A Blessing in Disguise: How DeFi Hacks Trigger Unintended Liquidity Injections into US Money Markets

Tingyi Lin

Papers from arXiv.org

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.

Date: 2026-01
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