Stablecoins as Dry Powder: A Copula-Based Risk Analysis of Cryptocurrency Markets

TL;DR

This paper investigates how stablecoins influence systemic risk in cryptocurrency markets using copula models, revealing their role as 'dry powder' that affects volatility transmission and improves forecasting accuracy.

Contribution

It introduces a copula-based framework to quantify stablecoin impact on systemic risk and demonstrates their significance in volatility transmission and risk reduction in crypto markets.

Findings

Stablecoins transmit volatility to broader markets.

Incorporating stablecoin data improves crypto forecasting.

Stablecoin activity reduces risk in volatility targeting models.

Abstract

Stablecoins serve as the fundamental infrastructure for Decentralised Finance (DeFi), acting as the primary bridge between fiat currencies and the digital asset ecosystem. While peg stability is well-documented, the structural role stablecoins play in transmitting systemic risk to the broader market remains under-explored. This study uses copula-based approaches to quantify the transmission of volatility and activity from stablecoin to cryptocurrency markets. We demonstrate in-sample causality across daily, weekly, and monthly horizons. Furthermore, we show that incorporating stablecoin factors significantly reduces Mean Squared Error in cryptocurrency forecasting. Specifically, we link stablecoin volume and upside volatility to broader market volatility, indicating its role as dry powder. Finally, we establish economic value by demonstrating reduced risk in a cryptocurrency volatility targeting model when stablecoin factors are employed.