Redemption Liquidity Risk

Redemption liquidity risk is the possibility that a stablecoin issuer or protocol will be unable to fulfill user requests to exchange tokens for the underlying collateral. This risk typically arises when a large volume of users attempts to exit their positions simultaneously during a market crisis.

If the assets backing the stablecoin are illiquid or locked in long-term investments, the issuer cannot provide immediate redemption. This creates a feedback loop where the inability to redeem causes further panic and a deeper loss of the peg.

It is a classic problem of maturity mismatch where short-term liabilities are backed by long-term or illiquid assets. Managing this risk requires maintaining sufficient high-quality liquid assets to meet potential withdrawal demand.