Wrapped Stablecoins and the DeFi Systemic Risk

Wrapped stablecoins convert base stablecoins into receipt tokens that can be pledged repeatedly across DeFi lending protocols, implementing a form of shadow banking on-chain. We develop a model in which this recursive collateral reuse generates an endogenous liquidity multiplier that expands leverage in normal times but amplifies liquidation cascades when collateral constraints tighten. Using novel onchain data from Aave deployments across eight blockchain networks, we document three findings.

First, using regulatory announcements as instruments, we show that wrapped stablecoin creation causally increases recursive leverage: a one-standarddeviation increase raises the liquidity multiplier by 7% relative to its mean. Second, higher pre-event recursive leverage amplifies cryptocurrency volatility during stress episodes, with economically large effects concentrated in equally-weighted rather than value-weighted measures. Third, cross-chain bridge connectivity, not chain size, determines contagion speed: doubling bridge connections reduces time to stress arrival by 67% during the March 2023 USDC depeg.

Wallet-level evidence confirms that agents execute the deposit-borrow-redeposit loops predicted by our model. Our results highlight a fundamental tradeoff: deeper collateral reuse improves funding efficiency but increases exposure to systemic liquidation cascades.