Simulating Stablecoin Systems with Latent Market Confidence Index

Abstract

There is a real demand for an alternative form of money, with intrinsic price stability in the system. In this paper, we examine a family of stablecoin that is intended to be used as a medium of exchange. We simulate an agent-based trading environment to study the stabilization mechanism of growth-collateralized stablecoin design with elastic money supply through bond auction and liquidation. Our model explicitly studies the endogenous demand dynamics for stablecoin when the system is subject to an exogenous price shock. In particular, we introduce a latent market confidence indicator that models the feedback loop between demand and price, where different agent types carry out different trading strategies and update their market beliefs as a function of market price and volatility. Through our simulation, we have found that the market confidence indicator responds to both a level effect and a variance effect of the stablecoin price movements. The increased variance in the excess demand ratio implies high market sensitivity, in which the system is reactive and beliefs are updated quickly to stabilize towards parity. Further, the demand for bonds as a derivative of the excess demand ratio for the stablecoin during the stabilization process has a strong impact on the variance of the bond queue. We believe by enacting the stabilization mechanism of bond auction or liquidation earlier on, the stability overall in the system can be improved.