The word "stable" in stablecoin is doing a lot of work. It doesn't mean guaranteed stability — it means the coin is designed to target a stable value, usually $1. Whether it achieves that depends entirely on the mechanism behind it, and that mechanism varies dramatically between different stablecoins.
In March 2023, USDC — the second-largest stablecoin, issued by a regulated U.S. company, backed by cash and Treasuries — traded below $0.87. Not because of a hack, not because of fraud. Because Circle disclosed it held $3.3 billion at Silicon Valley Bank when SVB failed. The peg broke. Then it recovered when the FDIC backstopped SVB deposits. The mechanism worked eventually, but with a scare most people didn't anticipate.
In May 2022, TerraUSD (UST) — an algorithmic stablecoin that briefly reached $18 billion market cap — collapsed to near zero in 72 hours. Roughly $40 billion in combined value was destroyed.
These aren't edge cases. They're the clearest evidence that "stablecoin" describes an aspiration, not a guarantee.
How Different Stablecoins Maintain Their Peg
There are three distinct types of stablecoins, and they maintain their pegs through fundamentally different systems.
Fiat-backed stablecoins (USDT, USDC, PYUSD) hold reserves — cash, short-term government bonds, commercial paper — and issue tokens representing claims on those reserves. The peg holds as long as: (1) the reserves are real and liquid, and (2) users can redeem tokens for dollars. USDC's SVB moment exposed the vulnerability: even with genuine reserves, if those reserves are concentrated in a failing institution, the peg can break before redemption resumes. Tether (USDT) has faced persistent questions about reserve composition and opacity; it settled with U.S. regulators twice without admitting wrongdoing. As of 2024, Tether publishes quarterly attestations — not full audits — showing substantial U.S. Treasury holdings.
Crypto-collateralized stablecoins (DAI, now rebranded as USDS through Sky Protocol) use excess cryptocurrency as collateral. To mint $100 in DAI, you might lock $150 in ETH. The overcollateralization provides the buffer. If ETH crashes far enough, the system automatically liquidates collateral positions to protect the peg. This survived the 2022 crypto crash. The constraint: if crypto crashes faster than liquidations can execute — or across sufficiently large positions simultaneously — undercollateralization becomes possible. The March 2020 "Black Thursday" crash briefly threatened DAI; the protocol survived but required emergency governance changes.
Algorithmic stablecoins (TerraUSD/UST is the primary case study) attempt to maintain a peg through token supply expansion and contraction, with no external reserve backing. TerraUSD worked by burning LUNA to mint UST and burning UST to mint LUNA. The mechanism relied entirely on sustained demand for both tokens. When large UST withdrawals began — partly triggered by deliberate short selling — the mint/burn loop inverted into a hyperinflationary death spiral. Combined LUNA and UST value lost roughly $40 billion in days. The fundamental design flaw: the only collateral for UST was another token whose value depended on UST's stability.
The category confusion happens because all three are called "stablecoins" and all three are designed to trade at $1.
Where the Stability Constraints Live
For fiat-backed stablecoins, stability is constrained by reserve quality and liquidity (can holdings be converted to dollars under stress?), counterparty risk (which banks and custodians hold the reserves?), and redemption access (can large holders redeem at scale without breaking the system?). Tether faced a CFTC settlement in 2021 related to reserve composition misrepresentation. USDC is regulated under U.S. money transmission laws and publishes monthly attestations from major accounting firms.
For crypto-collateralized stablecoins, the constraint is collateral ratio maintenance. MakerDAO's governance can adjust liquidation thresholds and stability fees, making the system adaptable — but also subject to governance failure.
For algorithmic designs, the constraint was always circular: the peg's stability depended on confidence, and confidence depended on stability. Once confidence broke, the mechanism accelerated collapse rather than resisting it. This is the structural flaw that killed TerraUSD and, before it, Basis Cash, Iron Finance, and others.
What's Changing
Regulatory clarity is the dominant shift. The EU's MiCA regulation established formal reserve and disclosure requirements for fiat-backed stablecoins, including a requirement to hold 30% cash reserves with regulated credit institutions. The U.S. Stablecoin TRUST Act (advancing in 2024-2025) targets a similar framework domestically.
Tether's reserve composition has shifted materially: from a disputed mix including commercial paper in 2021 to predominantly U.S. Treasuries by 2024. Still attested, not audited. Still issuer-reported. The reporting has improved under pressure; it hasn't yet met the standard a regulated money market fund faces.
Pure algorithmic stablecoins are effectively dead as a serious design category. New designs tend toward hybrid approaches — partial collateral plus algorithmic adjustment — rather than the zero-reserve model that failed at Terra.
What Would Confirm Stability
Fiat-backed stablecoins maintaining their pegs through a stress event equivalent to or worse than SVB without sustained depeg. Major issuers adopting full Big Four audits with complete reserve disclosure. MiCA-compliant stablecoins functioning through European banking stress without significant depeg.
What Would Break It
A Tether reserve audit revealing composition materially different from current attestations. A U.S. banking failure while USDC holds concentrated counterparty exposure at a scale the FDIC can't backstop. A crypto-collateralized protocol unable to execute liquidations in a rapid market crash, resulting in undercollateralized supply. Any pure-algorithmic stablecoin reaching $5B+ again — the scale that made TerraUSD fragile enough to collapse.
Timing Perspective
Now: USDT and USDC have survived serious stress events and maintained dominant positions. The open question is reserve transparency, not whether the mechanism functions under normal conditions.
Next: Bank-issued stablecoins (potentially with cleaner reserve structures by design) entering active competition in 2025-2026. MiCA compliance creating ongoing reporting pressure in Europe.
Later: Full audit standards for stablecoin reserves. Currently discussed; not yet required anywhere.
What This Doesn't Mean
Fiat-backed stablecoins like USDC and USDT have functioned adequately under documented stress. Crypto-collateralized stablecoins have held under market pressure, with caveats. Algorithmic stablecoins without reserve backing have structurally failed at scale — this isn't contested.
None of this is a recommendation to use any specific stablecoin. Reserve quality, regulatory status, and counterparty risk all matter and all change. What it does mean: reading the mechanism before selecting a stablecoin isn't optional. "Stable" describes the target, not the guarantee.
