Stablecoins aim to track the price of a reference asset—most commonly the US dollar—while letting users move value quickly on-chain. Understanding how pegs are maintained (and how they can fail) is essential for trading, saving, and using DeFi safely.
🏷️ What Is a Stablecoin?
A stablecoin is a cryptoasset designed to hold a predictable value (e.g., $1).
Under the hood, pegs are maintained through collateral, redemption rights, and market incentives.
🧩 Main Stablecoin Models
| Model | How It Works | Examples | Pros | Cons / Risks |
|---|---|---|---|---|
| Fiat-Backed (Custodial) | Issued against cash & cash-equivalents held by a centralized company. Users can redeem 1 coin for ~$1 via KYC channels. | USDC, USDT, PYUSD | High peg stability, deep liquidity, simple mental model. | Banking dependencies, blacklisting risk, centralized custody. |
| Crypto-Collateralized (Over-collateralized) | Users lock volatile crypto (e.g., ETH) as collateral to mint $1-denominated debt; liquidations keep the system solvent. | DAI, LUSD | On-chain, transparent, no bank needed. | Collateral volatility, liquidation cascades, oracle risks. |
| Hybrid / RWA-Backed | Collateral mixes on-chain assets with real-world assets (T-Bills, cash accounts), sometimes via DAOs or trusts. | DAI (RWA tranches), FRAX-style hybrids | Diversified backing, yield from RWAs. | Regulatory and custody exposure, transparency varies. |
| Algorithmic / Seigniorage | Uses incentives and supply adjustments (mint/burn with a paired token) to target $1 without full collateral. | Historical: UST (failed), various experiments | Capital efficient in good times. | Reflexive bank-run risk; can fail catastrophically. |
⚙️ How Pegs Are Maintained
1) Mint & Redemption (Arbitrage)
If a coin trades below $1, authorized parties (or anyone, depending on the design) can buy it cheap on exchanges and redeem for $1 of backing—profit pushes price up. If it trades above $1, they can mint at $1 and sell above peg—pushing price down.
Example: Coin trades at $0.995. A market maker buys 1,000,000 coins for $995,000 and redeems for $1,000,000 of reserves ⇒ $5,000 profit. This buying pressure lifts price toward $1.
2) Collateralization & Liquidations
In crypto-collateral systems, users mint stablecoins against collateral at a minimum ratio (e.g., 150%). If collateral value drops, liquidations repay the debt and keep the system solvent.
3) Oracles & Price Feeds
On-chain protocols rely on oracles (e.g., medianized feeds) to value collateral and trigger liquidations/mint limits. Robust oracles reduce manipulation and stale prices.
4) Liquidity & Market Depth
Deep liquidity on CEXs and DEXs helps absorb shocks. Protocols often incentivize pools (e.g., Curve) so large trades affect price less, keeping the peg tight.
5) Governance Controls (Risk Modules)
- Mint/redeem fees and limits
- Collateral onboarding/offboarding
- Stability fees (interest) on debt
- Reserve composition changes (e.g., more T-Bills)
🧪 Peg Health: What to Check
| Dimension | Healthy Signals | Red Flags |
|---|---|---|
| Backing | Clear reserve breakdown, regular attestations or audits, on-chain proofs. | Opaque disclosures, large “other assets,” mismatched durations. |
| Redemption | Reliable 1:1 redemption, predictable fees/limits, many authorized partners. | Suspended redemptions, high fees, narrow access windows. |
| Liquidity | Deep DEX/CEX books, tight spreads, multiple venues and chains. | Shallow pools, big slippage, single-venue concentration. |
| Risk Controls | Diverse collateral, conservative LTVs, robust oracles, circuit breakers. | Over-reliance on one asset, weak liquidation mechanisms. |
| Governance | Transparent proposals, timelocks, multi-sig or DAO oversight. | Centralized keys, upgrade powers without guardrails. |
| Compliance | Clear policy on blacklisting/sanctions; well-documented. | Surprise freezes, unclear jurisdictional exposure. |
⚠️ How Depegs Happen
- Banking/Custody Issues: Reserve accounts frozen or inaccessible.
- Collateral Shock: Crypto-backed coins face rapid drawdowns & liquidation spirals.
- Oracle Failures: Stale or manipulated feeds trigger bad liquidations.
- Liquidity Flight: Shallow pools cause large trades to push price away from $1.
- Policy/Blacklist Events: Trust shocks reduce demand and break confidence.
- Algorithmic Reflexivity: Confidence loss leads to death spirals in under-collateralized designs.
Tip: Short-lived wicks to $0.995–$1.005 are common in volatile markets; structural depegs persist across multiple venues and timeframes.
🧭 Practical Usage Tips
- Diversify stablecoin exposure across models and issuers.
- Match use to risk: Use fiat-backed for payments/off-ramps; crypto-backed for on-chain composability.
- Monitor peg dashboards and set alerts for price bands (e.g., <$0.997 or >$1.003).
- Check redemption mechanics (who can redeem, fees, KYC) before holding large balances.
- Mind smart-contract risk when depositing into yield strategies.
📚 Quick Glossary
- Collateral Ratio (CR): Value of collateral / value of issued stablecoins.
- Liquidation: Forced sale of collateral to repay stablecoin debt.
- Oracle: System that brings off-chain prices on-chain.
- Attestation vs Audit: Attestations are snapshots by accounting firms; audits are deeper investigations.
🛡️ Key Takeaway
A stablecoin is only as strong as its redemption process, collateral, and liquidity. Evaluate all three before you trust a $1 on-chain to behave like a $1 in your wallet.
Written by BitBlog — clear, practical crypto education.