Stablecoins: how they hold the peg
Stablecoins are crypto tokens designed to hold a steady value, usually $1. They're the plumbing of crypto markets: most trading, lending and settlement runs through them.
Three designs
- Fiat-backed: each token is backed by cash and short-term government bonds held by the issuer. Tether (USDT) and USD Coin (USDC) are by far the largest. The issuer earns the interest on the reserves, which has become a very profitable business.
- Crypto-backed: tokens such as DAI are backed by more crypto than they issue (overcollateralised), with automatic liquidations if collateral falls.
- Algorithmic: tokens that try to hold the peg through incentives and a linked token, without full reserves.
How the peg holds
If a fiat-backed stablecoin trades at $0.99, large holders can redeem it with the issuer for $1 and pocket the difference. If it trades at $1.01, they can create new tokens for $1 and sell them. That arbitrage, like the ETF mechanism in lesson 1.2, keeps the price close to $1, as long as people trust the reserves are really there.
When pegs break
TerraUSD, May 2022: UST was an algorithmic stablecoin, redeemable for $1 worth of its sister token LUNA. When confidence wavered, holders redeemed UST for LUNA and sold it, crashing LUNA's price, which made UST even less credible. Within days both had collapsed and roughly $40bn of value was wiped out, triggering a wave of crypto lender failures.
USDC, March 2023: Circle had part of its reserves at Silicon Valley Bank. When SVB failed, USDC briefly fell to around $0.88, recovering once US authorities guaranteed deposits. Even well-backed stablecoins carry the risk of where their reserves are held.
Why they matter beyond crypto
Stablecoin issuers are now among the larger holders of US Treasury bills, and the US passed dedicated stablecoin legislation, the GENIUS Act, in July 2025. They are increasingly used for cross-border payments, and regulators in the UK and EU are building their own regimes.
Key takeaway
A stablecoin is only as stable as its backing and its redemption mechanism. Fully reserved designs are boring by design, which is the point. Promised stability without reserves has a poor track record.
Educational content only, not financial advice. Investing involves risk and you can lose money.