Crypto
How Stablecoins Hold Their Peg — and How Pegs Break
Stablecoins are the plumbing of crypto markets: the unit traders price in, the asset that moves between exchanges, and increasingly a dollar substitute in countries with weak currencies. All of them promise a stable value, usually $1. How they keep that promise varies enormously — and the mechanism is everything.
Fiat-backed: a claim on a reserve
The largest stablecoins (USDT, USDC) are IOUs from a company that claims to hold a dollar of reserves — cash and short-term Treasuries — for every token issued. The peg is maintained by arbitrage: if the token trades at $0.99, authorized parties buy it and redeem at $1.00 with the issuer, pocketing the difference and pushing the price back up. The critical questions are boring, audit-shaped ones: What exactly is in the reserve? Who attests to it, how often? Who can actually redeem, and can redemption be suspended? A fiat-backed stablecoin is only as good as its reserve and its legal obligation to honor it.
Crypto-collateralized: overcollateralization on-chain
Coins like DAI are backed not by bank deposits but by crypto locked in smart contracts, and because that collateral is volatile, the system demands more than $1 of collateral per $1 issued — often 150% or more. If collateral value falls too far, positions are liquidated automatically to defend the peg. The advantage is transparency: reserves are on-chain, verifiable by anyone in real time. The costs are capital inefficiency and reliance on liquidation machinery that must work during exactly the chaotic moments when networks are congested.
Algorithmic: the graveyard category
Algorithmic stablecoins tried to hold $1 with no full backing at all, using an incentive loop with a sister token that absorbs volatility. TerraUSD (UST) was the flagship — until May 2022, when roughly $40 billion of value evaporated in a week. The failure mode is structural: the mechanism relies on confidence in the sister token, and the moments when the peg needs defending are precisely the moments confidence is collapsing. The design amplifies runs rather than absorbing them. Treat any uncollateralized "stable" asset accordingly.
How to read a depeg
Even good stablecoins wobble. USDC briefly traded near $0.88 in March 2023 when a portion of its reserves was stuck in a failed bank — and recovered fully within days once the deposits were guaranteed. The lesson: a depeg is a market's live estimate of redemption risk. Small, brief deviations are normal microstructure; deep ones are telling you something about the reserve. Know which kind you are looking at before you act.
The takeaway
"Stablecoin" describes a price target, not a guarantee. Fiat-backed coins carry issuer and banking risk, crypto-collateralized coins carry liquidation and smart-contract risk, and algorithmic designs have repeatedly carried existential risk. The label matters less than the mechanism — always know which one you're holding.