A stablecoin is a token engineered to track the price of a reference asset, usually a fiat currency. There are three families:
1. Fiat-backed (custodial)
The issuer holds dollars (or T-bills) in a bank account. They mint one token per dollar. Backed means: there is a real bank account; trust means: you trust the issuer's attestation that the dollars are there.
Examples: USDC (Circle), USDT (Tether), EURC (Circle).
Risks: issuer insolvency, banking failure, attestation lag, redemption gating.
2. Crypto-backed (over-collateralised)
The issuer locks volatile crypto worth $1.50+ to mint $1 of stablecoin. A liquidation mechanism unwinds collateral if its value falls.
Examples: DAI (MakerDAO, hybrid these days).
Risks: cascade liquidations during sharp drops, oracle failure, smart- contract bugs.
3. Algorithmic (no collateral)
The peg is maintained by mint/burn arbitrage with a sibling token. When the stablecoin trades over $1, anyone can burn the sibling to mint and sell; when under, the reverse.
Examples: historical — UST, before its 2022 collapse.
Risks: this is the failure mode that vapourised $40B in May 2022. The peg holds until the day it does not.
What you should ask of any stablecoin
- Backing. What sits behind each token?
- Attestation. Who audits it, how often, with what scope?
- Redemption. Can you personally redeem 1 token for $1? Under what conditions? In what timeframe?
- Jurisdiction. Where is the issuer? Which authority licenses it?