Stablecoin Reserves: Cash, Bills and Repo Under Stress

A fiat-backed stablecoin promises redemption at par. Whether it can honour that under pressure depends on what the reserves are made of and how quickly they can become cash without loss. Full reserves are necessary and not sufficient, and the gap between the two is where the interesting failures live.

Three risks, not one

Duration risk is the possibility that selling before maturity means selling at a loss. A short-dated government bill held to maturity returns its face value; sold in a hurry when rates have moved, it does not. The longer the instrument, the wider that gap.

Credit risk is the possibility that the counterparty does not pay. Commercial paper, corporate deposits and secured lending all carry it in different amounts, and it is the risk that concentrates in the tail — usually nothing, occasionally total.

Access risk is the possibility that the assets exist and cannot be reached. This is the one people forget, and it is the one that has actually caused a major de-peg: cash held at a bank is a claim on that bank, and if the bank fails the money is not gone but it is not available either.

A reserve report showing full backing tells you about none of these. It tells you the total, and the composition is what tells you how it behaves.

What each instrument does in a run

Cash at a bank is instantly available and carries the access risk described above. Deposit protection covers a trivial fraction of a reserve of any size, so the practical protection is diversification across institutions rather than insurance.

Short-dated government bills are the workhorse. They carry minimal credit risk, minimal duration risk at short maturities, and trade in the deepest market that exists. Held to maturity in a laddered structure, a meaningful portion matures every week without any need to sell.

Repurchase agreements — lending cash against securities as collateral — are short-dated and secured, which makes them low risk under normal conditions and dependent on the counterparty and the collateral under abnormal ones.

Money market funds add a layer: the reserve is a claim on a fund which itself holds instruments, and that fund can gate redemptions. A stablecoin backed by a fund that gates is a stablecoin that cannot redeem, regardless of what the fund holds.

Longer-dated or lower-quality holdings raise yield and lower the reliability of par redemption under pressure. That trade is a business decision by the issuer, funded by holders who receive no share of the yield.

The lesson from a real de-peg

The most instructive episode in this category was not about reserve quality at all. An issuer held a portion of its reserves as cash deposits at a bank that failed, disclosed the exposure immediately, and the coin traded well below par until the deposits were guaranteed, at which point it recovered fully.

The reserves were high quality. The problem was that a bank deposit is a claim on a bank, and the concentration of that claim mattered more than the average quality of the portfolio around it.

That is the practical reason a reserve report should be read for concentration as well as composition, and why diversification across custodians is a distinct question from what instruments are held.

Reading a composition disclosure

• What share is cash at banks, and across how many institutions — concentration here is the access risk.
• What is the maturity profile, and how much matures within a week without any need to sell.
• What share is anything other than government bills and cash, and what is the credit exposure behind it.
• Is any of the reserve held through a fund that could gate redemptions.
• Who holds the assets, in which jurisdiction, and are they segregated from the issuer's own funds.

The last question is the one that decides what happens in an issuer insolvency rather than in a market event, and it is answered in the terms rather than in the composition table.