Types of Stablecoins
What is a Stablecoin
A stablecoin is a cryptocurrency with its price pegged to a specific asset (usually the US dollar). It's designed to maintain 1 USDC = 1 USD.
It allows you to avoid cryptocurrency's high volatility while enjoying blockchain's benefits (fast transfers, 24/7 operation, global access). In DeFi, it serves as the reserve currency, forming the foundation for trading pairs, lending, and yield farming.
Three Types of Stablecoins
1. Fiat-Backed
Real dollars deposited in banks, with equivalent tokens issued
Representatives: USDT, USDC, BUSD, TUSD
How it works:
- Issuer receives $1 → Issues 1 stablecoin
- User redeems 1 stablecoin → Issuer pays $1
- Reserves back the issuance
Advantages:
- Simplest and most intuitive
- High price stability
- Large-scale liquidity
Disadvantages:
- Centralized (requires trust in issuer)
- Regulatory risk (accounts can be frozen)
- Reserve transparency issues
2. Crypto-Backed
Stablecoins issued by depositing cryptocurrency as collateral
Representatives: DAI, LUSD, sUSD
How it works:
- User deposits ETH or other collateral
- Issues stablecoins worth a portion of collateral value (overcollateralized)
- Liquidation if collateral value drops
Advantages:
- Decentralized
- Transparent (on-chain verifiable)
- Censorship resistant
Disadvantages:
- Requires overcollateralization (capital inefficient)
- Liquidation risk when collateral price fluctuates
- Scalability limited (requires collateral demand)
3. Algorithmic
Maintains price by adjusting supply through algorithms without collateral
Representatives: (Failed) UST, (Reduced) FRAX
How it works:
- Price > $1: Increase supply (minting)
- Price < $1: Decrease supply (burning)
- Exchange mechanism with seigniorage token
Advantages:
- No collateral needed (capital efficient)
- Can be fully decentralized
Disadvantages:
- Death spiral risk (Terra/UST incident)
- Trust-based (no collateral backing)
- Collapses in extreme situations
Warning: Most purely algorithmic stablecoins have failed. Terra/UST's $40B collapse is a prime example.
Major Stablecoin Comparison
USDT (Tether)
Market Cap: ~$110B (2024, #1)
Features:
- Oldest and largest stablecoin
- Supported by most exchanges/chains
- Reserve controversy (past claims of 100% dollar backing were false)
- Issued by Tether Limited (Hong Kong/US)
Reserve Composition:
- Cash and cash equivalents ~85%
- Corporate loans, bonds, etc. ~15%
USDC (Circle)
Market Cap: ~$30B
Features:
- Regulatory compliant, US-based
- Monthly audit reports published
- Can be censored due to regulatory compliance
- Partnership with Coinbase
Reserve Composition:
- US Treasury and cash 100%
DAI (MakerDAO)
Market Cap: ~$5B
Features:
- Decentralized crypto-collateralized stablecoin
- Accepts various collateral (ETH, WBTC, USDC, etc.)
- Governed by MKR token
- Oldest decentralized stablecoin
Collateral:
- Overcollateralized (150%+ collateral ratio)
- Some centralized collateral (USDC) included → Controversial
Comparison Table
| Stablecoin | Type | Decentralized | Censorship Resistant | Capital Efficient |
|---|---|---|---|---|
| USDT | Fiat-backed | No | No | Yes |
| USDC | Fiat-backed | No | No | Yes |
| DAI | Crypto-backed | Partial | Partial | No |
| LUSD | Crypto-backed (ETH only) | Yes | Yes | No |
| FRAX | Hybrid | Partial | Partial | Partial |
Depegging
What is Depegging
When a stablecoin's price deviates from its target price ($1).
- Premium: Trading above $1 (demand > supply)
- Discount: Trading below $1 (supply > demand or loss of confidence)
Depegging Examples
USDC (March 2023):
- Silicon Valley Bank (SVB) bankruptcy
- Circle disclosed $3.3B in USDC reserves were at SVB
- USDC temporarily dropped to $0.87
- Peg recovered after SVB bailout
UST (May 2022):
- Large-scale selling pressure
- Algorithm mechanism failed
- LUNA hyperinflation
- UST crashed below $0.10
- $40B+ evaporated, unrecoverable
Responding to Depegging
Minor depegging (2~5%):
- Likely temporary
- Avoid panic selling
- Understand the cause
Severe depegging (10%+):
- Possible structural issues
- Consider diversifying to other stablecoins
- Review DeFi position risks
Major Stablecoins by Chain
| Chain | Major Stablecoins |
|---|---|
| Ethereum | USDT, USDC, DAI |
| Arbitrum | USDC, USDT, DAI |
| Polygon | USDC, USDT, DAI |
| Solana | USDC, USDT |
| BNB Chain | USDT, BUSD (reduced), USDC |
| Avalanche | USDC, USDT |
The same stablecoin is a different version on each chain. Ethereum's USDC and Solana's USDC are separate tokens, but they exchange 1:1 through official bridges.
Stablecoin Selection Guide
Prioritizing Liquidity
USDT - Most exchanges, deepest liquidity
Prioritizing Regulatory Compliance/Transparency
USDC - Monthly audits, US regulatory compliance
Prioritizing Decentralization
DAI or LUSD - On-chain collateral, smart contract-based
Needing Censorship Resistance
LUSD - ETH-only collateral, immutable contract
Recommended Diversification
Don't concentrate in one stablecoin, diversify holdings:
- 50% USDC (stability)
- 30% USDT (liquidity)
- 20% DAI (decentralization)
Summary
Stablecoins come in three types: fiat-backed (USDT, USDC), crypto-backed (DAI, LUSD), and algorithmic (mostly failed). USDT is the largest with highest liquidity but has transparency concerns, USDC is regulatory compliant but can be censored, and DAI is decentralized but requires overcollateralization. Be aware of depegging risks and diversify across multiple stablecoins for safety.
Next article: Stablecoin Risks - Hidden Dangers of 'Stable' Assets