What Is the Eurodollar Market? How It Works, Why It Matters - Part 1
Written by Arbitrage • 2026-01-21 00:00:00
If you think "dollars" live inside the United States, you are missing the main plumbing of modern finance. A huge chunk of global dollar activity occurs outside the U.S. banking system, on the balance sheets of offshore banks and institutions, or at least outside direct U.S. jurisdiction. That offshore dollar ecosystem is what people mean when they talk about the eurodollar market.
And yes, the name is confusing. "Eurodollar" usually has nothing to do with euros, and it is not limited to Europe. It is basically shorthand for U.S. dollars held and intermediated outside the United States. If you understand eurodollars, a lot of market behavior makes more sense: sudden risk-off moves, weird stress episodes that start "somewhere else," and why global liquidity can tighten even when the U.S. economy looks fine on the surface.
The eurodollar market in one sentence
A eurodollar is a U.S. dollar deposit (or dollar-denominated bank liability) held at a bank outside the United States, and the eurodollar market is the network of lending, borrowing, and funding built on top of those offshore dollars. That's the clean definition.
Now the important part: eurodollars are not physical cash. They are not pallets of $100 bills sitting in London. They are balance-sheet money, which means they are claims inside a banking system, created and expanded through lending and interbank funding. The eurodollar market is the offshore extension of dollar banking.
Why does this market exist?
Because the world runs on dollars. Even if you never trade Forex (FX) or care about macro, the dollar sits underneath global trade and finance because commodities are priced in dollars, international trade is often settled in dollars, many companies and countries borrow in dollars, and global investors hedge and collateralize in dollars. So demand for dollars is not just "American;" it is global.
Why offshore dollars specifically?
Offshore dollar banking grew because it was convenient and, at different points in history, strategically attractive:
- Global trade needed a neutral funding currency. The dollar became that currency.
- Non-U.S. banks wanted to serve clients who needed USD. If your client sells oil, aircraft, chips, or shipping services in USD, they want USD banking.
- Banking regulations and reserve rules historically created incentives to book activity offshore. Not always "dodging rules" in a cartoon villain way, but in the normal financial way: if you can fund more efficiently in one place, you do it.
- It matched the real world. A Japanese insurer buying U.S. bonds, a Singapore trader funding inventory in USD, a European corporate issuing USD debt... all of that naturally produces offshore USD activity.
The"global dollar shortage" concept
Once you accept that the world needs dollars, the next idea is the one traders remember in a crisis: you can get a global dollar shortage even if the U.S. is not "short of dollars" domestically. Why? Because offshore dollar funding depends on confidence, rollover and maturity transformation, collateral and balance sheet capacity, and interbank trust. When those tighten, dollar funding becomes scarce where it matters, and the stress transmits fast.
How the eurodollar market works
Let's do the simplest possible mechanical picture.
The key players
- Non-U.S. banks (and foreign branches/subs of U.S. banks) that take USD deposits and make USD loans offshore.
- Corporates and multinationals that earn, hold, or borrow dollars.
- Institutional investors that park cash and manage collateral.
- Other banks that borrow and lend dollars in wholesale markets.
A basic eurodollar flow
- A depositor places USD at an offshore bank. A multinational keeps USD cash at a bank in Singapore, London, Hong Kong, etc.
- That bank now has a USD liability. The deposit is what the bank owes the depositor.
- The bank needs a USD asset to match it. So the bank does what banks do: it lends, it funds, it invests.
- The bank lends USD to someone else. This could be a corporate borrower, another bank, or a trade finance structure.
That is the eurodollar market in motion: offshore dollar liabilities funding offshore dollar assets.
The part most people miss: layering and maturity transformation
In practice, the system scales because banks do not just "move" dollars. They create credit. They borrow short (deposits, wholesale funding). They lend longer (loans, credit lines, securities). This is normal banking. The eurodollar market is just banking in USD, offshore. And this is why it can seize up: if short-term funding dries up or gets expensive, the whole structure feels it.
Why it freezes in stress
Eurodollar funding can tighten quickly because it relies on trust and rollover. Interbank lenders pull back, haircuts rise in collateralized markets, balance sheets get constrained, and everyone wants dollars at the same time. When that happens, "global liquidity" tightens. Markets do not need a recession to reprice risk. They just need dollar funding to get tight.
The controversy: who controls offshore dollars?
This is where eurodollars get spicy. There are two competing instincts people have about the eurodollar system.
View A: Eurodollars are "shadow dollars" outside Fed control. This view says:
- Offshore banks can create and expand USD liabilities outside the U.S.
- That means a large part of dollar liquidity is not directly governed by the Fed's domestic tools.
- Therefore, the Fed does not fully control the true money supply of the dollar system.
This camp tends to emphasize how crises can originate in offshore funding markets and then ricochet back into U.S. markets.
View B: The system is still anchored to the U.S. dollar core. This view says:
- Even offshore, dollars are linked to U.S. assets, U.S. payment rails, and U.S. collateral.
- The dollar system is not a free-floating offshore invention. It is still connected to the U.S. financial core through treasury collateral, dealer balance sheets, global dollar payment infrastructure, and, in crisis moments, the Fed and U.S. institutions' ability to backstop liquidity.
In other words, the Fed may not micromanage offshore bank balance sheets day to day, but the dollar system still has a center of gravity.
What matters for you as a market watcher
You do not need to pick a religion here. The useful takeaway is this:
- The eurodollar system amplifies dollar liquidity cycles.
- In good times, it expands credit and makes funding feel easy.
- In bad times, it can contract quickly and make funding feel scarce.
That contraction is why you see sudden "dollar up, everything down" moments. It is not always about growth. It is often about funding.
Come back tomorrow for Part 2 of this topic!