Chapter 13 · Why Stablecoins Matter
Why has the internet lacked native dollars?
- Capabilities practiced
- Financial LiteracyOnchain Literacy
- Hands on
- Compare the on-chain supply and reserve reports of two stablecoins; note who can mint, who can freeze, and how redemption works.
- AI Lab
- Have AI compare the mechanisms of three stablecoins. Verify their reserve compositions, issuers, and audit reports one by one.
A Real-World Problem
The internet brought information transmission costs close to zero. Email reaches the other side of Earth in a second, for free.
What about sending someone there $100?
Both parties need bank accounts. You must enter bank codes and addresses, pay fees that may consume several percent of the principal, and wait one to five business days. Weekends and holidays are excluded; larger transfers require explaining the source of funds.
This international transfer process has barely changed since the 1970s.
The result is strange: the internet has native information, images, video, and social interaction, but has long lacked native money. Online payments eventually return to an offline banking settlement system.
Stablecoins address this problem.
Thought Experiment
Design an internet-native dollar that travels like email: worldwide, around the clock, within minutes, without requiring the recipient's bank account.
The simplest approach:
- An institution receives real dollars and deposits them in a bank.
- It issues equal-value on-chain tokens, each representing one dollar.
- Anyone can transfer these tokens freely on-chain.
- Anyone can return tokens to the institution for real dollars.
As long as step 4 holds, arbitrage keeps the token near $1. At $0.98, someone can buy it, redeem it, and earn $0.02.
It sounds airtight. Examine the assumptions:
- Do those real dollars actually exist?
- Where are they: deposits, Treasuries, commercial paper, or loans to affiliates?
- Who can redeem: everyone or only a few large clients?
- Can the institution freeze your tokens?
- What happens if the bank fails, Treasury prices fall sharply, or regulators freeze its account?
You discover: the on-chain portion rarely fails; the problems are off-chain.
Your Decision
One morning a major stablecoin falls to $0.96. Markets panic and social platforms fill with screenshots.
You hold 10,000 tokens. What do you do?
What Happens
The options reveal a recurring structure:
Stablecoin price volatility is the symptom; reserves and redemption are the cause.
A token's dollar value depends on three connections remaining intact:
- On-chain token
- Issuer
- Reserve assets
- Real dollars
Only when exiting do you discover another fact: a quoted $0.96 does not mean you can sell at $0.96.
Try the two sliders. The left controls pool depth; the right controls your sale amount:
No market maker sets this quote. The x·y=k curve determines the price. A shallower pool and a larger purchase move your price further from the market price; arbitrageurs and liquidity providers capture that difference.
A shallower pool and larger sale widen the gap between quote and execution. Panic brings both at once: everyone sells and pools drain. Chapters 14 and 15 explain the mechanism. For now remember: a quote is not an execution price.
This yields an evaluation order opposite to most people's instinct:
| What people check first | What to check first |
|---|---|
| Is the price $1? | What assets actually constitute reserves? |
| How large is market capitalization? | Who can redeem, and how quickly? |
| Which exchanges support it? | Who can freeze and mint? |
| How high is the yield? | Who pays that yield? |
Stablecoins can give dramatically different answers despite all displaying "1.00" in a wallet.
Build a Model
Classify stablecoins by what maintains their dollar value. This is the chapter's main framework.
| Type | Peg mechanism | Main risk | In one sentence |
|---|---|---|---|
| Fiat-backed | Real off-chain dollars and Treasuries, redeemable | Custody, regulation, transparency | Nearly all risk is off-chain |
| Crypto-collateralized | Excess on-chain crypto collateral | Collateral crashes, liquidation failure, oracles | Price and liquidation speed dominate |
| Algorithmic | Mechanisms and market incentives | Reflexive collapse | Multiple historical collapses to zero |
Each involves trade-offs. Remember: the true test comes when everyone wants to exit simultaneously. Ordinary conditions hide the differences.
Add a more basic model: stablecoins move bank deposits onto a chain:
| Bank deposit | Fiat-backed stablecoin | |
|---|---|---|
| What you hold | A bank liability | An issuer liability |
| Backing assets | Loans, Treasuries, reserves | Cash, Treasuries, other reserves |
| Who records balances | Bank | Chain for balances; issuer for reserves |
| Settlement speed | Business days; hours to days | Around the clock; minutes |
| Reversible | Yes | No |
| Deposit insurance | Usually | Usually absent |
| Freezing authority | Bank and judicial authorities | Issuer, often with built-in freezing, and judicial authorities |
This explains the value and risk: settlement moves on-chain; credit remains off-chain.
What It Is Called
A blockchain token whose price is pegged to a reference, usually the dollar.
Stable means stable relative to that reference, not risk-free.
A peg is the promised price relationship, usually 1:1. A depeg is its failure.
Distinguish temporary liquidity depegs, caused by panic or redemption congestion and often reversible, from reserve depegs, caused by insufficient backing and often permanent. Price alone cannot distinguish them; inspect reserves.
Assets the issuer holds to back outstanding tokens.
Ask what the reserves contain: demand deposits, short-term Treasuries, commercial paper, or affiliate loans. Less liquid assets are less dependable during a run.
Minting receives fiat and issues equivalent tokens; redemption burns tokens and returns fiat.
These complete the arbitrage loop that maintains the peg. Once redemption closes to the market, confidence alone supports the peg.
Third-party reporting on reserves. An attestation often confirms assets at one moment and is weaker than a full audit.
Check who issued it, its observation date, and the detail of its asset breakdown.
Most centralized stablecoin contracts let issuers block an address from transferring its balance.
A fundamental difference from Bitcoin: being on-chain does not make it permissionless.
Hands-on
Choose two different types, preferably one fiat-backed and one crypto-collateralized, and complete this table.
Check on-chain supply. Open the contract in an explorer, find total supply, and record the amount and timestamp.
Find reserve reporting. On the issuer's website, find the latest reserve or attestation report. Record total reserves, composition, reporting date, and provider.
For a crypto-collateralized token, inspect collateral composition and its current collateralization ratio instead.
Inspect permissions. Find minting authority, freezing authority, and upgradeability in the contract. If absent from your findings, record "not found" rather than guessing.
Check redemption conditions. Who qualifies, what is the minimum, how long does it take, and what does it cost?
Complete the comparison and reach a judgment.
| Stablecoin A | Stablecoin B | |
|---|---|---|
| On-chain supply | ||
| Reserve composition | ||
| Report provider and date | ||
| Minting authority | ||
| Freezing authority | ||
| Redemption eligibility | ||
| Greatest concern |
The last row is the point: if you cannot name your greatest concern, the investigation is incomplete.
AI Lab
Give AI a structured task:
Compare three stablecoin mechanisms in a table with these fields:
- Type: fiat-backed, crypto-collateralized, or algorithmic
- Issuer
- Reserve or collateral composition
- Provider and date of the latest public report
- Minting and freezing authorities
- Redemption eligibility, timing, and fees
- Historical depegs and causes
- Main risk in your judgment
Provide a source link for every field. Write "not found" for missing information;
do not speculate.Then open every supplied link.
The real goal is to observe where the model fails. Typical errors include outdated reserve reports, mixing different observation dates, and plausible-looking links that do not exist.
Count how many links both open and support the claim. Remember that proportion.
Verify these points yourself after using AI
- Can you find every cited reserve report on the issuer website?
- Are report dates correct? Models often use data from one or two years earlier.
- Does it confuse a dollar peg with 1:1 cash reserves?
- Are freezing and minting powers supported by contracts or official documentation?
- Do crypto collateralization ratios and liquidation settings match current protocol parameters?
- Does each specific number include a source link and timestamp?
Real-World Case
Several issuers disclosed reserves under pressure, revealing commercial paper and corporate bonds that were less liquid than cash.
Ordinarily these assets worked; under heavy redemption pressure they were slow to sell and fetched poor prices.
The lesson: reserve liquidity can matter more than reserve size during a run. Non-cash holdings themselves are not the whole question.
A stablecoin using a two-token mechanism fell to zero within days, erasing tens of billions of dollars in value.
Its collapse was reflexive: a falling stablecoin triggered issuance of the other token, issuance depressed that token's price, and the decline weakened the stablecoin's support further. Each step reinforced the next.
Chapter 21 examines this recurring structure.
A bank holding part of a stablecoin's reserves encountered trouble. The stablecoin temporarily fell below $1 over a weekend.
The crucial detail was the weekend: on-chain markets run continuously, but bank redemption channels close. Off-chain backing and on-chain trading have different opening hours.
Once banks reopened and reserves were confirmed, the price recovered quickly.
This was a liquidity depeg rather than a reserve depeg, although price alone made them look identical at the time.
In regions with high inflation, many people save and receive payments in dollar stablecoins. They do not trade or care about on-chain ecosystems; they want an account that preserves value.
This large use receives little discussion. For some people it is their first accessible stable account, rather than a speculative instrument.
Several jurisdictions introduced stablecoin laws requiring liquid reserves, regular disclosure, and licensed issuance. The question of reserve composition moved from issuer promises to legal requirements.
Custodian-bank risk, freezing risk, and the issuer's retention of reserve interest remain. See Hot Topic: Stablecoin Legislation.
Change One Variable
Arbitrage becomes so smooth that depegs rarely last more than minutes.
The issuer must hold large amounts of highly liquid assets, substantially reducing earnings, and bear global compliance costs: open redemption requires identifying every redeemer.
Every real stablecoin chooses a position on this spectrum.
Bank-failure exposure disappears, but Treasuries must be sold for cash. Under volatile conditions that sale can itself generate losses.
Risk changes form rather than disappearing. This theme returns throughout the course.
The token becomes more permissionless and resistant to censorship.
Stolen funds cannot be intercepted, sanctions and enforcement lose a tool, compliance becomes harder, and large institutions may stop holding it.
Decentralization involves trade-offs rather than an always-better maximum. The same reasoning appeared in Chapter 8.
On-chain balances remain; nobody can remotely erase them. But compliant banking ramps close and local exchanges delist the token, making conversion to local fiat difficult.
On-chain ownership is hard to strip away, while its connection to the real world remains regulated. Chapter 24 includes this in its risk model.
Takeaway Questions
Stablecoins address the internet's lack of native money. Ask whether any payment project really solves that problem or merely moves it elsewhere.
How does an issuer earn money? Interest on reserve assets, often Treasuries. Holders give that interest to the issuer in exchange for freely transferable money. Understanding that exchange explains the business.
Holders bear issuer credit risk, reserve market risk, and private-key loss risk. Bank deposits often have insurance; stablecoins usually do not. Risk shifts from the system to individuals.
Some stablecoins pay holders yield. Determine whether it comes from Treasury interest, lending spreads, or newly issued token subsidies. Chapter 17 follows this question through.
Chapter Check
Transfers, balances, and contract logic are deterministic and rarely cause problems.
Risks concentrate in whether reserves exist and are sufficient, their liquidity, custodian safety, regulatory freezes, and redemption availability.
Crypto-collateralized stablecoins are an exception: collateral prices, liquidation, and oracles make their main risks on-chain.
Price alone cannot. Check:
- Reserve reports: adequacy, composition, and freshness.
- Redemption channels: operation and suspension notices.
Sound reserves plus temporary congestion or bank closures usually indicate a recoverable liquidity depeg. Impaired reserves may prevent recovery.
Yes. That is an intentional design choice.
Freezing enables compliance, institutional access, and traditional-finance connections, at the cost of censorship resistance. It is a trade-off, not necessarily an error.
Know which kind of asset you hold instead of assuming every on-chain asset is alike.
Ask: who pays that 15%?
Possible sources: Treasury interest, far below 15% in the described rate environment; lending spreads, requiring borrower and collateral investigation; or new token subsidies, requiring an end-date investigation.
If none is explained, the likely answer is: later participants are paying you. Chapter 17 expands this.
Stronger: Settlement. Around the clock, within minutes, irreversible, and without requiring the recipient's bank account.
Weaker: Storage safety. No deposit insurance, permanent losses from lost keys, and issuers often less transparent than regulated banks.
Measurement and Exchange each offer advantages in their respective contexts.
Key idea
Stablecoins are internet-native money. Their risks lie in reserves and redemption, not the price tag.