Stablecoin Risks
Are Stablecoins Safe?
Despite the name "stable," stablecoins carry multiple risks. Being pegged to $1 is a promise, not a guarantee.
The 2022 Terra/UST collapse evaporated over $40B, and in 2023, USDC temporarily dropped to $0.87. Without understanding stablecoin risks, you can suffer significant losses.
Types of Risks
1. Depegging Risk
The risk of a stablecoin's price deviating from $1.
Causes:
- Large-scale selling pressure
- Reserve issues (insufficient, frozen, etc.)
- Collateral value crash
- Algorithm failure
- Loss of market confidence
Impact:
- DeFi position value decline
- Lending collateral value drop → Liquidation
- LP position losses
- Bank run trigger
2. Regulatory Risk
Account Freezing:
- USDT and USDC issuers can add specific addresses to blacklists
- Funds frozen if suspected of criminal involvement
- Sanctioned addresses frozen
Regulatory Changes:
- Global trend of stricter stablecoin regulations
- US: Stablecoin legislation under discussion
- EU: MiCA regulations in effect
- Korea: Stablecoin regulation discussions ongoing
Issuer Operational Risk:
- Issuer bankruptcy
- License revocation
- Legal disputes
3. Reserve Risk
Lack of Transparency:
- Reserve composition unclear
- Audits insufficient or nonexistent
- Bank account access unavailable
Inadequate Reserves:
- Not 100% cash
- Operated with high-risk assets
- Difficult to liquidate during liquidity crises
USDT Controversy:
- Past: Claimed 100% dollar backing → Found to be false
- Present: Includes corporate loans, bonds, etc.
- Liquidity concerns during large-scale redemptions
4. Smart Contract Risk
Risks for crypto-collateralized stablecoins (DAI, etc.):
- Contract bugs
- Liquidation mechanism failure
- Oracle manipulation
5. Systemic Risk
Risks affecting the entire stablecoin space:
- Chain reaction if a major stablecoin collapses
- Loss of confidence in all of DeFi
- Cascading liquidations
UST/Luna Incident Analysis
What Happened
Terra's UST: Algorithmic stablecoin
- Maintained peg through exchange with LUNA token without collateral
- Guaranteed exchange of 1 UST ↔ $1 worth of LUNA
Anchor Protocol: Offered ~20% APY on UST deposits
May 2022:
- Large-scale UST selling began
- UST price dropped → Arbitrageurs exchanged UST for LUNA
- LUNA supply surged → LUNA price crashed
- LUNA value dropped → UST exchange value dropped
- More UST sold → More LUNA minted
- Death Spiral
- LUNA price crashed 99.99%
- UST permanently lost its peg
Damage:
- $40B+ market cap evaporated
- Countless investors bankrupted
- Suicide incidents occurred
- Founder Do Kwon arrested
Lessons Learned
- Uncollateralized stablecoins are extremely risky
- "Unsustainable yields" are a warning sign (Anchor's 20%)
- The larger the system, the greater the damage when it collapses
- Past stability doesn't guarantee the future
- DYOR (Do Your Own Research)
Hidden Risks of Fiat-Backed Stablecoins
USDT (Tether)
Reserve Composition (2024):
- US Treasury bonds ~80%
- Reverse repo, MMF, cash ~20%
- Corporate loans, other assets (small portion)
Concerns:
- No complete real-time audit
- History of false disclosures
- Liquidity concerns during large-scale redemptions
Scenario: What if all USDT holders simultaneously demand redemption? If some reserves are illiquid assets, immediate redemption may be difficult.
USDC (Circle)
March 2023 SVB Incident:
- Circle had $3.3B deposited at SVB
- SVB bankruptcy announced
- USDC dropped to $0.87
- Recovered after SVB bailout
Lessons:
- "Safe" stablecoins are also exposed to banking risk
- Where reserves are held matters
- Relied on government intervention
Centralized Issuer Powers
- Can freeze specific addresses
- Provide information at regulatory request
- Can change terms of service
Freezing Examples:
- Hack fund freezing
- Sanctioned address freezing
- Tornado Cash-related address freezing
Crypto-Collateralized Stablecoin Risks
DAI's Dilemma
Overcollateralization Limits:
- Requires 150%+ collateral → Capital inefficient
- Cascading liquidations if collateral price crashes
- Vulnerable to black swan events
Dependency on Centralized Collateral:
- Significant portion of DAI collateral is USDC
- If USDC depegs, DAI is affected
- Contradiction in "decentralization" claims
March 2020 Black Swan:
- ETH crashed 50%
- Massive liquidation failures (gas fee spike)
- Some vaults liquidated at $0
- MakerDAO emergency loan for recovery
LUSD (Liquity)
Advantages:
- ETH-only collateral (no centralized assets)
- Immutable contract (not upgradeable)
- No governance → Cannot be attacked
Disadvantages:
- Scale limitations
- Large-scale liquidations if ETH crashes
- Lower liquidity compared to USDC/USDT
Risk Mitigation Strategies
1. Diversification
Diversify across multiple stablecoins:
- USDC 40%
- USDT 30%
- DAI 20%
- LUSD 10%
Even if one has problems, you don't lose everything.
2. Size Limits
Limit stablecoin allocation:
- Only a certain percentage of total portfolio
- Rest in ETH, BTC, etc.
3. Regular Monitoring
Metrics to track:
- Peg status (price)
- Market cap changes (large redemption signals)
- Reserve reports
- Regulatory news
4. Exit Plan
If you see signs of depegging:
- Don't panic sell, understand the cause
- If serious, diversify into other assets
- Check DEX liquidity (slippage)
5. Consider Decentralized Options
If censorship resistance is important:
- LUSD (Liquity)
- RAI (reflexive stablecoin)
- sUSD (Synthetix)
Stablecoin Status Monitoring Tools
- DefiLlama Stablecoins: Market cap, peg status
- Dune Analytics: Stablecoin on-chain data
- CoinGecko/CoinMarketCap: Price tracking
- Issuer websites: Reserve reports
Summary
Stablecoins carry various risks including depegging, regulatory, reserve, and smart contract risks. The Terra/UST collapse demonstrated the fatal vulnerability of algorithmic stablecoins, while USDC's SVB incident showed that even fiat-backed stablecoins are exposed to banking risks. Diversifying across multiple stablecoins, monitoring regularly, and having an exit plan is wise.
Next article: CDP and Collateralized Stablecoins - How DAI is Created