dorsal/arxiv
View SchemaA Blessing in Disguise: How DeFi Hacks Trigger Unintended Liquidity Injections into US Money Markets
| Authors | Tingyi Lin |
|---|---|
| Categories | |
| ArXiv ID | 2601.08263vv2 |
| URL | https://arxiv.org/abs/2601.08263 |
| License | http://creativecommons.org/licenses/by/4.0/ |
Abstract
Do vulnerabilities in Decentralized Finance (DeFi) destabilize traditional short-term funding markets? While the prevailing "Contagion Hypothesis" posits that the liquidation of stablecoin reserves triggers fire-sale spirals that transmit distress to traditional markets , we document a robust "Flight-to-Quality" effect to the contrary. In the wake of major DeFi exploits, spreads on 3-month AA-rated commercial paper (CP) exhibit a paradoxical narrowing. We identify a "liquidity recycling" mechanism driving this outcome: capital fleeing DeFi protocols is re-intermediated into the traditional financial system via Prime Money Market Funds (MMFs) , where strict regulatory constraints (e.g., SEC Rule 2a-7) compel these funds to purchase high-quality paper. Our estimates indicate that this institutional demand shock quantitatively overwhelms the supply shock driven by stablecoin issuer redemptions. Rather than acting as vectors of financial contagion , these crypto native shocks serve as an inadvertent "safety valve" in segmented markets , providing transient liquidity support and effectively subsidizing borrowing costs for high-grade issuers in the real economy.
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"abstract": "Do vulnerabilities in Decentralized Finance (DeFi) destabilize traditional short-term funding markets? While the prevailing \"Contagion Hypothesis\" posits that the liquidation of stablecoin reserves triggers fire-sale spirals that transmit distress to traditional markets , we document a robust \"Flight-to-Quality\" effect to the contrary. In the wake of major DeFi exploits, spreads on 3-month AA-rated commercial paper (CP) exhibit a paradoxical narrowing. We identify a \"liquidity recycling\" mechanism driving this outcome: capital fleeing DeFi protocols is re-intermediated into the traditional financial system via Prime Money Market Funds (MMFs) , where strict regulatory constraints (e.g., SEC Rule 2a-7) compel these funds to purchase high-quality paper. Our estimates indicate that this institutional demand shock quantitatively overwhelms the supply shock driven by stablecoin issuer redemptions. Rather than acting as vectors of financial contagion , these crypto native shocks serve as an inadvertent \"safety valve\" in segmented markets , providing transient liquidity support and effectively subsidizing borrowing costs for high-grade issuers in the real economy.",
"arxiv_id": "2601.08263",
"authors": [
"Tingyi Lin"
],
"categories": [
"q-fin.GN",
"econ.EM"
],
"license": "http://creativecommons.org/licenses/by/4.0/",
"title": "A Blessing in Disguise: How DeFi Hacks Trigger Unintended Liquidity Injections into US Money Markets",
"url": "https://arxiv.org/abs/2601.08263",
"version": "v2"
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