Understanding Stablecoins

Easy 18 minutes

What Are Stablecoins?

Stablecoins are cryptocurrencies pegged 1:1 to USD. Critical for DeFi trading, earning yield, and avoiding volatility. Total market: $120B+ (January 2026), down from $180B peak before Terra's $40B collapse in May 2022.

Top Stablecoins Compared (January 2026)

Stablecoin	Market Cap	Type	Backing	Risk Level	Best For
USDT (Tether)	$90B	Fiat-backed	Cash + T-bills	Medium	Trading, most pairs
USDC (Circle)	$25B	Fiat-backed	Cash + T-bills	Low-Medium	US users, DeFi
DAI (MakerDAO)	$5B	Crypto-backed	ETH, wBTC collateral	Medium	Decentralization
USDC (PYUSD)	$800M	Fiat-backed	Paxos reserves	Low-Medium	PayPal users
FDUSD	$2.8B	Fiat-backed	First Digital	Medium-High	Asian markets

Stablecoin Market Share

USDT: ~75% dominance - most liquid, most trading pairs
USDC: ~21% - growing, preferred by US institutions
DAI: ~4% - decentralized alternative
Others: ~3% - regional or specialized

Types of Stablecoins

Fiat-Backed (USDC, USDT)

Backed by real dollars in bank accounts
Centralized - company controls it
Most stable and widely used

Crypto-Backed (DAI)

Backed by locked cryptocurrency
Decentralized - no company controls it
Over-collateralized for safety

Algorithmic Stablecoins (EXTREMELY HIGH RISK)

The $40 Billion Lesson: Terra UST Collapse

What Happened (May 2022):
- UST was algorithmic stablecoin (no real backing)
- Maintained $1 peg through LUNA burn/mint mechanism
- Anchor protocol offered 19.5% APY on UST deposits
- Seemed sustainable for months

The Death Spiral:
- May 7: UST starts losing peg ($0.98)
- May 9: Panic selling, drops to $0.60
- May 10: LUNA hyperinflation begins
- May 12: UST at $0.10, LUNA at $0.0001
- Total loss: $40 billion

Victims:
- Retail investors holding UST: $25B+ lost
- Anchor depositors: Lost "guaranteed" 19.5% yield + principal
- LUNA holders: 99.99% loss in 72 hours
- Three Arrows Capital: Bankrupted

Lesson: Algorithmic stablecoins can and do fail catastrophically. The "stability mechanism" breaks during panic.

Other Failed Algorithmic Stablecoins

Iron Finance IRON (June 2021): $2B crash, TITAN from $64 to $0 in hours
Neutrino USD/WAVES (2022): De-pegged to $0.50, never recovered
Empty Set Dollar (2020-2021): Death spiral to $0.20
Basis Cash (2021): Lost peg, now trading at $0.08

Avoid Algorithmic Stablecoins

Pattern is clear: Every major algorithmic stablecoin has either:
1. Already failed (UST, IRON, etc.)
2. Will fail eventually

The mechanism SEEMS to work until it doesn't. Then you lose everything in hours.

Stick to fiat-backed (USDC, USDT) or crypto-backed (DAI) stablecoins.

Stablecoin Risk Comparison

Risk Factor	USDT	USDC	DAI
Regulatory	Medium-High	Low-Medium	Low
Transparency	Medium	High	High
Centralization	High	High	Low
De-peg History	Brief ($0.95 in 2022)	Brief ($0.88 March 2023)	Moderate ($0.89 March 2023)
Redemption	$100k+ minimum	Easier ($2k+ minimum)	Always (decentralized)

De-Pegging Events: What Actually Happened

USDC De-peg (March 2023)

Silicon Valley Bank Collapse

March 10, 2023:
- Circle revealed $3.3B in SVB (8% of USDC reserves)
- Fear Circle couldn't redeem full amount
- USDC dropped to $0.88 temporarily
- DAI also de-pegged (holds USDC as backing)
- Massive panic selling

Resolution:
- Government guaranteed SVB deposits
- Circle got all funds back
- USDC returned to $1.00 within 48 hours

Lesson: Even "safe" stablecoins can de-peg temporarily

USDT Controversies (Ongoing)

2017-2019: Questions about reserves, transparency
2021: Settled with NY AG, admitted not fully backed
2022: Brief de-peg to $0.95 during Terra collapse
2024: Improved attestations, still less transparent than USDC
Reality: Still most used despite concerns

Which Stablecoin Should You Use?

Decision Matrix

Your Priority	Best Choice	Why
Maximum liquidity	USDT	Most trading pairs, deepest markets
US compliance	USDC	Regulated, transparent, Circle/Coinbase
Decentralization	DAI	No company can freeze it
DeFi yield	USDC or DAI	Better rates on Aave, Curve
Safety first	Split 50/50	Diversify between USDC and USDT

Recommended Allocation

Don't Put All Eggs in One Basket

Conservative portfolio:
- 40% USDC (regulatory compliant, transparent)
- 40% USDT (liquidity, trading pairs)
- 20% DAI (decentralization hedge)

Why diversify?
- If USDC has SVB-style issue, you have USDT/DAI
- If USDT gets regulated away, you have USDC/DAI
- If crypto crashes, DAI might hold peg better

Cost: Slightly less convenient, but much safer

Stablecoin Use Cases

Trading

Take profits: Sell BTC to USDT without off-ramping to bank
Sit in cash: Wait for opportunities without volatility
Most pairs: BTC/USDT has higher volume than BTC/USD

DeFi Yield

Aave: 3-8% APY on USDC deposits (January 2026)
Curve: 8-15% APY on 3pool (USDC/USDT/DAI)
Better than banks: Traditional savings = 0.5-1%
Risk: Smart contract exploits, no FDIC insurance

Payments & Remittance

Send $10k internationally for $1-5 in fees
Arrives in minutes, not days
No forex conversion fees
Growing adoption in emerging markets

Avoiding Capital Gains Tax

Sell appreciated crypto to USDC (taxable)
Move USDC between wallets/exchanges (not taxable)
Earn yield on USDC (taxable as income)
Better than repeated BTC → USD → BTC conversions

Stablecoin Risks You Must Know

Regulatory Risk

US government considering stablecoin regulations
Could require banking licenses
Some stablecoins might get banned
International users could lose access

Bank Run Risk

If everyone tries to redeem at once, can break
Seen during UST collapse (algorithmic)
Also happened briefly with USDC (SVB)
Fiat-backed should survive, but panic causes de-pegs

Frozen Funds Risk

USDC and USDT can freeze addresses
Done for regulatory/legal compliance
Your funds can be blacklisted
DAI cannot be frozen (decentralized)