Repo markets can break a stablecoin
The plumbing matters more than the peg: Part 3
In Part 1 of this series, we looked past “trillions settled on‑chain” and asked where stablecoins actually matter in payments. Part 2 walked through how lawmakers are forcing these instruments into familiar legal boxes, from the US Genius Act to MiCA and Asia’s first licensing regimes.
Part 1: Stablecoins and the real world of payments
Part 2: The legal limbo of stablecoins
This final piece tackles the awkward question: if we now have 1:1 reserves, licenses, and real users, what can still break the peg?
The answer sits in a narrow strip of infrastructure that connects stablecoin treasuries to the rest of finance: repo markets, Treasury liquidity, and the capital that dealers and issuers are willing to put at risk. That strip – perhaps “knife’s edge” is a better description – is where stablecoins live or die in a crisis.
Solvency vs liquidity
New rules are explicit about solvency.
The Genius Act forces US “payment stablecoin” issuers into a tight reserve box: cash, bank deposits, and short‑term Treasury‑linked instruments, at least one‑for‑one against tokens, with attestations and audits for larger names. Hong Kong and Singapore take a similar line, insisting reserves sit in segregated bank accounts and low‑risk securities.
A quick explanation of repo may help.
For large banks and dealers, repo is the main way to turn securities into cash day‑to‑day. It lets them finance big inventories of Treasuries and other bonds without locking up scarce long‑term funding or equity. When repo is cheap and plentiful, banks and dealers can carry more inventory, quote tight prices, and stand between buyers and sellers. This makes overall market liquidity look deep and smooth. When repo funding tightens, they have to shrink positions and widen spreads, and even “safe” assets can suddenly be hard to move without hitting the price.
A repurchase agreement, or repo, is structurally a secured loan. One party “sells” a security (usually a government bond) to another, while simultaneously agreeing to buy it back later at a slightly higher price. Economically, the first party is borrowing cash and posting the bond as collateral; the second is lending cash against that collateral. The price difference is the interest on the loan, and the haircut – the amount by which the collateral value exceeds the cash lent – is the lender’s buffer against market moves.
Looked at from the other side, a reverse repo is what the cash‑rich institution enters into: it is the lender, taking collateral and earning a short‑term, money‑market yield. For that lender, whether a bank, money‑market fund, or stablecoin issuer, reverse repo is a way to park liquidity very safely and very short‑term, while holding high‑quality collateral that can be sold if needed.
Taken together, repo and reverse repo form the core of the secured funding market. When those markets are healthy, banks can fund their securities books smoothly; when they are stressed, the funding chain that underpins both bank balance sheets and bond‑market liquidity comes under strain. The most dramatic example of this was in 2008, when the rest of Wall Street made a disastrous bank run against Lehman Brothers via the repo markets.
So, back to our stablecoin story. Legislation and regulation in leading money centers have addressed the obvious failure mode: the issuer that mis‑invests or misappropriates assets. But these rules don’t say what happens if those reserves can’t be immediately turned into cash, which is likely to happen when everyone heads for the doors at the same time.
Three design facts define this liquidity risk:
Hierarchy. Stablecoins sit below banks and central banks. Redemptions settle in commercial‑bank deposits, not reserves, and often require selling securities through dealers. The peg is hostage to market access.
Portfolio shape. The big issuers are conservative: treasuries full of T‑bills, overnight reverse repo, and bank deposits, designed to minimize duration risk. That shrinks insolvency risk but pins them to the liquidity of Treasury and repo markets.
Intermediated redemption. Even in a Genius world, direct token mint/burn tends to be limited to a narrow circle of institutions, with everyone else relying on secondary markets. MiCA’s direct‑access requirement simply shifts where pressure shows up: from secondary‑market discounts onto stablecoin issuer balance sheets.
In fair weather, these choices look prudent. Under stress, they turn “fully reserved” stablecoins into forced sellers in markets that may not want to buy.
The redemption wave
In the process of token mint‑and‑burn accounting, deposits move between accounts, but the system does not conjure or destroy bank money just because someone flips between tokens and deposits. Stablecoin issuers are, in this sense, “narrow” banks that don’t create money.
That remains true in a run. What changes is who is forced to hold which assets, at what price.
For a detailed look at repo mechanics, check out Austin Campbell’s articles at Zero Knowledge Consulting. He’s a good resource on this topic. But simply, a stylized wholesale redemption works like this.
A token holder sends stablecoins to the issuer to redeem.
The issuer sells T‑bills or unwinds reverse repo via a dealer to raise deposits.
The dealer’s bank moves reserves to the issuer’s bank; the issuer’s bank credits the issuer.
The issuer wires deposits to the redeemer’s bank; the tokens are burned.
On paper: fewer tokens, the same aggregate deposits, a reshuffled distribution of Treasuries and repo positions.
In practice, each hop can misfire:
Dealers can hit internal risk limits or leverage constraints and widen spreads rather than warehouse more paper.
Repo haircuts can jump, squeezing some borrowers out just as issuers most need liquidity.
Trading and settlement systems can slow or fail under load, delaying execution.
The March 2020 dash‑for‑cash, when Western countries were shocked by Covid and everyone on Wall Street grabbed cash at the same time, showed how little selling it takes to flip into this regime. A few hundred billion dollars of Treasury liquidations in a multi‑trillion market were enough to dislocate prices and force central‑bank intervention. Stablecoins were marginal then. With hundreds of billions in reserves and growing real‑economy usage, they are large enough now to be part of the next dash‑for‑cash.
Given current wobbles in capital markets – AI bubbles, Iran war/oil dislocations, private-equity troubles – such a crisis is very possible. Worse, we have the example of the run on Silicon Valley Bank, which transpired too quickly for the Fed to backstop SVB. Now imagine that kind of one-click panic involving a stablecoin issuer holding billions of dollars worth of US government debt.
Safe harbor or choke point?
Reverse repo has become the focus of reserve disclosures, and not by accident.
A recent paper by MIT Media Lab, “The Hidden Plumbing of Stablecoins: Financial and Technical Risks in the Genius Act Era”, shows that an overnight reverse repo with a haircut protects an issuer against rate moves better than owning longer‑dated bonds outright. The lender is over‑collateralized; even if prices fall between the two legs, they can sell the collateral and recover principal up to the haircut. Short tenors or frequent re‑margining let them roll into higher yields rather than sit on underwater positions.
With stablecoins, the issuer takes a bank deposit, lends it overnight via reverse repo to a dealer, receives Treasuries as collateral, and either gets the cash back or sells the collateral if something breaks. Deposits move between balance sheets; nothing is created or destroyed.
This sounds safe, but in a crisis, the protection reverse repo offers on individual balance sheets can become a bottleneck at system level.
Cash lenders may pull back or limit business to the strongest counterparties.
Haircuts can widen, forcing more collateral for the same cash.
Central‑bank standing repo facilities backstop only a small club of firms, under their own policy and risk limits.
Stablecoin issuers are not in that club. They access repo through the same big banks and dealers that, in a crunch, can hit various regulated constraints on how much capital banks must hold to operate in “low-risk, high volume” activities such as repo that were imposed after the 2008 Lehman bankruptcy. Genius instructs supervisors to write capital and liquidity rules for issuers, but those standards are still in development; for now, issuers run with thin capital relative to their potential obligations.
Reverse repo is therefore a private buffer that works well in normal times. It is not a magic shield against a broad funding crunch.
Who eats the loss?
As noted above, the US, Europe, Hong Kong, Singapore and other places are introducing capital rules for banks and brokers meant to encourage the safe handling of stablecoins. Better capital doesn’t stop runs, but it changes who can absorb what.
A well‑capitalized issuer can redeem for longer out of bank deposits, accept more slippage on asset sales, and survive operational losses without dipping into reserves. Basel capital regulations have until recently forced massive over-collateralization against stablecoins. Standard-setters like the Financial Stability Board (created by the G20 after the 2008 crisis) insist intermediaries serving stablecoins should hold capital for operational and liquidity risk, not just for the underlying credit exposure, which penalizes token-related business.
These buffers are being whittled down by crypto-industry lobbying. The US Securities and Exchange Commission has now decided broker-dealers can treat stablecoin capital requirements as equivalent to cash, with a mere 2 percent capital reserve requirement. This will encourage them to hold stablecoins and use them for settling client trades or for internal liquidity “sweeps” (automated movements of extra cash into yield-bearing investments). This makes stablecoins far more attractive tools for corporate treasurers and payments.
But it doesn’t change the basic reality that when a dealer needs US dollars to meet a wave of redemptions, it still has to turn T-bills or reverse repo into bank deposits via the same constrained balance sheets and repo markets. There may be some benefit to encouraging broker-dealers to inventory stablecoins, which can provide a broader market, but whether this makes a difference in a crisis is hard to say.
If there’s a dash for cash, no one is going to be asking “what reserves back this token”? They’ll be asking “whose balance sheet stands between me and the exit”? Which banks will be able to ride out a crisis, and which will be forced to pull back from markets just when treasurers need them the most?
Better, safer
Ultimately, the risk has to sit somewhere. That could be on the balance sheet of thinly capitalized issuers, who become forced sellers in a crisis. It could be on the balance sheet of large banks and dealers, whose own capital and liquidity constraints could turn them from serving as shock absorbers into crisis amplifiers. Or it could even sit on central-bank balance sheets, via banks’ capital reserve accounts or (in theory) direct token settlement.
If we think a 1:1 reserve rule solves the hard questions of liquidity, then we are deluding ourselves. This does not mean stablecoins are “bad” or that banks shouldn’t be willing to deal in them. Stablecoins offer a rare opportunity to bring real competition to the giant Wall Street banks that exercise far too much power in US politics, and therefore in the world. But if crypto tools are going to become a systemic part of financial fabric, we must ask far more of issuers and exchanges, as well as traditional institutions.
What might this look like? Well, here are three suggestions guaranteed to be widely hated. But here we go:
Boost capital requirements in repo. Focusing just on stablecoin-specific risks misses the bigger picture. Regulators can adjust capital-related surcharges so that balance‑sheet used for market‑making in Treasuries and central‑bank‑eligible collateral is not penalised as heavily as genuinely risky assets, provided banks hold strong Tier 1 capital and meet liquidity standards. For their part, banks can strengthen repo infrastructure, by dedicating capital and liquidity limits to secured‑funding desks, adding contingency plans for expanding repo and bond‑market intermediation in stress, and backing balance sheets by pre‑arranged access to central‑bank facilities where available.
Require stablecoin issuers build liquidity buffers. Issuers should hold a meaningful slice of reserves in instantly available deposits at strong banks and in central‑bank‑eligible overnight reverse repo, above and beyond the legal 1:1 minimum. They can also publish details about their available deposits, overnight reverse repo, and holdings of T-bills by tenor, so counteparties knows what to expect if they want to redeem. And these attestations are weak and backward looking: issuers must undergo regular, independent stress tests that replicate conditions akin to the Covid shock of March 2020 or the SVB run.
Regulators modernize the infrastructure. Backstops such as the Fed’s facilities for repo markets and money-market funds should also be tested for stablecoin-related crises, to ensure collateral can be turned into cash at a reasonable haircut, and build resilience into broker-dealer balance sheets. In addition to changing data and capital rules mentioned above, regulators can also consider how to improve central clearing of Treasury and repo markets, so these don’t gum up in a panic.
Yeah, thought you’d hate that. But here’s the truth: stablecoin pegs will hold, or break, not on the quality of assets in a PDF attestation, but on whether someone with enough capital and balance‑sheet room is willing to be buyer of last resort when stablecoin holders all decide they would rather have deposits today than T‑bills tomorrow. This story isn’t about the peg. What counts is the plumbing.