How Stablecoins Maintain Value

Stablecoins are supposed to be the quiet workhorses of the crypto world. While Bitcoin swings 20% in a day and Ethereum dances to the rhythm of speculation, stablecoins sit still-pegged to $1, no matter what. But how? If they’re digital tokens on a blockchain, why don’t they crash like other cryptos? The answer isn’t magic. It’s mechanics. And it’s messy.

Fiat-Backed Stablecoins: The Simplest Way

The most common stablecoins-like USDT (Tether) and USDC (USD Coin)-are backed by actual U.S. dollars. For every coin in circulation, the issuer claims to hold one dollar in reserve. That’s it. No complex math. No algorithms. Just a bank account.

Think of it like a gift card. You pay $10 to get a $10 gift card for a store. The card isn’t money, but you can trade it for $10 worth of goods. USDC works the same way. You send $1 million to Circle, and they issue you $1 million in USDC. When you want cash back, you send the USDC back, and they send you the dollars.

But here’s the catch: you have to trust them. If Circle suddenly says, "We only have $700,000 in reserves," the whole thing collapses. That’s why audits matter. In 2023, after Tether’s reputation took a hit, USDC started publishing daily reserve reports. They show exactly how much cash and short-term U.S. Treasuries they hold. No guesswork. No delays.

Crypto-Backed Stablecoins: Overcollateralized and Fragile

Not all stablecoins use dollars. Some, like DAI, use other cryptocurrencies as collateral. But crypto is volatile. So to make up for that, you have to lock up way more than you borrow.

Let’s say you want $100 in DAI. You need to deposit $150 worth of Ethereum. Why? Because Ethereum’s price might drop 30% overnight. If it does, your $150 becomes $105-and you still owe $100. The system has a safety buffer. If the value of your collateral falls too far, the protocol automatically sells some of it to cover the loan. It’s like a margin call, but automated.

This system works fine when markets are calm. But in 2022, when Ethereum dropped 60% in a week, thousands of DAI loans got liquidated. The system didn’t break, but it came close. The price of DAI briefly dipped to $0.90. People panicked. Traders rushed to sell. It took days for confidence to return.

So crypto-backed stablecoins are more resilient than you’d think-but only if the market doesn’t go haywire.

Algorithmic Stablecoins: The Failed Experiment

Then there are the ones that don’t use any collateral at all. These are called algorithmic stablecoins. They try to mimic the Federal Reserve-printing more coins when demand goes up, burning them when demand falls. The idea was elegant: no banks. No reserves. Just code.

UST (TerraUSD) was the biggest example. It was supposed to stay at $1 by swapping with its sister token, LUNA. When UST dipped to $0.99, users could burn $1 worth of LUNA to mint $1 of UST. When UST rose to $1.01, they could burn UST to get LUNA. The theory was that arbitrage would keep it pegged.

It worked-for a while. Then in May 2022, a large withdrawal triggered a death spiral. People started selling UST, which made the price drop. Others rushed to burn UST for LUNA, flooding the market with LUNA tokens. LUNA’s price crashed. No one wanted it. The peg broke. UST fell to 10 cents. Over $40 billion in value vanished in 72 hours.

Algorithmic stablecoins aren’t dead-but they’re deeply distrusted now. No major project has tried to rebuild the model the same way. The lesson? You can’t create value out of thin air. Even code can’t override basic economics.

Why Stability Matters

Why does any of this matter? Because stablecoins are the bridge between crypto and the real world.

Traders use them to move money quickly between exchanges without converting to fiat. In countries with hyperinflation-like Argentina or Nigeria-people use stablecoins to save money that won’t lose value overnight. Remittance companies use them to send cash across borders in minutes for pennies, instead of days and 10% fees.

But if stablecoins can’t stay stable, none of that works. A $0.95 stablecoin isn’t useful for paying rent. A $1.10 stablecoin isn’t reliable for payroll. The whole system depends on trust in the peg.

What Happens When the Peg Breaks

When a stablecoin loses its $1 peg, it’s not just a price drop. It’s a loss of confidence. And confidence doesn’t come back easily.

After UST crashed, exchanges like Coinbase and Binance temporarily delisted it. Wallets froze withdrawals. People who held UST as savings lost money. Even stablecoins that weren’t involved-like USDC-saw their prices dip to $0.97 because everyone panicked.

That’s contagion. One failure shakes the whole ecosystem. That’s why regulators are watching. The U.S. Treasury now requires stablecoin issuers to hold 100% reserves in cash or short-term Treasuries. No corporate bonds. No loans. No risky assets. Just the safest stuff on Earth.

Some issuers are adapting. USDC now holds 90% in U.S. Treasuries and 10% in cash. Tether still holds commercial paper and other assets-but it’s under pressure to change. The era of "trust us" is over. The era of "prove it" is here.

What to Watch For

If you’re using stablecoins, here’s what you need to check:

• Reserve transparency: Does the issuer publish daily reports? Can you verify the assets?
• Asset quality: Are reserves in cash and U.S. Treasuries? Or are they in corporate bonds, crypto, or loans?
• Issuer reputation: Is it Circle (USDC)? Or a little-known startup with no track record?
• Exchange support: Is the stablecoin listed on major platforms? If not, it’s harder to cash out.

Don’t assume all stablecoins are equal. USDC and USDT are the most trusted-but even they aren’t perfect. USDT still holds some commercial paper. USDC has no debt, but it’s still a private company. You’re trusting a corporation, not a government.

The Future of Stablecoin Stability

The future isn’t about better algorithms. It’s about better regulation.

Right now, the U.S. is pushing for federal rules that would require stablecoin issuers to be licensed banks or bank-like entities. That means they’d be subject to capital requirements, audits, and oversight-just like traditional banks.

If that happens, stablecoins will become safer. But they’ll also become slower. More expensive. Less decentralized.

Or maybe the market will decide. If users keep choosing USDC because it’s transparent, and ignore others because they’re opaque, then the market will police itself. That’s already happening.

Stablecoins don’t maintain value through genius code. They do it through trust, transparency, and simple rules: back them with real assets, report them clearly, and don’t gamble with people’s money.

That’s not glamorous. But it works.