On June 2, the Bank for International Settlements (BIS) published a working paper titled “Making stablecoins stable(r): can regulation help?,” by Tirupam Goel, Ulf Lewrick, and Isha Agarwal. The paper analyzes how capital and liquidity thresholds could reduce the risks posed by stablecoins. It focuses on the “liquidity mismatch” between stablecoins that can be redeemed on demand and reserve portfolios that may include cash and short-dated government bonds. The authors stated that large redemptions can expose coin holders to default risk and transmit stress to money markets through bond sales. The paper modeled an issuer’s balance sheet and found that, without regulation, issuers tend to hold limited capital and prefer interest-bearing bonds to cash, which can heighten default risk and the price impact of forced bond sales.

The authors found that liquidity and capital thresholds can reduce default and spillover risks when designed as “usable buffers.” Those thresholds may be temporarily breached during stress, with breaches affecting coin-holder flows and thereby disciplining issuer behavior. The paper stated that liquidity thresholds primarily increase cash holdings, while capital thresholds increase both capital and cash. The authors found that the tools can be substitutes when targeting either default risk or spillover risk. They also found that both tools may be needed when regulators target both risks at the same time. Using stablecoin flow data and U.S. Treasury market depth, the paper calibrated a framework linking capital and liquidity threshold combinations to policy targets. For example, one threshold pair reduced the modeled weekly probability of default from more than 15 basis points to about 0.7 basis points. It also reduced expected price impact from about 4 basis points to 2.7 basis points.