Stablecoins Demystified: Fiat-Backed, Crypto-Backed, and Algorithmic

The dollar of crypto

A stablecoin is a token designed to hold a steady value, almost always one US dollar. They are the settlement layer of crypto: traders park in them between positions, DeFi protocols price loans in them, and workers use them to move money across borders. But not all stablecoins keep their peg the same way.

Fiat-backed

The simplest model: for every token in circulation, the issuer claims to hold a real dollar (or a T-bill) in a bank. USDC and USDT dominate here. The peg holds because you trust the issuer to actually have the reserves and to honor redemptions.

reserve_attestation:
  tokens_outstanding: 32,100,000,000
  cash_and_equivalents: 32,140,000,000
  ratio: 1.001
  status: fully_backed

The catch is trust and regulation: you are betting the reserves exist and are liquid. Monthly attestations help, but they are not the same as a full audit.

Crypto-backed

Tokens like DAI are backed by other crypto locked in smart contracts, over-collateralized to absorb volatility. Deposit $150 of ETH to mint $100 of stablecoin, and if ETH falls too far the position is liquidated to protect the peg. It is transparent and on-chain, but capital-inefficient by design.

Algorithmic — and why UST broke

Algorithmic stablecoins try to hold the peg with code and a paired token instead of hard collateral. In May 2022, TerraUSD (UST) lost its dollar peg, the arbitrage mechanism that was supposed to restore it spiraled instead, and roughly $40 billion evaporated in days. The lesson: a peg backed only by market confidence disappears exactly when you need it most.

How to read a stablecoin

Ask three questions: what backs it, who can freeze or redeem it, and what happened to it during the last market crash. If the answer to "what backs it" is "another token from the same project," treat the yield as a warning, not a reward.