Cryptocurrency's Bank Run Problem: A Game Theory 101 Investigation

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Much of the liquidity in the cryptocurrency market comes from something known as a stablecoin. Unlike your average cryptocurrency, stablecoins do not have wild fluctuations in price. Instead, they are backed by some type of reserve currency. For example, a particular stablecoin may only be minted when its backer has received $1, and anyone may exchange that stablecoin for exactly $1 later.

But stablecoins introduce two new types of problems. First, legitimate stablecoin creators are vulnerable to runs just like a normal bank. If everyone tries to withdraw their money at the same time, the holder of the reserve dollars won't be able to pay all of them. And unlike traditional banks, stablecoins do not have deposit insurance. This further incentivizes stablecoin holders to race to withdraw funds.

Second, illegitimate stablecoin creators can mint stablecoins without any monetary backing. They can then use those coins to buy other cryptocurrencies. After that, they can convert those other cryptocurrencies to cash using a system outside their particular stablecoin. This can create instability in the market for other cryptocurrencies, which rise to inflated prices due to the unbacked stablecoin. The mere possibility of the stablecoin's duplicity can also trigger the original bank run problem.