Blog / Crypto
Stablecoins: How They Work and the Risks Traders Overlook
Stablecoins aim to track a currency such as the dollar. Learn the main designs and the real risks: depeg, custody and regulation.
The main types
Fiat-backed stablecoins hold cash and short-term securities in reserve. Crypto-backed ones use over-collateralised crypto. Algorithmic designs rely on code and incentives and have failed more often. Every type tries to hold a 1:1 peg to a currency.
Why risk exists
A peg can slip when users doubt the reserves or when redemptions surge. Issuers can freeze addresses. Banks that hold reserves can fail. A stablecoin is a claim on a company or protocol, not a bank deposit.
Practical steps
Check how reserves are reported and by whom, and diversify across more than one stablecoin if you hold large sums. Do not assume a stablecoin quoted at 1.00 on one exchange is redeemable at that price for every user.
Why traders use them
Stablecoins are the base currency for most crypto trading pairs and for margin on perps. Keep the amount parked in one to what you can tolerate losing temporarily and move profits to a bank when you can.
Examples from history
In 2022 the algorithmic stablecoin UST collapsed from $1 to near zero within days, wiping out billions. In March 2023 USDC briefly traded near $0.88 after its issuer disclosed exposure to a failed bank, then recovered once the funds were secured.
The lesson: even well-backed coins can slip temporarily, and poorly designed ones can fail completely.
How to hold them more safely
Spread large amounts across two or three major issuers, prefer coins that publish regular reserve reports from independent accountants and avoid chasing very high yields on stablecoin deposits, which usually carry hidden risks. Keep an eye on the peg during market stress and know how to exit quickly.
Questions before you hold one
Who is the issuer and where are they regulated? How often are reserves reported and by whom? Can I redeem directly at one dollar, and what are the fees and minimums? How has the coin traded during past market stress? Answers guide how much you should hold.
Key takeaways
- Know what backs the coin.
- Depegs happen in stress.
- Diversify if large.
- It is a claim, not an insured deposit.
Related
Educational content, not financial advice.