NY Fed Economists Describe Run on Algorithmic Stablecoin

Federal Reserve Bank of New York senior economists described differences among stablecoins, reviewed the risks of runs on stablecoins and examined the stablecoin run of May 2022.

In its Liberty Street Economics blog, the economists stated that Terra, an algorithmic stablecoin and its crypto asset Luna, used an algorithmic mechanism that relied on investors buying the stablecoin, whenever its price dropped below a certain threshold. The economists explained that after a rapid decline in the price, investors were unwilling to buy the stablecoin. The economists stated that within the span of about a week in May 2022, $17.17 billion in Terra’s market value was wiped out, as was $20.77 billion in Luna’s market value. The economists said that the run caused investors to move from riskier stablecoins to less risky ones, and created "significant inflows" for stablecoins, such as USD Coin and Binance USD.

The economists said that the inflow to less risky stablecoins paralleled a similar dynamic as recent runs on the money market mutual funds industry, where investments moved from riskier prime funds to less risky government funds

The economists warned that "as the digital asset ecosystem continues to grow, its potential to affect traditional financial markets and a broader section of households and firms could grow accordingly."