Stablecoins explained: what keeps one coin worth one dollar

One stablecoin is supposed to be worth one dollar, and most of the time it is. The interesting question is what is doing the work, because a token on a blockchain isn’t worth a dollar by itself. Something has to hold it there.

The answer depends on how the coin is built, and it also explains why stablecoins have occasionally slipped away from their target. Here’s what keeps the price steady, the main ways to build one, and where the design can fail.

Why a stablecoin exists

Most crypto prices move a lot, which makes them awkward as a steady unit for trading or sending value. A stablecoin tries to solve this by targeting a stable value, usually a currency such as the US dollar. The IMF describes stablecoins as privately issued crypto assets that aim to maintain a stable value, and notes that they act as a bridge between volatile crypto assets and traditional currencies.

The word “aim” matters. A stablecoin is designed to hold its value, and that design can work well or badly depending on what stands behind it.

The reserve and the promise to redeem

The most common design is the fiat-backed stablecoin. According to the Federal Reserve, these are backed by cash and cash-equivalent reserves such as deposits and Treasuries, and most are centralized, meaning one company issues the tokens at a 1:1 ratio with reserves held outside the blockchain.

The second half of the design is redemption. In principle, the issuer will exchange each token for a dollar. In practice, direct redemption with the issuer is typically limited to approved customers, so most people simply buy and sell on markets. Issuers usually publish reserve reports, and these are often attestations, which are not the same as full audits.

How the price stays close to $1

The link between the two is arbitrage. If the token trades below $1 on a market, someone who can redeem with the issuer has an incentive to buy it cheaply and redeem it for a dollar, which pushes the price back up. If it trades above $1, new tokens can be created and sold, which pushes the price down. The Federal Reserve describes this arbitrage incentive as what keeps a stablecoin from drifting far from its peg.

So the peg is held less by the market itself and more by the credible ability to create and redeem. Small deviations still happen day to day, because transaction costs and settlement delays limit how perfectly this works.

Three ways to build one

The Federal Reserve groups stablecoins into three categories. Fiat-backed coins hold reserves as described above. Crypto-collateralized coins are backed by other crypto-assets locked in smart contracts, with at least a dollar’s worth held for each token, and usually more, because the collateral itself can swing in value.

Algorithmic stablecoins hold few or no reserve assets and rely on code that adjusts the supply of tokens. The IMF notes that they typically don’t have dedicated reserve assets. Each design has its own way of failing: reserve and custody problems for fiat-backed coins, collateral drops for crypto-backed ones, and a loss of confidence for algorithmic ones.

When the peg slips

In March 2023, USDC fell to about $0.87 after its issuer disclosed that around $3.3 billion of its reserves were held at Silicon Valley Bank, which had just failed. The reserves existed, but redemption was temporarily blocked, and the price recovered after US authorities guaranteed the bank’s deposits. In May 2022, TerraUSD, an algorithmic stablecoin, collapsed after its supply mechanism broke down, and it never regained its peg.

WEEX Reminder: stable is a goal, not a guarantee

WEEX reminds users that a stablecoin’s price depends on the reserves, collateral, or code behind it, and on how easily it can be redeemed. Before sending one, confirm which network it’s on, since the same stablecoin can exist on several. Be cautious with unfamiliar coins that advertise a steady price together with unusually high returns, and never share a seed phrase or private key. Nothing here is financial advice.

Conclusion

A stablecoin stays near $1 through a mix of reserves or collateral, a promise to redeem, and the arbitrage that this promise makes possible. The three main designs fail in different ways, and history shows that both well-backed and algorithmic coins can slip. Understanding what stands behind a particular coin explains a lot about how stable it can be.

FAQ

1. What is a stablecoin?
A stablecoin is a crypto asset designed to keep a stable value, usually by tracking a currency such as the US dollar. It is typically issued by a private company or protocol.

2. What backs a stablecoin?
It depends on the type. Fiat-backed coins hold cash and cash-equivalent reserves, crypto-collateralized coins lock other crypto-assets in smart contracts, and algorithmic coins hold few or no reserves and rely on code.

3. Can a stablecoin lose its $1 value?
Yes. USDC fell to about $0.87 in March 2023 and later recovered, while TerraUSD collapsed in May 2022 and did not. Both show that a stable target is not a guarantee.

4. Is a stablecoin the same as dollars in a bank account?
No. It’s a token issued by a private party, and its value depends on the reserves behind it and the terms of redemption. It isn’t a bank deposit.

5. Why does the same stablecoin exist on different networks?
Issuers can create their token on more than one blockchain, and each version is separate. See the next article for how TRC20, ERC20, and BEP20 versions differ.