Stablecoins: what actually backs them
A stablecoin is a promise that a token will be worth a dollar. The interesting question is never whether the promise is made — it always is — but who is making it, what stands behind it, and what happens to you specifically if it breaks.
Most people holding stablecoins have never asked. That's understandable: they work almost all of the time, which is exactly the property that makes the rare failures so expensive.
Three ways to make a dollar
Fiat-backed. An issuer holds real dollars and dollar-equivalents — bank deposits, short-term Treasury bills, repurchase agreements — and issues one token per dollar held. USDT and USDC work this way. The peg holds because the issuer will redeem tokens for dollars, so anyone who can buy a token below a dollar and redeem it at par has a reason to do so. The backing is real, and it is entirely off-chain. You are trusting a company and its banks.
Crypto-backed and overcollateralized. Users lock volatile collateral — ETH, say — worth substantially more than the stablecoins they mint against it, and the system liquidates positions automatically when the collateral falls too far. DAI is the best-known example. Everything is on-chain and auditable by anyone. The cost is capital inefficiency and exposure to sharp crashes, where liquidations can fail to clear fast enough.
Algorithmic. No meaningful collateral. The peg is held by a mint-and-burn mechanism against a second, floating token: if the stablecoin trades below a dollar, you can burn it for a dollar's worth of the other token, which is supposed to shrink supply and restore the price.
That third category deserves plain speech. It has been tried repeatedly and it has failed repeatedly. TerraUSD collapsed in May 2022, destroying tens of billions of dollars of value in days. The mechanism has a structural flaw: the thing propping up the stablecoin is a token whose value derives from confidence in the stablecoin. When confidence goes, both legs go at once, and the mint-and-burn machinery accelerates the fall instead of arresting it. A high advertised yield attracts the deposits that make the eventual unwind larger.
"Backed" and "audited" are doing a lot of work
Fiat-backed issuers publish attestations. It is worth understanding what those are, because the word gets used as though it meant audit.
An attestation is an accountant confirming that specified figures matched specified records on a specified date. A full audit is a much broader examination of an entity's financial statements and controls over a period. The former is a snapshot with an agreed scope; the latter is an opinion on the whole picture. Attestations are genuinely informative — a monthly attestation is far better than nothing — but they say nothing about the days in between and nothing about what isn't in scope.
The composition of reserves matters as much as their existence. Cash in a bank account, three-month Treasury bills, commercial paper, and loans to affiliated companies are all "reserves", and they are not remotely the same thing under stress. The question that matters is not "is it backed" but "backed by what, and how fast can it be turned into dollars on a bad day".
Tether has settled with both the New York Attorney General and the CFTC over its historical reserve representations, paying $18.5 million and $41 million respectively in 2021. That is a matter of public record and worth knowing whichever stablecoin you hold — not because it predicts the future, but because it's a reminder that the claim and the reality are separate things that require checking.
The failure that actually happened
In March 2023, USDC lost its peg and traded as low as around 87 cents.
Nothing had gone wrong with the smart contract, the blockchain, or the crypto market. Circle had $3.3 billion of USDC reserves deposited at Silicon Valley Bank, and Silicon Valley Bank failed. The reserves were real; they were simply stuck inside a bank that had just collapsed, over a weekend when nobody knew whether uninsured deposits would be made whole. When US regulators guaranteed the deposits, USDC returned to a dollar within days.
Two lessons survive that episode.
The first is that a fiat-backed stablecoin inherits the risks of the traditional banking system it sits on. That's not a criticism — holding dollars requires holding them somewhere — but it means "fully backed" and "safe" are different claims.
The second is subtler and matters more to anyone who trades. During the depeg, holders who panicked and sold at 87 cents took a permanent 13% loss. Holders who did nothing lost nothing. The peg recovered because the backing was real. Understanding what actually secures your stablecoin is what lets you tell the difference between a liquidity crisis and an insolvency — and that difference is the entire question of whether to sell.
Whose dollar is it, really
Here's the part that matters most to a self-custody audience, and it's the part that sits least comfortably.
The major fiat-backed stablecoins have freeze functions. The issuers of USDT and USDC can blacklist an address, rendering the tokens at that address permanently unmovable. This is not a hidden backdoor — the capability is written into the token contracts, is publicly documented, and has been used many times, often at the request of law enforcement after a hack or a sanctions designation.
Now sit that next to what SSP actually does. Your keys are yours. A 2-of-2 multisig means no single compromised device can move your funds, and no server anywhere can sign on your behalf. That protection is real and it holds against phishing, malware, theft, and coercion of a single key.
It does not hold against the issuer. If Circle or Tether freezes an address, the tokens sitting in your perfectly secured, self-custodied vault stop being spendable, and there is nothing your wallet can do about it. Self-custody of a stablecoin gives you control of the key, not control of the asset.
That's an uncomfortable thing for a wallet company to write down, and it's true, so we write it down. Not your keys, not your coins is a statement about bearer assets — bitcoin, ether, the native coin of a chain. A stablecoin is not a bearer asset. It is a claim on an issuer, represented by a token, and the issuer retains powers over that token that no amount of key management can remove.
This isn't an argument against stablecoins. It's an argument for knowing what you're holding. A dollar-denominated claim on a regulated company is a genuinely useful instrument, with a risk profile that is different from — not worse than, not better than — holding the underlying chain's own coin.
Two risks that are easy to miss
The version you hold may not be the real one. A stablecoin issued natively on a chain is the issuer's own token, redeemable with the issuer. A bridged version is a wrapper: someone locked the real tokens somewhere else and minted a representation here. The wrapper is only as good as the bridge holding the collateral, and bridges are where the largest crypto hacks keep happening. The two versions often have near-identical names and tickers. Check which one you're actually receiving, especially on smaller chains and especially when a bridge is involved in getting it there.
Redemption is usually not available to you. The peg is enforced by arbitrage, but the arbitrageurs are institutions with direct issuer relationships, minimum redemption sizes, and completed KYC. As an individual, your exit is almost always a secondary market — an exchange or a DEX — at whatever price that market offers. In calm conditions the difference is invisible. In a crisis, the market price is the only price you have access to, and that is precisely when it diverges most.
What to actually check
Before holding a meaningful amount of any stablecoin:
Who issues it, and under what supervision? A regulated issuer in a known jurisdiction is a different proposition from an offshore entity, and the EU's MiCA regime has made this distinction sharper by imposing reserve and redemption requirements on stablecoins offered in Europe.
What are the reserves, in detail? Not "fully backed" — the actual composition. Short-dated government paper behaves very differently from anything else in a panic.
Attestation or audit, and how often? Monthly attestation by a recognised firm is a reasonable standard. Vague assurances with no third party involved are not.
Can it be frozen, and has it been? For the major fiat-backed coins the answer is yes and yes. Know it before it matters to you.
Native or bridged on the chain you're using? Verify the contract address against the issuer's own documentation, not against a link someone sent you.
Is a high yield attached? Stablecoin yield comes from lending your tokens to someone. That is a credit risk stacked on top of the issuer risk, and it is the mechanism by which most stablecoin losses have actually happened. The yield is the compensation for a risk, not a free feature.
The honest summary
Fiat-backed stablecoins are IOUs from companies, and they work well as long as the company is solvent, its banks are solvent, and it doesn't freeze you. Overcollateralized crypto-backed stablecoins are transparent and verifiable, at the cost of efficiency and with real liquidation risk in a crash — and several of them now hold significant fiat-backed stablecoins as collateral, which quietly reintroduces the issuer risk they were designed to avoid. Algorithmic stablecoins without collateral have a track record you should take seriously.
None of that makes stablecoins a bad tool. It makes them a specific tool, with counterparties, and worth roughly ten minutes of due diligence before you keep serious money in one. The tokens in your wallet are not dollars. They are a promise about dollars, and it's worth knowing who made it.
