Stablecoins are the backbone of DeFi — the dollar you trade in and out of, the safe harbor between trades. But "stable" is a goal, not a guarantee, and understanding how a stablecoin holds its value tells you how much to trust it.
What a stablecoin is
A stablecoin is a token designed to track a steady value, almost always $1. It lets you hold dollars on-chain, price trades, and sit out volatility without leaving DeFi. The big three are USDC, USDT (Tether) and DAI.
Three ways to hold a peg
| Type | How it's backed | Examples |
|---|---|---|
| Fiat-backed | Real dollars & equivalents in reserve, 1:1 | USDC, USDT |
| Crypto-backed | Over-collateralized with crypto locked in contracts | DAI |
| Algorithmic | Code and incentives, often under-collateralized | (mostly defunct) |
Fiat-backed coins are only as good as their reserves and the institutions holding them. Crypto-backed coins like DAI hold more than $1 of crypto per coin to absorb volatility. Algorithmic coins tried to hold the peg with code alone — and have the worst track record by far.
When pegs break: two cautionary tales
- USDC, March 2023. When Silicon Valley Bank failed, Circle disclosed that about $3.3 billion of USDC's reserves were stuck there. USDC briefly depegged to roughly $0.87 as panic spread, then recovered to $1 once US regulators backstopped the bank's deposits. A fully-backed coin still wobbled on where its reserves sat.
- TerraUST, May 2022. UST was an algorithmic stablecoin that held its peg via a mechanism with its sister token LUNA. When confidence cracked, the mechanism spiraled and UST collapsed to near zero, vaporizing tens of billions of dollars in days. It's the definitive warning against "stable" coins backed only by code.
Practical takeaways
- Prefer well-established, transparently-backed stablecoins for holding value.
- Be wary of any stablecoin advertising unusually high yields — that yield comes from somewhere, and risk usually rides with it.
- A peg is a promise, not a law of physics; even good stablecoins can wobble briefly under stress.
Used sensibly, stablecoins are indispensable. Just remember that "stable" describes the intent — always know what's behind the one you hold.
- Assuming every 'stablecoin' is equally safe regardless of how it's backed.
- Chasing eye-catching stablecoin yields without asking where the return comes from.
- Trusting algorithmic, under-collateralized stablecoins as a safe store of value.