Stablecoin

Stablecoins began as plumbing. Traders needed somewhere to park value between trades without leaving the blockchain, and a token that tried to be worth one dollar did the job. Today stablecoins settle payments, serve as collateral in lending markets and cross borders in minutes, and their combined supply is measured in hundreds of billions of dollars.

How a stablecoin holds its value

The common design is fiat-backed. An issuer takes in dollars, holds them as bank balances and short-dated Treasury bills, and creates tokens against them. Approved partners can usually hand tokens back to the issuer for dollars, and that two-way door keeps the market price close to one dollar: if the token trades below, buying it cheaply and handing it back for a full dollar closes the gap. USDC and USDT work this way.

Two other families exist. Crypto-backed stablecoins lock more crypto than the tokens they issue, so a fall in the collateral's price can be absorbed before holders are affected; Maker's DAI, now part of Sky, is the classic example. Algorithmic stablecoins tried to hold their value with supply rules and a second token instead of reserves. TerraUSD showed how that can fail: in May 2022 it lost its dollar value within days, taking tens of billions of dollars of market value with it.

Who earns the reserve income

Reserves of cash and government debt earn interest, and when short-term rates are high that income is large. In most designs it goes to the issuer, not to the holder, and the rules for payment stablecoins in several jurisdictions bar issuers from paying interest to holders at all. That gap is why yield-bearing dollar tokens and synthetic dollars exist: they are built to pass a return to holders, and they carry different risks in exchange.

A simple example

Imagine an issuer with 10 billion tokens in circulation, backed by 10.1 billion dollars of cash and Treasury bills. If those bills pay about four cents per dollar per year, the reserves earn roughly 400 million dollars a year. Holders get a steady dollar token they can move at any hour. The issuer keeps the 400 million.

Risks and limits

• Reserve risk. A stablecoin is only as sound as its reserves and the institutions holding them. In March 2023 part of USDC's reserves was caught in a US bank failure, and its price briefly fell to about 87 cents, a depeg that reversed within days.
• Transparency. Monthly attestations show a snapshot; proof of reserves that updates continuously shows more, though neither proves every liability.
• Issuer control. Most fiat-backed issuers can freeze addresses, which helps against theft but means holders do not fully control their tokens.
• Regulation. Rules differ by jurisdiction and are still changing, which can affect who may hold or use a given token.

None of this makes stablecoins unusual. It makes them what they are: claims on an issuer's reserves, with the strengths and weaknesses of the issuer behind them.