing how safety is intermediated in crypto markets. They also offer new insights into the segmentation and structure of decentralized finance (DeFi) as it evolves alongside traditional financial systems.