Categories of Stablecoins
Stablecoins peg one unit to a fiat currency such as 1 USD, and fall into three broad categories by peg-maintenance design. First, fiat-collateralized stablecoins (USDT, USDC, BUSD) are issued by entities holding 1-USD-equivalent reserves in bank deposits and short-term Treasuries, supporting issuance and redemption. Second, crypto-collateralized stablecoins (DAI) lock on-chain collateral - primarily ETH - at over-collateralized ratios (e.g., 150%) and use a liquidation system to maintain peg. Third, algorithmic stablecoins (the former UST) hold no fiat or crypto collateral and rely solely on a conversion algorithm with a paired token (such as LUNA) to maintain peg.
Operational Structure of Fiat-Backed Stablecoins
USDT (Tether), launched in 2014, and USDC, issued by Circle from 2018, are the dominant fiat-backed stablecoins. Issuers invest received USD in short-term Treasuries, cash, and repos, capturing yield as their primary revenue. On transparency, USDC publishes monthly reserve attestations from a recognized accounting firm, while USDT historically issued only quarterly limited assurances rather than full audits. Both saw stress in March 2023: USDC held about USD 3.3 billion in reserves at Silicon Valley Bank, and the peg briefly broke to as low as 0.88 USD when SVB collapsed. Counterparty risk persists even when collateral exists.
Algorithmic Fragility - The Terra/Luna Case
The Terra (UST) collapse in May 2022 is the canonical example of algorithmic stablecoin fragility. UST maintained its peg through 1:1 convertibility with LUNA (1 USD of LUNA exchangeable for 1 UST), but underlying demand was sustained largely by the Anchor Protocol's 19.5% APY rather than organic use. On May 7-8, 2022, large UST sales pushed the peg below 0.99, prompting arbitrageurs to convert UST into LUNA. LUNA's supply expanded exponentially in hyperinflation, the LUNA price collapsed from around USD 80 to below USD 0.0001, and UST fell below USD 0.10. The design embedded a 'death spiral' that detonates the moment self-reinforcing confidence in demand evaporates.
Indicators of Peg Health
Useful indicators for evaluating stablecoin peg health include: (1) deviation of median exchange price from 1 USD, (2) pool composition on major DEX venues such as Curve - heavy skew suggests broken supply-demand balance, (3) on-chain issuance and redemption flows, (4) reserve composition and audit frequency at the issuer, and (5) recovery time after de-peg events. USDC's recovery from the SVB shock took about four days. Brief deviations of a few percent occur in normal market stress, but a deviation that persists for more than 24 hours warrants attention as a possible structural signal.
Practical Risk Management
Where USDT or USDC is used as collateral or settlement currency in crypto trading, peg-failure risk should be treated as a portfolio-level risk. First, diversify across multiple stablecoins to reduce single-issuer exposure. Second, monitor issuer transparency on an ongoing basis, including reserve composition and audit cadence. Third, define a quantitative trigger for action in stress (for example, exit to base currency if deviation exceeds 5% for more than six hours), and automate the execution. Fourth, avoid concentrated holdings of algorithmic stablecoins. Even after Terra/Luna, similarly designed projects continue to appear, and the structural fragility has not been resolved. This article is for informational purposes only and does not constitute investment advice. Investment decisions are made at your own discretion.