Stablecoins Explained: How They Hold a Peg and When They Don't
Not all stablecoins are the same. Fiat-backed, crypto-backed and algorithmic designs fail in different ways. How each holds its peg, what backing really means, and how regulation is reshaping them.
A stablecoin is a token designed to hold a steady value, almost always one US dollar. They are the settlement layer of crypto: most trading pairs, most lending markets and most yield strategies are denominated in them.
The word "stablecoin" covers designs with almost nothing in common beyond the target price. Treating them as interchangeable is how people get hurt.
The three designs
Fiat-backed
An issuer holds dollars and short-term government debt, and issues tokens against them. USDC and USDT dominate this category; our guide to the major stablecoin issuers in 2026 compares who issues what and how large each token is.
The peg holds through redemption: if the token trades below a dollar, arbitrageurs buy it cheap and redeem it at par. That mechanism only works if redemption is genuinely available, which is why the composition of reserves matters more than their headline size. Reserves in overnight treasuries behave very differently from reserves in commercial paper during stress.
What breaks it: the issuer's banking access. USDC briefly lost its peg in March 2023 not because reserves were missing but because a portion sat in a bank that failed over a weekend.
Crypto-backed
Collateral is crypto, locked in smart contracts and deliberately over-collateralised — typically $150 or more of collateral per $100 issued. DAI is the archetype.
Over-collateralisation absorbs volatility. If collateral falls too far, positions are liquidated automatically to keep the system solvent. Capital-inefficient by design, and that inefficiency is the safety margin.
What breaks it: collateral falling faster than liquidations can clear, leaving the system under-collateralised. Congestion makes this worse, because liquidations compete for the same blockspace as everyone exiting.
Algorithmic
No meaningful collateral. The peg is maintained by minting and burning against a paired token, on the assumption that arbitrage will do the rest.
Terra's UST is the reference failure. When confidence went, the mechanism did not just fail to hold the peg — it actively accelerated the collapse by minting the paired token into a falling market.
What breaks it: the design. Purely algorithmic stablecoins have no floor when reflexivity turns against them. Approach with the assumption they can go to zero.
What "backed" actually means
Backing is a claim about reserves, and it has three separate dimensions.
- Composition — what the reserves are held in. Treasuries and cash are not the same as corporate debt or other crypto.
- Custody — who holds them, and what happens if that institution fails.
- Verification — whether anyone independent has confirmed it. An attestation is a snapshot; an audit is a stronger claim. Neither is a guarantee. See proof of reserves for what these attestations do and do not cover.
Yield on stablecoins
Stablecoins do not pay interest by themselves. Any yield comes from somewhere specific, and it is worth naming which.
Lending markets pay from borrower interest. Liquidity pools pay from trading fees. Tokenised treasury products pass through government bond yields. Synthetic dollars such as Ethena's USDe earn from derivatives funding rates, which is a different risk again. Incentive programmes pay from token emissions — and those end.
We cover the practical routes in how to earn yield on stablecoins, the tokens that build it in at yield-bearing stablecoins, and the higher-risk end at stablecoin yield farming.
A rule that ages well: if the yield is far above short-term government rates, you are being paid for a risk. Identify it before depositing.
Regulation is now the main variable
Stablecoins were the first part of crypto regulators moved on, because they touch payments and monetary policy, and card networks and payment firms are now building them into everyday payments.
In the United States, the GENIUS Act, signed in July 2025, created the federal framework for payment stablecoin issuers. In Europe, MiCA sets reserve, redemption and reporting requirements for issuers, and restricts what can be offered to EU users — which is why some tokens were delisted for European customers rather than adapted. Issuers and the platforms distributing them now carry identity and monitoring obligations, and KYC and KYB systems are part of how that is met in practice.
Our MiCA-compliant stablecoins guide covers which designs fit the framework.
Choosing one
For holding value, prefer the largest fiat-backed tokens with transparent, short-duration reserves. For DeFi-native exposure, over-collateralised designs remove issuer risk but add smart contract and liquidation risk. For anything algorithmic, size it as a speculative position.
And avoid concentration — holding a single stablecoin means a single issuer's failure is your failure too.
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