What drives the popularity of stablecoins? Measuring the frequency dynamics of connectedness between volatile and stable cryptocurrencies

Abstract

Stablecoins are a relatively recent phenomenon in the cryptocurrency market, gaining prominence particularly since 2018. These digital currencies are usually pegged to nonvolatile underlying assets, offering a solution to the problem of the high price volatility of nonstable cryptocurrencies such as Bitcoin. Therefore, stablecoins seem attractive to participants in the cryptocurrency market, especially in times of turmoil. This paper aims to measure the spillover effect of shocks in volatile cryptocurrencies (Bitcoin, Ethereum, Litecoin and the Cryptocurrencies Index) on the activity of investors in the stablecoin market (Tether, USD Coin, Binance USD, DAI, Paxos, Huobi USD, and Gemini USD). Using the spectral representation of variance decomposition, the paper measures the strength of the spillover effect and investigates whether the cryptocurrency market processes information rapidly or slowly. The results suggest that shocks in the volatile cryptocurrency market moderately drive the popularity of stablecoins. The spillover effects on stablecoin popularity are short-lived, as they are observed mostly within up to 3 days of the shock. The findings indicate that investors use stablecoins as safe haven assets after bad news in the volatile cryptocurrency market; however, they react more strongly to news related to individual cryptocurrencies and not so intensively to the general sentiment in the cryptocurrency market. Investors with larger capital are more resistant to shocks.