Guide
Stablecoins are increasingly becoming a core infrastructure within the cryptocurrency system. Since the beginning of 2025, several major economies have accelerated the construction of regulatory frameworks for stablecoins: the United States has clarified compliance stablecoins as payment tools through the “Guidance and Establishment of the American Stablecoin National Innovation Act” (GENIUS Act); Hong Kong has also announced the “Stablecoin Regulation Draft,” proposing to establish a licensing system to prevent potential financial stability risks, ensure the anchoring relationship between stablecoins and fiat currencies, and consolidate Hong Kong’s status as an international financial center. Against the backdrop of increasing global interest rate volatility and rising macroeconomic uncertainty, stablecoins are gradually taking on the role of a “safe haven” and a “transit point,” becoming an important buffering mechanism for the flow of funds in the cryptocurrency market between risk release and reallocation. As their market functions expand and policy regulations continue to advance, the price stability mechanism of stablecoins has increasingly become a core issue of concern for all parties. This article focuses on the arbitrage mechanisms of mainstream stablecoins such as Tether, systematically analyzing their price stability paths and extracting key institutional elements that support their anchoring effects, aiming to provide theoretical analysis and empirical references for understanding the operational mechanisms of the stablecoin market and future policy design.
1. Design of the Arbitrage Mechanism for Stablecoins
Stablecoins are a type of cryptocurrency pegged to fiat currencies (such as the US dollar) designed to provide lower price volatility compared to traditional crypto assets (like Bitcoin). They are widely used in trading within the crypto market, offering a more efficient settlement method than directly using fiat currency. Especially in the decentralized finance ecosystem, stablecoins have gradually become an important medium for crypto trading due to their lower volatility, programmability, and cross-platform availability.
Among all stablecoins, Tether (USDT) is the most dominant variety, accounting for over 80% of the market capitalization during the study period. Tether adopts a pegging mechanism, meaning that 1 USDT is intended to be equivalent to 1 US dollar. Unlike traditional fixed exchange rate systems, Tether’s exchange rate stability does not rely on foreign exchange operations led by central banks, nor does it depend on pre-authorized market makers like ETFs; rather, it is entirely maintained by private participants in the market through arbitrage activities.
In this mechanism, the core institution is Tether Treasury, which is Tether’s issuance management account, and can also be understood as an “official pool” or “vault” operated by the issuer. Investors can exchange US dollars for USDT (i.e., “create” USDT) through the Treasury, or exchange USDT back for US dollars (i.e., “redeem” USDT). Tether Treasury does not directly participate in market transactions, but rather plays the role of the “primary market”, responsible for injecting or withdrawing USDT from the market. Investors can take advantage of the price difference between the primary market price and the secondary market price to arbitrage, thereby influencing market circulation and prices, forming an automatic adjustment mechanism for stablecoin prices.
For example, when the market price of USDT is higher than 1 dollar, investors can obtain USDT at a fixed price of 1 dollar from the Treasury and sell it at a higher price in the market, thereby gaining arbitrage profits. This operation increases the supply of USDT in the market, which in turn lowers the price back to the pegged level. Conversely, when the market price is below 1 dollar, investors can buy USDT in the market and redeem it from the Treasury for 1 dollar, thereby reducing market supply and pushing the price closer to 1 dollar.
The effectiveness of the arbitrage mechanism depends on two key design factors: first, whether multiple investors are allowed equal access to the Treasury for creation and redemption; second, whether arbitrage can be achieved at low cost and high efficiency. In April 2019, Tether migrated from the Omni blockchain to the Ethereum blockchain, which greatly enhanced the efficiency of the arbitrage mechanism. The Ethereum network supports a higher frequency of transaction confirmations (one block every 15 seconds compared to one block every 10 minutes on Omni, which is based on the Bitcoin network), also providing more access opportunities for investors. Data shows that the number of unique addresses interacting with the Treasury on the Ethereum chain increased from the original 1.4 on Omni to 4.0, indicating a significant reduction in the entry barrier for investors.
The direct impact of migration is reflected in two aspects: first, the degree to which the USDT price in the market deviates from the $1 peg has significantly narrowed; second, the speed at which the price returns to the pegged level has accelerated, meaning that when the price deviates, the time required for the market to correct this deviation has been significantly shortened. This improvement in adjustment efficiency reflects the key role of the arbitrage mechanism in price stability. However, during the same period, the cryptocurrency market also experienced an increase in overall trading activity and continuous optimization of infrastructure, which may also impact price stability. Therefore, simply observing market outcomes does not directly indicate that the reform itself has played a decisive role.
This leads to a key research question: the effectiveness of Tether’s price anchoring mechanism—has it improved after optimizing the design of the arbitrage mechanism, or is it disrupted by other macro or market structure changes? Furthermore, in the arbitrage mechanism, do the design details such as “who can arbitrage,” “is it open enough,” and “are the arbitrage incentives sufficient” constitute decisive factors in maintaining the price anchoring of stablecoins? Around this question, this paper conducts a systematic empirical study, introducing structural reforms as a quasi-natural experiment, comparing with a control group of stablecoins, to assess the actual impact of arbitrage design reforms on price stability, and to explore the institutional basis of stablecoin stability in a broader sense.
2. The Market Operation Structure of Stablecoins
To assess the impact of the arbitrage mechanism on the price stability of stablecoins, it is first necessary to clarify the operational structure of the stable market. Stablecoins typically have two types of collateralization: one type uses fiat currencies such as the US dollar as reserve assets, held by centralized institutions that commit to redeeming at a 1:1 ratio; the other type uses crypto assets (such as Ethereum) as collateral and relies on smart contracts for self-liquidation and risk control. Among the top six stablecoins by market capitalization during the study period, five are USD-collateralized stablecoins, with Tether (USDT) and USDC being the most representative, except for DAI.
The operation of stablecoins relies on the distinction between the so-called “primary market” and “secondary market.” The primary market is where the issuer, through Tether Treasury, takes on the creation and redemption of USDT, processing the inflow and outflow of investor funds at a fixed exchange rate (1 USDT = 1 USD). The secondary market refers to the free circulation of stablecoins among various cryptocurrency exchanges, with prices determined by market supply and demand. Therefore, under the arbitrage mechanism, investors can obtain or redeem USDT at a low price in the primary market, and then sell high or buy low in the secondary market, in order to correct the deviation between the price and the pegged value. Tether has clearly stated that it will not intervene in prices in the secondary market, and price stability relies entirely on the spontaneous trading behavior of market participants.
Based on this structure, multiple key data metrics need to be constructed to measure the effectiveness of price anchoring.
(1) Degree of Price Deviation: The degree of daily price deviation is measured based on the difference between the trading price of Tether/USD in the secondary market and its anchor value (1 USD). Additionally, an intraday volatility indicator is constructed by calculating the square root of the sum of squared daily intraday returns using high-frequency data at 5-minute intervals, capturing the short-term volatility level of the stablecoin market. Price data is sourced from three major exchanges (Bitfinex, Bittrex, Kraken) and integrated through Coinapi to ensure the reliability and representativeness of the price sources.
(2) Supply Volume: To depict the circulation of Tether in the market, supply volume data is constructed using the blockchain public ledger. Tether’s issuance records are stored on multiple blockchain platforms (Omni, Ethereum, Tron), and all on-chain “grant” and “revoke” transactions are traceable. Researchers sum up the total creation of USDT across all chains to obtain the daily total supply volume (AggreGate Tether Supply), and further identify the portion retained in the Treasury account as uncirculated reserves. The difference between the two represents the actual quantity of USDT that has entered the market circulation, held by private wallets and exchanges. This method allows for the precise identification of Tether’s daily “net injection” from official accounts to the market, which can be used to observe the dynamic impact of arbitrage flows on prices.
(3) Net Arbitrage Flow: To further capture the liquidity conditions of the primary market, a measurement method for net arbitrage flow is introduced. By subtracting the changes in Treasury account reserves from the total issuance changes each day, we can obtain the actual liquidity value “flowing from Treasury to the market”, which represents the arbitrage activities that truly impact market liquidity. This indicator can be seen as a reflection of the arbitrageurs’ operations initiated directly from the primary market, having a high degree of economic explanatory power, and will be used as a core independent variable in subsequent regression models to examine the moderating effect of the arbitrage mechanism on price deviations.
(4) Issuance Rhythm and Concentration: By recording the number of wallet addresses interacting with the Treasury daily, we measure whether there are instances of a few institutions dominating the arbitrage channels. Data shows that on the Omni chain, funds are primarily concentrated from Bitfinex, whereas after the migration to the Ethereum chain, the number of active addresses has significantly increased, indicating that the arbitrage mechanism has become more decentralized, and arbitrage rights are gradually opening up to ordinary market participants. This structural change provides foundational data support for subsequent research on whether the “decentralization” of arbitrage leads to higher price stability.
3. Examination of Tether’s Arbitrage Mechanism
Tether’s arbitrage mechanism has undergone significant reforms, focusing on two main aspects: first, the decentralization of the issuance channel, meaning it no longer relies on Bitfinex as the primary source for obtaining Tether; second, the migration to the Ethereum blockchain in April 2019, which greatly enhanced the convenience and efficiency for investors to access the primary market (Tether Treasury).
To verify whether the aforementioned institutional reforms have truly enhanced the stability of the pegged exchange rate, the empirical section analyzes three core dimensions: the impact of arbitrage accessibility on price deviations, the price correction effect of arbitrage capital flows, and the changes in the profitability of arbitrage trading.
First, in terms of price stability, the study uses the change in price deviation before and after the reform as an observation indicator. Using the Ethereum migration in April 2019 as a structural event, the sample is divided into “pre-period” (Omni dominated) and “post-period” (Ethereum dominated). The results show that after the reform, the absolute magnitude of Tether’s price deviation from the $1 peg significantly decreased, and the speed of price return to the peg also increased significantly. To eliminate the interference of overall market improvement, the study introduces two structurally similar stablecoins that did not undergo blockchain migration (Paxos and TrueUSD) as a control group and employs a difference-in-differences (DID) method for identification. The comparative analysis results show that, after controlling for other factors, Tether’s anchoring deviation decreased by approximately 24 basis points compared to the control group.
Second, to verify whether the arbitrage mechanism plays a stable role in practice, the study further analyzed the dynamic impact of arbitrage fund flows (i.e., the net injection of USDT by Tether Treasury into the market) on price changes. Using local projection methods, a causal response path of arbitrage flows to price was constructed, and the results showed that after Tether migrated to Ethereum, the price impact of arbitrage flows became more pronounced: when the Treasury net injects USDT into the market, Tether’s price converges more quickly to the anchor point, manifested as a reduction in the degree of deviation. This indicates that the decentralized arbitrage design enhances the market’s sensitivity to price deviations and its self-repair capability.
Thirdly, regarding arbitrage profits, the study tracked the specific yield of high-frequency arbitrage trading. By matching the timestamps of USDT creation and redemption transactions in Treasury accounts with the real-time prices in the secondary market, and deducting transaction costs such as fees, slippage, gas fees, and bid-ask spreads, an arbitrage profit indicator was constructed. The results found that, whether on the Omni or Ethereum chain, the average arbitrage profit was positive, indicating that arbitrage activities have real incentives; however, on the Ethereum chain, both the profit per arbitrage transaction and the transaction scale were smaller, indicating that arbitrage activities are no longer concentrated in the hands of a few large institutions, but are widely distributed among more small and medium-sized investors. This phenomenon enhances overall market efficiency while reducing systemic risk and the possibility of price manipulation.
4. Arbitrage Mechanism Practices of Other Stablecoins
After identifying how Tether’s institutional reforms enhance its price stability, the research further proposes an extension question at the mechanism level: Does the effectiveness of stablecoin price anchoring depend on a specific institutional context, or does the arbitrage mechanism itself possess universal effectiveness within a broader structure? To this end, the analysis expands its focus to two other stablecoins that adopt different technologies and governance structures—DAI and WBTC—examining whether they have established market-driven arbitrage paths similar to Tether’s institutionally, and based on this, evaluating the intrinsic stability of their anchoring mechanisms.
DAI was originally issued based on an over-collateralized lending system, and its price stability relies on market expectations of collateral assets and liquidation mechanisms. However, since the introduction of the “Peg Stability Module” (PSM) in December 2020, the DAI system has undergone significant changes. This module allows users to exchange USDC for DAI at a fixed price of 1:1 without establishing a collateral position, and the reverse exchange is also valid. This mechanism is executed automatically through smart contracts, without the need for central approval, allowing any market participant to arbitrage in real time. The low barriers to entry, low friction, and high certainty of the arbitrage path enable rapid convergence of price deviations, constituting a strongly binding institutional anchoring mechanism.
WBTC represents a different structural design. The core mechanism behind this cryptocurrency is to wrap native Bitcoin as an ERC-20 token for circulation on the Ethereum network. Its minting and redemption are operated by multiple authorized “merchants,” allowing regular users to exchange through these merchants. Although the entry points for arbitrage are relatively concentrated in the hands of authorized nodes, they are not controlled by the issuer, and there is no one-to-one approval, thus still constituting a decentralized, multi-entity arbitrage framework. When price discrepancies occur between Bitcoin and WBTC in the market, price corrections are completed through the arbitrage operations of these merchants.
By analyzing the institutional structure of the arbitrage paths between DAI and WBTC, two key characteristics can be distilled: First, the arbitrage mechanism must possess openness or accessibility, meaning there are no approval thresholds controlled by the issuer; second, the execution of arbitrage should have a clear operational process and predictable return logic, facilitating the market’s quick response to price deviations. Although DAI is fully open and WBTC has some authorization mechanisms, both have achieved a closed loop between arbitrage decision-making and execution, without relying on central institutions to initiate, showcasing strong market-driven characteristics.
5. Applicable Boundaries of the Arbitrage Mechanism
The stability of stablecoin prices depends on whether the market-driven arbitrage mechanism exists, which is determined by whether the institutional structure allows for the existence and execution of arbitrage paths. Although global stablecoins and central bank digital currencies (CBDCs) are also pegged to fiat currencies, their price stabilization mechanisms do not rely on market arbitrage. For example, Libra (Diem) or various countries’ CBDCs establish price pegs through statutory settlement, asset backing, or direct redemption by the central bank. Such mechanisms complete price adjustments internally within a centralized system, leaving no arbitrage space, and the arbitrage mechanism cannot function. Due to the absence of arbitrage price differences and a freely accessible arbitrage market, market participants do not have a regulatory function over the pegged price. The arbitrage mechanism is replaced in this institutional structure and does not have practical operational space.
In contrast, algorithmic stablecoins attempt to maintain price pegs through built-in algorithms within the protocol under uncollateralized or partially collateralized conditions. TerraUSD is a typical design in this regard, where the peg mechanism relies on the exchange relationship with another token, LUNA. Theoretically, when TerraUSD is below $1, users can purchase UST at a discount and exchange it for an equivalent value of LUNA worth $1, thus realizing arbitrage; and vice versa. However, this arbitrage mechanism is not based on clear asset backing or verifiable solvency. When the price of LUNA itself falls and market confidence weakens, this arbitrage path cannot be maintained, the expectation of arbitrage fails, and the peg mechanism collapses.
In May 2022, the price of TerraUSD decoupled and experienced a systemic collapse, primarily due to the lack of a solid and executable arbitrage mechanism. When the market widely questioned its collateral effectiveness, theoretical arbitrage trades went unexecuted, leading to price deviations that could not be corrected, plunging the system into a death spiral, with both UST and LUNA depreciating. Under this structural mechanism, the anchored price lacked a trading support pathway, making it difficult for arbitrage incentives to form a closed loop, thus losing the foundation for price stability.
By comparing the structural differences between collateralized stablecoins and uncollateralized algorithmic currencies, we can draw a clear conclusion: price anchoring only possesses intrinsic stability when the system provides market participants with clear, low-friction, and reliable arbitrage execution pathways. Whether it’s Tether through the primary market mechanism of Treasury or DAI through smart contracts setting fixed exchange rates, the price stability of stablecoins always relies on the accessibility, immediacy, and convertibility of the arbitrage mechanism. In systems that lack this structural support, anchoring commitments cannot automatically translate into actual pricing behavior, and price stability cannot be sustained.
6. Conclusion
Whether the price of a stablecoin can effectively anchor to the target value does not depend on the existence of any commitment or collateral, but rather on whether the system provides market participants with a practical path to execute arbitrage. Even if a stablecoin claims to “always equal 1 dollar,” if market participants cannot redeem the deviated price back to the anchor value in a predictable and low-cost manner, the price deviation cannot be corrected, and the anchoring mechanism will lose its practical constraint.
The blockchain migration reform carried out by Tether in 2021 provided a natural experiment for observing the institutional effects of the arbitrage mechanism. After the reform, investors could initiate creation and redemption operations directly through the ERC-20 contract, and the arbitrage path was institutionally opened to the public. This change significantly increased the speed of price deviation recovery and noticeably converged the extent of deviation. After controlling for changes in the market environment through a difference-in-differences estimation, the improvement in price stability brought about by this institutional reform can still be identified.
Compared to other stablecoin systems, DAI has built an arbitrage channel that does not require central approval after introducing a fixed exchange module controlled by smart contracts, enhancing price stability simultaneously; WBTC retains some authorization thresholds, but its arbitrage logic is still driven by the market. In contrast, TerraUSD, which lacks an executable arbitrage mechanism, was unable to maintain its theoretical arbitrage space after market confidence weakened, ultimately leading to the collapse of its peg mechanism.
Overall, whether the anchored price of stablecoins can remain stable is not solely determined by the collateral structure or the degree of centralization, but depends on whether the arbitrage mechanism possesses three core characteristics: clear execution channels, controllable transaction costs, and open participation rights. As long as these three conditions are met, market participants can respond rationally to price deviations, and the anchoring commitment can be transformed into price behavior at the transaction level, which gives the system intrinsic stability. The arbitrage mechanism is not a supplementary device, but an indispensable core structure in the design of stablecoin systems.
