Currency Development through Liquidity Provision

Drawing on the experiences of the historical Eurodollar market and recent Chinese dollar bond issuances traded outside US jurisdiction at negative spreads to Treasuries, we examine the conditions under which a parallel offshore dollar financial system that circumvents Western sanctions may emerge. We propose a model in which liquidity provision and a safe bond supply drive currency use. We characterize three equilibrium regimes: High convenience yields emerge in both the initial sanctions-driven region and the final liquidity-driven region, separated by an intermediate region. Transitions between equilibria depend on safe-asset supply and liquidity technologies, in addition to endogenous dynamic complementarities.