Why a stablecoin might not be as stable as you think
Stablecoins were created to reduce the price swings associated with cryptocurrencies. A token designed to track the US dollar can make it easier to move funds between exchanges, settle trades, or hold digital cash without leaving the blockchain. That design sounds straightforward, but the promise of stability depends on reserves, redemption access, market liquidity, governance, and the technology supporting the token.
A stablecoin can therefore lose stability in several ways. Its market price may fall below one dollar, withdrawals may become difficult, collateral may lose value, or users may discover that the issuer’s backing is less transparent than expected. Even a temporary deviation can create serious losses when leverage, automated trading, or forced liquidations are involved.
Understanding these risks is part of responsible participation in digital-asset markets. Granimator’s frequently asked questions provide useful background for readers who are still learning how financial technology and trading platforms work.
What stability actually means
The word stable usually refers to a token’s target price, not a guarantee that its value will never move. A fiat-backed coin may aim to maintain a one-to-one relationship with the dollar, while a crypto-collateralized coin may rely on excess collateral and liquidation rules. An algorithmic stablecoin may use supply adjustments or incentives instead of traditional reserves.
These models carry different risks. A reserve-backed token depends on the quality and accessibility of its assets. A crypto-backed token is exposed to market crashes and software design. An algorithmic system depends heavily on confidence: if users rush to redeem their holdings, the mechanism may not have enough real value to support the peg.
Liquidity is another important distinction. A coin can be fully backed in theory yet trade below its target if holders cannot redeem quickly or if exchanges lack buyers. Stability should therefore be assessed across price, reserves, redemption, liquidity, and operational reliability.
TerraUSD and the danger of reflexive design
TerraUSD, commonly known as UST, became one of the clearest examples of how an algorithmic peg can fail. It was designed to maintain a dollar value through a relationship with the LUNA token, allowing users to exchange UST and LUNA according to a programmed mechanism. The system did not rely on a conventional reserve of dollars or short-term government securities.
When confidence weakened in May 2022, UST holders began selling and redeeming. The mechanism issued large amounts of LUNA in an attempt to restore the peg, but that expansion reduced LUNA’s value and made the system appear even less capable of supporting UST. This feedback loop became a classic “death spiral,” with falling confidence leading to more selling and further dilution.
The case shows why a stablecoin’s stability mechanism must be tested under extreme conditions. A design can work during calm markets and still fail when everyone seeks the exit at once. High yields and rapid adoption may attract users, but they do not replace durable collateral or credible liquidity.
USDC and the banking connection
USD Coin, or USDC, experienced a sharp temporary depeg in March 2023 after Circle disclosed that part of its reserves was held at Silicon Valley Bank. The bank’s failure created uncertainty about how much of those funds could be recovered. USDC traded well below one dollar on some markets as users rushed to exchange it for other assets.
The token later recovered after regulators indicated that depositors would have access to their funds. This episode was different from TerraUSD: USDC was intended to be backed by traditional assets, yet it was still exposed to banking, settlement, and confidence risks. The problem was not necessarily a permanent shortage of reserves; it was uncertainty about access to those reserves at a critical moment.
This case highlights the importance of examining where collateral is held and how quickly it can be converted into cash. A stablecoin may inherit the risks of the financial institutions, custodians, payment networks, and jurisdictions connected to its reserve portfolio.
Tether, liquidity, and disclosure questions
Tether’s USDT has generally maintained substantial market use and has recovered from previous periods of trading below its target. However, its history has also raised questions about reserve composition, disclosure, and the liquidity of the assets supporting the token. When a stablecoin becomes a major source of market liquidity, even small doubts can produce large redemption demands.
Reserve quality matters because assets are not equally dependable in a crisis. Cash and short-term Treasury instruments are usually easier to value and liquidate than loans, commercial paper, or less transparent investments. The timing and frequency of attestations also matter, since a report is a snapshot rather than a continuous guarantee.
Stablecoin markets resemble other financial markets in this respect. Understanding market maker roles can clarify why quoted prices, order-book depth, and available counterparties affect a token’s ability to stay near its intended value. A thin market can amplify even modest selling pressure.
Comparing the main failure patterns
The following examples show that “depeg” is not a single event with one cause. Some failures begin with inadequate collateral, while others result from a bank problem, a technology fault, or a sudden loss of market confidence.
| Stablecoin or model | Main stability mechanism | Stress event | Key lesson |
|---|---|---|---|
| TerraUSD | Algorithmic exchange with LUNA | Confidence collapse in 2022 | A self-referential system can amplify selling |
| USDC | Fiat and cash-equivalent reserves | Silicon Valley Bank failure in 2023 | Reserve access and banking exposure matter |
| Tether USDT | Asset-backed reserve model | Repeated periods of market pressure | Transparency and liquidity influence confidence |
| DAI | Crypto collateral and liquidation rules | “Black Thursday” in 2020 | Blockchain congestion can disrupt liquidations |
| Iron Finance TITAN | Algorithmic and partially collateralized design | Bank run in 2021 | Incentives cannot guarantee lasting value |
DAI’s Black Thursday episode demonstrated that even a collateralized stablecoin can face trouble when blockchain congestion, falling collateral prices, and liquidation problems occur together. Users may be solvent according to normal conditions but unable to act before positions are liquidated or undercollateralized.
Iron Finance’s collapse showed another weakness: a token can appear stable while its supporting incentives remain fragile. Once holders lose confidence, redemption mechanics may accelerate the decline rather than stop it. These examples make clear that technical architecture and user behavior are closely connected.
How to assess a stablecoin before using it
Start by identifying the type of backing. Ask whether the token is supported by bank deposits, Treasury bills, cryptocurrencies, protocol reserves, or an algorithm. Then examine the issuer’s reporting practices, reserve attestations, redemption policy, geographic restrictions, and history during previous market shocks.
It is also useful to check the token’s actual trading conditions. Review volume across several venues, the size of buy and sell orders, the difference between quoted prices, and whether withdrawals or redemptions have recently been delayed. A one-dollar price on one exchange does not prove that every holder can convert the token at that rate.
Finally, consider counterparty and platform risk. An exchange may suspend withdrawals, a smart contract may contain an exploit, or a custodian may become unavailable. Reading the relevant platform terms can help clarify account responsibilities, restrictions, and the limits of any service connected to digital-asset activity.
Practical safeguards for traders and investors
No stablecoin assessment can remove risk, but a disciplined process can reduce avoidable exposure. Useful safeguards include:
- Avoid treating a stablecoin balance as identical to insured bank cash.
- Spread operational exposure across reputable venues instead of relying on one exchange.
- Review reserve disclosures, redemption rules, and historical depeg events.
- Keep position sizes appropriate for the possibility of delayed withdrawals or price gaps.
- Do not borrow heavily against a token merely because its target price appears stable.
Diversification should include more than holding several tokens with similar reserve structures. If multiple coins depend on the same banking partners, custodians, market makers, or blockchain network, they may weaken at the same time. Holding a smaller amount and maintaining access to traditional cash can be more meaningful than choosing a larger number of correlated tokens.
Risk controls should also account for speed. In a fast-moving market, a planned exit may be impossible at the expected price. Limit orders, lower leverage, independent research, and a clear loss threshold are practical tools for avoiding decisions driven by panic.
A stablecoin can be useful for payments, settlement, and portfolio management, but its label describes an objective rather than a promise. Before using one, investigate its reserves, redemption process, liquidity, technology, and history under stress. Continue building that knowledge through reliable educational material and evaluate every digital-asset decision according to your own risk capacity.