Stablecoin
What is Stablecoin?
A stablecoin is a cryptocurrency designed to hold a fixed value against a reference asset, usually a national currency, through backing or an algorithmic rule.
Three designs dominate: asset-backed coins hold reserves such as bank deposits and short-term government debt and promise redemption at par, so the peg is only as good as those reserves and the right to redeem them. Crypto-collateralized coins are over-collateralized with volatile assets and rely on forced liquidations when the collateral falls, which works until the selling has to happen fast in a falling market. Algorithmic coins hold no full backing and defend the peg by expanding and contracting supply against a companion token, which depends entirely on continued demand. An asset-backed stablecoin is economically close to a money market fund, taking in money, buying short-term assets and issuing claims people treat as worth a dollar. That makes it run-prone, which is the question regulators keep returning to.
Stablecoin: a worked example
An issuer has 5 billion coins outstanding, each redeemable for $1, and holds reserves worth $4.95 billion, so backing is 4.95 ÷ 5 = $0.99 per coin. Redemptions are still paid at the full $1. After holders redeem 1 billion coins, reserves are 4.95 minus 1 = $3.95 billion against 4 billion coins, or 3.95 ÷ 4 = $0.9875 of backing each. Every redemption leaves the remaining holders slightly worse off, so the rational move is to redeem before the others do, which is the same incentive that produces a run on an uninsured bank.
The mistake students make with stablecoin
Students hear stable and assume the value is guaranteed, or treat a stablecoin balance as the equivalent of a bank deposit. A peg is a promise by an issuer, and it holds only while that issuer can meet redemptions at par. Holders are unsecured creditors of the issuer rather than insured depositors, so no deposit insurance sits behind the balance and no central bank stands ready to lend against it.
Stablecoin questions
What actually keeps a stablecoin's value stable?
A stablecoin holds its value mainly through arbitrage against a redemption promise, because if the coin trades below the peg someone can buy it cheaply, redeem it at par, and pocket the difference, which removes supply and pushes the price back up. That mechanism depends on reserves being genuinely there and liquid enough to pay out, which is why reserve composition and independent attestations get so much attention.
How does a stablecoin lose its peg?
A stablecoin loses its peg when the market doubts it can pay out at par, whether because reserves are illiquid, insufficient or simply not visible. Doubt triggers redemptions, redemptions force asset sales at a loss, and the losses confirm the doubt, which is why depegs tend to happen suddenly rather than gradually. Algorithmic designs are the most exposed, because there is no reserve to sell at all.
Is a stablecoin the same as a bank deposit?
No, a stablecoin is a claim on a private issuer with no deposit insurance and no central bank backstop, while a bank deposit is insured up to a legal limit and sits inside a supervised institution. Both promise a fixed value in national currency, but only one of them has a public safety net standing behind that promise.
Related terms
Common comparisons
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