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(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks

Author

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  • Ariah Klages-Mundt
  • Andreea Minca

Abstract

We develop a model of stable assets, including non-custodial stablecoins backed by cryptocurrencies. Such stablecoins are popular methods for bootstrapping price stability within public blockchain settings. We derive fundamental results about dynamics and liquidity in stablecoin markets, demonstrate that these markets face deleveraging feedback effects that cause illiquidity during crises and exacerbate collateral drawdown, and characterize stable dynamics of the system under particular conditions. The possibility of such `deleveraging spirals' was first predicted in the initial release of our paper in 2019 and later directly observed during the `Black Thursday' crisis in Dai in 2020. From these insights, we suggest design improvements that aim to improve long-term stability. We also introduce new attacks that exploit arbitrage-like opportunities around stablecoin liquidations. Using our model, we demonstrate that these can be profitable. These attacks may induce volatility in the `stable' asset and cause perverse incentives for miners, posing risks to blockchain consensus. A variant of such attacks also later occurred during Black Thursday, taking the form of mempool manipulation to clear Dai liquidation auctions at near zero prices, costing $8m.

Suggested Citation

  • Ariah Klages-Mundt & Andreea Minca, 2019. "(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks," Papers 1906.02152, arXiv.org, revised Mar 2021.
    • Handle: RePEc:arx:papers:1906.02152
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    Cited by:

    1. Ariah Klages-Mundt & Dominik Harz & Lewis Gudgeon & Jun-You Liu & Andreea Minca, 2020. "Stablecoins 2.0: Economic Foundations and Risk-based Models," Papers 2006.12388, arXiv.org, revised Oct 2020.
    2. Raphael Auer & Bernhard Haslhofer & Stefan Kitzler & Pietro Saggese & Friedhelm Victor, 2023. "The Technology of Decentralized Finance (DeFi)," BIS Working Papers 1066, Bank for International Settlements.
    3. Ariah Klages-Mundt & Steffen Schuldenzucker, 2022. "Designing Autonomous Markets for Stablecoin Monetary Policy," Papers 2212.12398, arXiv.org.
    4. Tarun Chitra, 2019. "Competitive equilibria between staking and on-chain lending," Papers 2001.00919, arXiv.org, revised Feb 2020.

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