Stablecoins are everywhere in crypto. Exchanges price most trading pairs in them, DeFi protocols lend them, and many people use them to send money across borders.
"One stablecoin equals one dollar" is something most people take for granted. But that peg isn't a law of nature. It's held in place by a mechanism, and when the mechanism fails, a stablecoin can become very unstable.
Key takeaways
- There are three main types of stablecoins: fiat-backed, crypto-collateralized and algorithmic, each with different risks.
- USDT and USDC rely on reserves like cash and short-term Treasuries held by the issuer. The core risk is whether those reserves are sufficient and transparent.
- The algorithmic stablecoin UST collapsed in 2022, wiping out tens of billions of dollars along with its sister token LUNA.
- When Silicon Valley Bank failed in 2023, USDC briefly fell to about $0.87 because part of its reserves was trapped.
- Centralized stablecoins can be frozen by their issuers, a tool for law enforcement and a risk every holder should understand.
What stablecoins are and why we need them
Bitcoin and ether swing too much to be convenient for pricing, settling or parking money short-term. A stablecoin provides an asset with relatively stable value on the blockchain, usually pegged 1:1 to the US dollar.
Main uses include:
- Pricing trades: most exchange trading pairs are quoted in stablecoins.
- A safe harbor: switching into stablecoins to wait out volatile markets.
- DeFi: a base asset for lending, market-making and more.
- Payments: fast on-chain transfers that don't depend on banking hours.
Three types of stablecoin, three ways to stay stable
| Type | Examples | How the peg is held | Main risks |
|---|---|---|---|
| Fiat-backed | USDT, USDC | The issuer holds cash, short-term Treasuries and other reserves; users can redeem 1:1 | Insufficient or opaque reserves, issuer risk, freezes |
| Crypto-collateralized | DAI (and its successor USDS) | Users mint it by over-collateralizing crypto; undercollateralized positions get liquidated | Collateral crashes, failed liquidations, smart contract risk |
| Algorithmic | The collapsed UST | Algorithms and a companion token adjust supply | A "death spiral" if confidence breaks |
Fiat-backed: USDT and USDC
USDT, issued by Tether and launched in 2014, is the largest and most widely used stablecoin. It faced years of questions about reserve transparency. In 2021, Tether settled with the New York Attorney General's office over statements about its reserves and was fined by the US Commodity Futures Trading Commission. Since then, it has published regular reserve attestations.
USDC, issued by Circle, is known for compliance and transparency. It publishes regular reserve reports from an accounting firm, and its reserves are mostly cash and short-term US Treasuries.
What they share: trusting that they're worth $1 really means trusting that the issuer holds enough reserves and is willing and able to redeem 1:1.
Crypto-collateralized: DAI
DAI was launched by MakerDAO (the project later rebranded as Sky and introduced a new stablecoin, USDS). To mint DAI, users deposit crypto worth more than the amount they borrow. If collateral prices fall and a position becomes undercollateralized, the system liquidates it automatically so every DAI stays backed.
It's more decentralized and transparent on-chain, but it depends on collateral prices and liquidations working. Notably, DAI's collateral has included centralized assets like USDC.
Algorithmic: the lesson of UST
Algorithmic stablecoins try to hold their peg without full reserves, using algorithms to adjust supply. The best-known example is Terra's UST, which held $1 through a swap mechanism with its companion token, LUNA.
In May 2022, heavy selling pushed UST off its peg. Holders rushed to swap UST for LUNA, which minted huge amounts of LUNA, crashed its price and destroyed what confidence remained in UST. Within days, both were nearly worthless, tens of billions in value vanished, and the fallout spread across the industry.
Real depegs
| Date | Event | Low (approx.) | Outcome |
|---|---|---|---|
| May 2022 | Algorithmic stablecoin UST collapses | Near $0 | Never recovered; the Terra ecosystem collapsed |
| March 2023 | Silicon Valley Bank fails with about $3.3 billion of Circle's reserves | About $0.87 | Recovered within days after US regulators backstopped deposits |
| March 2023 | DAI depegs alongside USDC | About $0.90 | Recovered as USDC recovered |
The USDC case deserves attention: even a stablecoin known for compliance and transparency briefly lost its peg because of trouble at a bank holding its reserves. The risks of fiat-backed stablecoins lie not only with the issuer but also with the traditional financial system it depends on.
Other risks stablecoin holders should know
- Freezes: the issuers of USDT and USDC can freeze assets at specific addresses at the contract level, usually to support law enforcement and fight fraud and money laundering. Receiving stablecoins of unknown origin can drag you into that. See why an unknown USDT deposit could be a trap.
- Regulation: the EU's Markets in Crypto-Assets regulation (MiCA) sets clear rules for stablecoin issuers, and the US signed its stablecoin law, the GENIUS Act, in July 2025. Rule changes can affect which stablecoins are available where.
- Chain and contract risk: the same stablecoin may be issued on several blockchains. Bridge hacks or fake token contracts can cause losses.
- Yield traps: some platforms advertise high interest on stablecoins. High yields often mean risky lending or speculation, and if the platform fails, your principal may be gone.
FAQ
Which is safer, USDT or USDC?
Their risks differ. USDC's reserve reporting and compliance are generally seen as more transparent, while USDT is larger and more liquid. A sensible approach is to avoid keeping large sums in a single stablecoin for long and to follow the reserve information each issuer publishes.
Can I treat stablecoins like a bank deposit?
No. Stablecoins generally aren't covered by deposit insurance. Their value depends on the issuer's reserves and credibility, or on smart contracts and collateral, which is a different kind of risk from a bank deposit.
Why was my USDT frozen?
Issuers may freeze funds in response to law enforcement requests or because an address is linked to fraud or money laundering. If your funds are legitimate, contact the relevant platform through official channels or seek legal help, and beware of scammers offering to "unfreeze" them.
Where does stablecoin yield come from?
It can come from lending interest, market-making fees, a share of the issuer's reserve income or token incentives paid by a project. The higher the yield, the higher the risk, usually. Read more in DeFi explained: DEXs, lending and the real risks.
Summary
A stablecoin's stability comes from reserves, collateral or algorithms, and each mechanism has its weak spot: fiat-backed coins depend on the issuer and the banking system, crypto-backed coins on collateral and liquidations, and algorithmic coins can unravel quickly when confidence breaks.
Know which type you're holding and where its risks lie, and avoid concentrating all your funds in one stablecoin or one platform. To learn more about the risks behind DeFi yields, read where DeFi yields really come from. This article is for education only and isn't investment advice.
Covers Ethereum and DeFi: smart contracts, gas, Layer 2, and how decentralized exchanges and lending protocols work, and where they can fail.
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Michael Carter
David Mitchell