Stablecoin

What Is a Stablecoin?

A stablecoin is a cryptocurrency designed to maintain a stable value relative to a reference asset, almost always the US dollar at a 1:1 ratio. They are the plumbing of the crypto financial system: the primary medium of exchange between crypto assets, the unit of account for DeFi protocols, the settlement layer for global crypto trading, and an increasingly important force in dollar globalisation and US Treasury demand.

The total stablecoin market cap exceeds $200 billion (2024-2025), making stablecoins collectively the third-largest "cryptocurrency" after Bitcoin and Ethereum. More importantly, stablecoin daily settlement volume exceeds $50-100 billion, approaching Visa's daily payment volume and far exceeding PayPal's.

The Stablecoin Landscape

How Stablecoins Maintain Their Peg

Fiat-Backed (Centralised)

Mechanism: Issuer holds $1 of reserve assets (Treasuries, cash, bank deposits) for every 1 stablecoin in circulation. Users can redeem 1 stablecoin for $1 of reserves.

Peg maintenance: If USDT trades at $0.99 on exchanges, arbitrageurs buy USDT at $0.99 and redeem it from Tether for $1.00, earning $0.01 per coin, pushing the price back to $1.00. If USDT trades at $1.01, arbitrageurs mint new USDT from Tether at $1.00 and sell on exchanges at $1.01.

Risk: Reserve adequacy. If the reserves are insufficient (as critics have alleged about Tether's early years) or if reserves are in illiquid or depreciating assets, redemptions may not be honored at par.

Crypto-Backed (Decentralised)

Mechanism: Users lock crypto collateral (e.g., ETH worth $150) in a smart contract to mint $100 of stablecoins. The 150% over-collateralization provides a buffer against crypto price declines.

Peg maintenance: If the collateral value falls below the minimum ratio (e.g., 150%), the position is automatically liquidated, the smart contract sells the crypto and repays the stablecoin debt. This ensures there are always more assets backing the stablecoins than stablecoins outstanding.

Risk: In a flash crash, collateral can fall below the minimum before liquidation bots can execute, leaving the protocol undercollateralized. This nearly occurred during the March 2020 "Black Thursday" crash when Ethereum fell 50% in hours.

Algorithmic (Undercollateralised)

Mechanism: Maintains the peg through an algorithmic relationship between the stablecoin and a companion token. No (or insufficient) reserves back the stablecoin directly.

Risk: Catastrophic. If confidence in the mechanism breaks, a death spiral occurs: the stablecoin de-pegs → holders rush to redeem → the companion token must absorb enormous selling pressure → companion token crashes → further loss of confidence → accelerating spiral. This is exactly what destroyed TerraUSD/LUNA in May 2022.

The Terra/UST Collapse: A Case Study in Systemic Failure

Timeline of Destruction

The Contagion Chain

The UST collapse triggered a cascade of failures that defined the 2022 crypto winter:

1. Three Arrows Capital (3AC): $10B+ hedge fund with massive LUNA/UST exposure → bankrupt June 2022
2. Celsius Network: Crypto lending platform with 3AC exposure → froze withdrawals June 2022 → bankrupt July 2022
3. Voyager Digital: Crypto broker with 3AC loans → bankrupt July 2022
4. BlockFi: Crypto lender with 3AC/FTX exposure → bankrupt November 2022
5. FTX: Used Alameda Research (which had Terra exposure) as its trading arm → revealed as insolvent November 2022

Total estimated losses from the UST-initiated contagion: $200+ billion in market cap destruction across the crypto ecosystem.

Stablecoins and the US Dollar: The Macro Impact

Dollar Globalisation

Stablecoins have become the primary mechanism for global dollar access outside the traditional banking system:

• In Nigeria, Argentina, Turkey, and other countries with capital controls or unstable currencies, USDT is the most reliable way to hold dollar purchasing power
• Remittance workers use USDT/USDC to send dollars home at a fraction of traditional wire transfer costs
• International trade settlement (especially in Asia and Africa) increasingly uses stablecoins as a faster, cheaper alternative to SWIFT

The Treasury Demand Channel

Stablecoin issuers have become major buyers of US government debt:

This demand is structural and price-insensitive: stablecoin issuers must hold reserves regardless of yield levels. As stablecoin adoption grows, the Treasury demand from this channel will grow proportionally, potentially providing a durable source of T-bill demand that partly offsets the fiscal deficit challenge.

Monetary Policy Implications

Stablecoins create dollar-denominated purchasing power that operates outside the Federal Reserve's direct control. When Tether mints $1 billion in new USDT, it creates the functional equivalent of $1 billion in new dollar deposits, without any bank, any reserve requirement, or any Fed oversight. This represents a novel form of "monetary policy leakage" that central bankers are only beginning to grapple with.

Stablecoin Supply as a Crypto Market Indicator

The Liquidity Signal

Total stablecoin supply is one of the most reliable macro indicators for crypto markets:

Historical Correlation

The correlation is not perfect (stablecoin supply can grow during bear markets as traders park funds in stables), but the directional signal is strong over 6-12 month horizons.

The Regulatory Future

US Stablecoin Legislation

Congress has been developing stablecoin-specific legislation since 2022, with key provisions likely to include:

1. Reserve requirements: Full backing in Treasuries, cash, or cash equivalents
2. Audit requirements: Regular, comprehensive audits (not just attestations) by regulated accounting firms
3. Issuer registration: Federal or state banking charter or money transmitter license
4. Redemption guarantees: Right of holders to redeem at par within specified timeframes

Implications for the Market

Regulation would likely: consolidate the market toward larger, regulated issuers (USDC, PYUSD would benefit; Tether would face pressure), increase institutional comfort with stablecoins (enabling broader adoption), and formalize the Treasury demand channel (potentially hundreds of billions in mandated T-bill holdings).

What to Watch