Stablecoin Flows and Foreign Exchange Parity Deviations in Segmented Markets

Abstract

Using granular data on four USD-pegged stablecoins and 35 fiat currencies, this paper documents spillovers from stablecoin-based foreign exchange (FX) to traditional FX markets through distortions in relative pricing between crypto and traditional venues (parity deviations). To establish causality, we use a granular instrumental variable that exploits idiosyncratic shocks in other currencies.

Our estimates indicate that a 1% exogenous increase in net stablecoin inflows raises parity deviations by 40 basis points, depreciates the local currency, and widens the dollar premium in synthetic funding markets (covered interest parity (CIP) deviations). A model of constrained arbitrage rationalizes these findings and provides structural foundations for our identification strategy. Counterfactual simulations show that halving cross-market frictions would attenuate CIP spillovers by roughly one-third and cut exchange rate effects by nearly half, while a dynamic extension that closely matches the empirical impulse responses reveals scope for nonlinear amplification when intermediary balance sheets are impaired. Our results establish stablecoins as an emerging segment of global currency markets with direct implications for financial stability.