Stablecoins Explained: The Cryptocurrency That Promises Not to Crash (Narrator: Some Did Anyway)

Description: Understand stablecoins and digital currencies—what they are, how they work, and why some collapsed spectacularly. Learn the difference between stablecoins, CBDCs, and regular crypto.

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Let me tell you about the moment I understood stablecoins were neither particularly stable nor simple coins.

I was trying to understand why crypto people were obsessed with Tether (USDT). "It's always worth $1," they said. "It's backed by real dollars," they claimed. "It's the safe harbor when crypto markets crash," they insisted.

So I dug deeper and discovered: Maybe it's backed by dollars? Or maybe commercial paper? Or maybe... nobody actually knows for sure because audits are vague and transparency is optional? And occasionally it trades at $0.96 or $1.04, which doesn't seem very "stable" for something pegged to a dollar. And the company behind it has been investigated multiple times by regulators who aren't convinced everything's above board.

Suddenly "stablecoin" seemed like marketing genius—taking the two concepts people want most in crypto (stability and legitimacy) and declaring you've achieved both regardless of whether you actually have.

What are stablecoins should have a simple answer: cryptocurrencies designed to maintain stable value, usually pegged to a dollar. But the how they maintain that value ranges from "reasonably legitimate" to "elaborate house of cards that eventually collapsed" (looking at you, Terra/Luna).

Stablecoins explained requires understanding collateralization, algorithmic mechanisms, centralized issuers, and why something can be simultaneously brilliant financial innovation and ticking time bomb depending on who built it and how honest they're being about the backing.

Digital currencies is broader—includes stablecoins, cryptocurrencies like Bitcoin, and government-issued digital currencies (CBDCs) that don't exist yet but everyone's planning. Each has different purposes, risks, and levels of "this will definitely work" vs. "this might spectacularly explode."

So let me walk you through stablecoin types, how they supposedly work, which ones have already failed catastrophically, and what central bank digital currencies might mean for the future.

Because stablecoins are either the most important crypto innovation or the most dangerous depending on whether they're actually backed by what they claim.

Let's find out which is which.

What Stablecoins Are (And Why They Exist)

Stablecoin definition and purpose:

The Problem They Solve

Cryptocurrency volatility: Bitcoin can gain or lose 20% in a day. Can't price goods in something that unstable.

Need for stability: To use crypto for transactions, payments, or storing value, need predictable pricing.

Fiat on-ramps are slow: Converting crypto to dollars and back is time-consuming and expensive.

Trading pairs: Crypto traders need stable assets to move between volatile cryptos without converting to fiat.

The Solution (In Theory)

Stablecoins: Cryptocurrencies pegged to stable assets (usually US dollar) to maintain consistent value.

The promise: Crypto's speed and borderlessness combined with fiat currency's stability.

The ideal: 1 stablecoin = 1 USD, always and forever.

The reality: Sometimes 1 stablecoin = $1.04, sometimes $0.96, and occasionally $0.00 (when they collapse).

Main Use Cases

Crypto trading: Move between cryptos without converting to fiat.

DeFi (Decentralized Finance): Lending, borrowing, yield farming using stable assets.

Payments: Sending value across borders quickly and cheaply (in theory).

Savings: Holding crypto value without volatility (dubious claim given collapse risks).

Remittances: International money transfers bypassing traditional banking (growing use case).

Types of Stablecoins

Stablecoin types explained:

1. Fiat-Collateralized (Most Common)

How they work: Backed 1:1 by fiat currency (supposedly) held in bank accounts or reserves.

Mechanism:

• Company holds $1 in bank for every stablecoin issued
• Users can (theoretically) redeem stablecoins for dollars
• Peg maintained through this redemption mechanism

Examples: Tether (USDT), USD Coin (USDC), Binance USD (BUSD), TrueUSD (TUSD)

Advantages: Simple to understand, should be stable if actually backed.

Risks: Requires trusting issuer actually has reserves, transparent auditing, and won't freeze your assets.

The catch: "Backed by dollars" can mean actual dollars, or treasury bills, or commercial paper, or... who knows? Transparency varies wildly.

2. Crypto-Collateralized

How they work: Backed by other cryptocurrencies, usually over-collateralized to account for crypto volatility.

Mechanism:

• Lock up $150 worth of Ethereum to mint $100 stablecoin
• Extra collateral absorbs crypto price fluctuations
• If collateral value drops too much, position liquidates

Example: DAI (backed by Ethereum and other crypto assets)

Advantages: Decentralized (no company controlling it), transparent (all on blockchain).

Disadvantages: Complex, capital inefficient (need $1.50 to create $1 stablecoin), vulnerable to crypto crashes.

Market crash risk: If backing crypto crashes hard enough, the stablecoin can lose peg.

3. Algorithmic (The Experimental, Often Disastrous Type)

How they supposedly work: No backing at all. Algorithms adjust supply to maintain price.

Mechanism:

• Price above $1: Algorithm creates new stablecoins to increase supply, lowering price
• Price below $1: Algorithm reduces supply or incentivizes burning coins to raise price
• Relies on market participants responding to incentives

Examples: Terra/Luna (collapsed May 2022, $40 billion evaporated), Basis Cash (shut down), Empty Set Dollar (failed)

The theory: Mathematical elegance. No collateral needed. Pure code.

The reality: All major algorithmic stablecoins have failed. Turns out you can't create stability from nothing through clever math when market loses confidence.

Death spiral: Price drops slightly → people panic → sell stablecoins → price drops more → more panic → complete collapse.

4. Commodity-Backed

How they work: Backed by physical assets like gold.

Examples: Paxos Gold (PAXG), Tether Gold (XAUT)

Mechanism: Each coin represents ownership of specific amount of gold stored in vault.

Advantages: Backed by tangible asset with intrinsic value.

Disadvantages: Storage costs, trust in custodian, not as stable as dollar-pegged (gold price fluctuates).

Use case: Digital gold ownership more than true "stablecoin."

The Major Stablecoins (Detailed)

Popular stablecoins breakdown:

Tether (USDT) - The Controversial Giant

Market cap: ~$110 billion (largest stablecoin)

Pegged to: US Dollar

Backing: Claims to be backed 1:1 by reserves (dollars, treasury bills, commercial paper)

The controversy:

• Lack of transparent auditing (attestations, not full audits)
• History of changing reserve composition without clear communication
• Regulatory investigations and settlements
• Banned in New York (settled with NY Attorney General)
• Questions about whether reserves actually exist in full

Why people use it anyway:

• Most liquid stablecoin
• Widely accepted on all exchanges
• Network effects (everyone uses it because everyone uses it)

The risk: If Tether collapsed, entire crypto market could crash (it's foundational infrastructure).

USD Coin (USDC) - The "Safer" Alternative

Market cap: ~$35 billion (second largest)

Issued by: Circle (with Coinbase partnership)

Backing: US dollars and short-term US treasuries

Transparency: Monthly attestation reports by Grant Thornton (accounting firm)

Regulation: Circle is regulated money transmitter in US

Advantages:

• Better transparency than Tether
• Regulatory compliance
• Generally trusted by institutions

The catch: March 2023 briefly de-pegged when Silicon Valley Bank (holding some reserves) collapsed. Shows even "safe" stablecoins have risks.

Why it's popular: Viewed as more legitimate and transparent than Tether.

DAI - The Decentralized Option

Market cap: ~$5 billion

Type: Crypto-collateralized

Issued by: MakerDAO (decentralized organization)

Backing: Ethereum and other cryptocurrencies (over-collateralized)

Advantages:

• Decentralized (no company can shut it down)
• Transparent (everything on blockchain)
• Doesn't require trusting centralized entity

Disadvantages:

• Complex mechanics
• Vulnerable to crypto market crashes
• Less liquid than USDT/USDC
• Has incorporated some centralized collateral (USDC) reducing pure decentralization

Appeal: For crypto purists who don't want to trust centralized stablecoin issuers.

Binance USD (BUSD) - The Exchange-Backed Option

Market cap: Varies (was ~$16 billion, declining after regulatory pressure)

Issued by: Paxos, branded as Binance

Status: New issuance stopped February 2023 after SEC/NYDFS pressure

What happened: Regulators weren't happy with Paxos issuing BUSD, ordered them to stop.

Current state: Existing BUSD still circulating but no new issuance. Slowly being phased out.

Lesson: Even regulated stablecoins face regulatory uncertainty.

The Terra/Luna Collapse (The Cautionary Tale)

Terra USD (UST) failure explained:

What It Was

Terra (LUNA): Cryptocurrency.

TerraUSD (UST): Algorithmic stablecoin supposedly pegged to $1.

The mechanism:

• 1 UST could always be swapped for $1 worth of LUNA
• This arbitrage was supposed to maintain UST at $1
• Price above $1: People create UST by burning LUNA (profitable), increasing UST supply, lowering price
• Price below $1: People burn UST to create LUNA (profitable), decreasing UST supply, raising price

Market cap at peak: ~$18 billion UST, LUNA at $40 billion

What Went Wrong (May 2022)

The trigger: Large UST sales caused price to drop below $1.

The death spiral:

1. UST drops to $0.98
2. People panic, try to redeem UST for LUNA
3. Massive LUNA minting to satisfy redemptions
4. LUNA supply explodes, price crashes from $80 to $0.0001
5. UST completely loses peg, drops to $0.10
6. Both coins effectively worthless

Total value destroyed: ~$60 billion

Victims: Millions of people lost savings. Some lost everything.

The fundamental flaw: System only worked if people believed it worked. Once confidence broke, nothing could stop the collapse.

The Aftermath

Do Kwon (founder): Arrested in Montenegro March 2023, facing fraud charges.

Lawsuits: Ongoing against Terraform Labs and Do Kwon.

Lesson: Algorithmic stablecoins without collateral are fundamentally unstable. Math can't create value from nothing.

Regulatory response: Increased scrutiny on all stablecoins.

Central Bank Digital Currencies (CBDCs)

Government digital currencies explained:

What CBDCs Are

Digital version of national currency: Issued and backed by central banks (like digital dollars from Federal Reserve).

Not cryptocurrency: Centralized, controlled by government, not blockchain-based necessarily.

Two types:

• Retail CBDCs: For public use (digital dollars in your digital wallet)
• Wholesale CBDCs: For banks and financial institutions

Why Governments Are Interested

Financial inclusion: Bank the unbanked with digital infrastructure.

Payment efficiency: Faster, cheaper domestic and international payments.

Monetary policy: More direct tools for implementing policy.

Combat crypto: Offer government-backed digital alternative to private cryptocurrencies.

Reduce cash costs: Printing, securing, and processing physical money is expensive.

Counter China: China's digital yuan is already testing; other nations don't want to fall behind.

Current Status Globally

China: Digital yuan already in trials, most advanced CBDC program.

European Union: Digital euro under development, expected mid-2020s.

United States: Federal Reserve researching, no definite timeline. Political opposition exists.

Bahamas: Sand Dollar already launched (first CBDC).

Jamaica, Nigeria: Have launched CBDCs with limited adoption so far.

The Concerns

Privacy: Government tracking every transaction.

Control: Government could program money (expiration dates, spending restrictions).

Banking system disruption: If everyone banks directly with central bank, what happens to commercial banks?

Cybersecurity: Massive hack target.

Freedom: Government could freeze accounts without court order.

CBDC vs. Stablecoins

CBDCs: Government-issued, backed by nation's full faith and credit, regulatory clarity.

Stablecoins: Private company-issued, backing varies, regulatory uncertainty.

Coexistence possible: CBDCs might not eliminate stablecoins, just compete with them.

Risks of Stablecoins

Stablecoin dangers:

Depegging Risk

What it means: Losing the $1 peg, even temporarily.

Causes: Bank run, loss of confidence, backing asset problems, algorithmic failure.

Examples: USDC briefly at $0.88 during SVB collapse, UST complete loss of peg.

Impact: If you're holding when depeg happens, instant losses.

Lack of Transparency

The problem: Many stablecoins don't provide real-time proof of reserves.

Tether particularly: Attestations, not audits. Limited detail on reserve composition.

Why it matters: Can't verify claims of full backing.

Regulatory push: Demanding better transparency and regular audits.

Counterparty Risk

Trusting the issuer: If company collapses or is fraudulent, your stablecoins could be worthless.

Freezing assets: Centralized stablecoins can freeze your holdings (has happened).

Regulatory action: Government can force stablecoin issuer to shut down (happened with BUSD).

Regulatory Uncertainty

Unclear legal status: Are they securities? Commodities? Money transmitters?

Changing rules: What's allowed today might be banned tomorrow.

Jurisdiction variation: Legal in some countries, banned in others.

Systemic Risk

Too big to fail: If Tether collapsed, could trigger crypto market crash affecting traditional markets.

Interconnection: Stablecoins are foundational to DeFi, exchanges, and crypto ecosystem.

Contagion: One stablecoin failure could trigger runs on others.

Use Cases and Practical Applications

What stablecoins are actually used for:

Crypto Trading

Primary use: Moving between cryptocurrencies without converting to fiat.

Why: Faster and cheaper than bank transfers.

Trading pairs: Most crypto exchanges use USDT or USDC trading pairs.

DeFi Applications

Lending/borrowing: Supply stablecoins to earn interest or borrow against crypto collateral.

Yield farming: Complex strategies to earn returns on stablecoin deposits.

Liquidity providing: Supplying stablecoins to decentralized exchanges.

International Remittances

Growing use: Sending money across borders using stablecoins.

Advantages: Faster and cheaper than Western Union or bank wires.

Challenges: Converting to local currency at destination, regulatory compliance.

Payments

Merchant acceptance: Some businesses accept USDC or USDT for payments.

Cross-border commerce: Avoid currency conversion fees and delays.

Current reality: Still niche. Most people use credit cards or traditional payments.

Store of Value (Questionable)

The claim: Hold wealth in stablecoins to avoid crypto volatility.

The reality: Depegging risk, counterparty risk, no FDIC insurance.

Better alternative: Actual savings account (boring but safer).

The Bottom Line

Understanding stablecoins and digital currencies requires recognizing:

Stablecoins are not actually stable: They're designed to be stable, but can and have failed.

Types matter: Fiat-backed (relatively safe if transparent), crypto-backed (complex but decentralized), algorithmic (repeatedly failed).

Major players: Tether (largest but controversial), USDC (more transparent), DAI (decentralized).

Use cases: Crypto trading, DeFi, remittances, not really consumer payments (yet).

Risks: Depegging, lack of transparency, regulatory uncertainty, counterparty risk.

CBDCs coming: Governments developing digital currencies that may compete with or replace private stablecoins.

Not for storing serious savings: Unless you fully understand risks and can afford total loss.

Ready to use stablecoins? Stick with most transparent options (USDC, USDT despite concerns). Understand you're taking on risk. Don't hold more than you can afford to lose.

Or just use dollars. Boring, but they actually maintain value.

Stablecoins are fascinating financial innovation.

They're also unregulated, sometimes fraudulent, occasionally collapsing experiments.

Knowing which stablecoin is which makes all the difference.

Now you know.

Use that knowledge wisely.

And maybe don't put your life savings in algorithmic stablecoins.

That's just common sense.

Which, ironically, isn't common in crypto.

Consider yourself warned.