Learn / Experienced · Tokens and Stablecoins

What backs the coin?

A stablecoin is a token designed to hold a steady value, usually one US dollar. That steadiness is a promise, and promises depend on what stands behind them. This module gives you a way to ask “what backs the coin?” and shows two real episodes where the answer mattered.

We deal only in design and history, not prices to buy or sell.

Education only, not financial advice. Examples use made-up numbers, not live prices.

Three ways to hold a peg

Almost every stablecoin falls into one of three groups, and each fails in its own way.

• Fiat-backed. The issuer holds cash and short-term safe assets, such as government bills, and promises to redeem each token for a dollar. The risk is whether the reserves really exist, are safe, and can be reached, plus whether the issuer can be trusted and is allowed to operate.
• Crypto-backed. Users lock more value in other crypto than the stablecoin they receive, and software manages it. The risk is that the collateral falls fast, or that it includes other stablecoins that fail.
• Algorithmic. The peg is meant to be held by incentives and a sister token, with little or no real backing. The risk is a loss of confidence that feeds on itself.

Case one: TerraUSD, May 2022

TerraUSD, called UST, was an algorithmic stablecoin tied to a companion token, LUNA. When UST slipped below one dollar, the system was meant to reward people for burning UST and creating LUNA. But as confidence broke, selling pushed UST further down and created huge amounts of LUNA, which pushed LUNA’s value toward zero, which made the whole arrangement even less credible. It was described as a bank-run-like spiral. Within days UST was trading at a tiny fraction of a dollar and tens of billions of dollars in value disappeared. Estimates vary by source, so treat any single number as approximate. The lesson is that a peg without real, redeemable backing can be only as strong as people’s belief in it.

Case two: USDC, March 2023

USDC is a fiat-backed stablecoin. On 10 March 2023 Silicon Valley Bank was closed by regulators. Its issuer, Circle, said that about 3.3 billion dollars of the roughly 40 billion in USDC reserves were held at that bank. Fear spread that part of the reserves could not be reached, and USDC briefly traded at around 87 to 90 cents on some markets over a weekend. Other coins that depended on USDC, such as DAI, slipped too. USDC recovered once the authorities acted to protect the bank’s depositors.

The lesson is different. Even a well-backed coin inherits the risks of the banks that hold its reserves, and a short break in the peg can still cause losses to people who sold in a panic.

Questions to ask any stablecoin

• What exactly backs it? Cash, bills, other crypto, or only a promise?
• Where are the reserves held, and how often are they reported? Look for regular, independent attestations, and be aware that an attestation is not a full audit.
• Who can redeem, and at what size? If only large customers can redeem directly, small holders rely on market prices.
• Who is the issuer, and under what rules? A known, regulated issuer is different from an anonymous team.
• Can the issuer freeze tokens? Some can, which is a safety feature to some and a control to others.
• What does it depend on? Another stablecoin, a bank, a single chain?

A Caribbean angle

Many people in T&T think in Trinidad and Tobago dollars but may be offered stablecoins pegged to US dollars. A US-dollar coin still carries exchange-rate risk against the TT dollar and is not a bank deposit, so it is not covered by deposit protection. Moving between TT dollars and stablecoins also depends on what platforms and banks will allow, which can change; Module 8 explains where to find official information.

Worked example: choosing between two coins

Suppose you must hold a US-dollar stablecoin for a short time while moving money. Coin X is fiat-backed, issued by a known company that publishes monthly reserve reports. Coin Y is algorithmic and offers a higher reward for holding it.

Apply the questions. For X, what are the reserves, and where are they held? If a large share sits in one bank, you learn from the USDC episode that a bank problem can become a coin problem. Is redemption open to you or only to large customers? For Y, what stands behind it? If the answer is “the market’s belief” and a sister token, that is the structure that failed with TerraUSD. The extra reward is the price of that risk.

Neither coin is a bank deposit. A careful holder might choose X, keep the holding period short, and avoid putting everything in one coin. The skill is not memorising which coin is “good”; it is asking the same questions every time and writing down the answers.

Common mistakes

Assuming “stable” means “safe”. Stable is a goal, not a guarantee.

Chasing a high yield on a stablecoin. An unusually high return usually comes from extra risk.

Trusting a coin because it has been stable for a long time. TerraUSD held its peg until it did not.

Putting everything in one stablecoin. Concentration turns one failure into a total loss.

Try it yourself

Pick two stablecoins. For each, find the issuer’s latest reserve report and write: what the reserves are, where they are held, who prepared the report, and how often it is published. Then say which one you would trust less and why, in two sentences.

Keep in mind

• A peg is a promise; reserves and redemption make it credible.
• Algorithmic designs have failed badly, and fiat-backed ones inherit bank risk.
• Stablecoins are not bank deposits.
• Not financial advice.

Key terms from this lesson

• Peg — the target value a stablecoin tries to hold.
• Reserves — the assets held to back a stablecoin.
• Redemption — exchanging a stablecoin with its issuer for the underlying currency.
• Depeg — when a stablecoin trades away from its target.
• Attestation — an accountant’s limited report on reserves at a point in time.
• Collateral — assets locked to support a loan or token.

Sources and credits

• The Block: USDC and DAI after Circle’s SVB disclosure — 3.3 billion at SVB and the dip
• CoinDesk: Why USDC’s unstable weekend matters — knock-on effects on other stablecoins
• Cointelegraph: why stablecoins fail to hold $1 — TerraUSD and USDC comparison
• Fortune: Why TerraUSD’s collapse mattered — algorithmic design debate
• ethereum.org: Stablecoins — types of stablecoin and how they hold a peg

Explained in our own words from these sources. Figures are approximate and reported by the sources named; check them yourself. Education only, not financial advice.

Module quiz

3 questions. Tap an answer to see if you are right and why. Get 2 right to complete the module.

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