The Quiet Foundation
The most important infrastructure in crypto markets is barely discussed compared to the assets that trade on top of it. Stablecoins — cryptocurrencies designed to maintain a stable value, typically pegged to the US dollar — now account for a substantial majority of on-chain transaction volume, serve as the primary settlement layer for crypto trading, and are increasingly being used for cross-border payments and dollar access in markets with restricted banking systems.
For traders, stablecoins are typically an afterthought: a parking lot for cash between trades, a way to take profits without converting to fiat. This is a mistake. The stability, reliability, and risk profile of the stablecoin you are using directly affects your trading outcomes — and the failure modes of stablecoins, when they occur, can be catastrophic.
This article covers the three dominant stablecoin models, their respective risk profiles, and the market dynamics that traders need to understand.
Fiat-Backed Stablecoins: USDT and USDC
The largest stablecoins by market capitalisation — Tether’s USDT at approximately $115 billion and Circle’s USDC at approximately $35 billion as of mid-2025 — are fiat-backed: each token is intended to represent a claim on one US dollar (or dollar-equivalent assets) held in reserve by the issuer.
The model is simple in principle: deposit dollars, receive tokens; redeem tokens, receive dollars. In practice, the details of what constitutes an acceptable reserve asset, how transparently reserves are reported, and the redemption process under stress conditions vary significantly between issuers and have been the source of persistent concern.
Tether’s reserves have been a source of controversy since at least 2017. The company settled with the New York Attorney General in 2021 over misrepresentations about reserve composition, and has since moved toward more regular attestations showing a portfolio predominantly composed of US Treasury bills and repo agreements. Whether these attestations — which are not full audits — provide adequate assurance remains a matter of debate. Tether’s role as the dominant stablecoin despite this controversy reflects the power of network effects: it is used because everyone else uses it, a logic that is both circular and operationally rational.
USDC is generally considered more transparent. Circle publishes monthly attestations of its reserve composition conducted by a Big Four accounting firm, and the reserves are predominantly held in short-duration US government obligations and cash. The March 2023 depeg event — when USDC briefly traded as low as $0.87 following the failure of Silicon Valley Bank, where Circle held approximately $3.3 billion of its reserves — demonstrated that even well-managed fiat stablecoins carry concentration risk in their banking arrangements. USDC recovered its peg within days once the FDIC backstop was announced, but the episode illustrated a failure mode that had not previously been tested at scale.
Algorithmic and Crypto-Backed Stablecoins
The category of stablecoins that has attracted the most dramatic failures is the algorithmic or partially-collateralised model. TerraUSD (UST), which maintained its peg through a mint-and-burn mechanism involving the Terra blockchain’s native token LUNA, collapsed in May 2022, wiping out approximately $40 billion in market value within days. The mechanism that was supposed to maintain the peg became a death spiral when confidence broke: UST holders redeemed for LUNA, LUNA was sold on the open market, LUNA’s price fell, the UST peg weakened further, more redemptions followed.
The Terra collapse did not eliminate the category, but it fundamentally changed the risk appetite for algorithmic stablecoins. Most surviving designs in this space have moved toward over-collateralisation as a key safety mechanism.
MakerDAO’s DAI remains the most successful crypto-backed stablecoin. Each DAI is backed by more than one dollar of collateral — primarily ETH, WBTC, and an increasing proportion of real-world assets including US Treasury bills via tokenised fund products. The over-collateralisation means that the peg can be maintained even through significant declines in collateral value, though liquidation cascades during sharp market drops can create temporary stress. DAI’s track record across multiple market cycles, including the March 2020 crash and the 2022 bear market, provides reasonable evidence that the model is robust under realistic stress conditions.
Stablecoin Liquidity Dynamics in Trading
For active traders, stablecoin dynamics matter for several reasons beyond simple peg stability.
The stablecoin supply ratio (total stablecoin market cap divided by total crypto market cap) serves as a useful indicator of dry powder in the market. When the stablecoin ratio is high, there is a large amount of dollar-denominated capital sitting on the sidelines that could be deployed into crypto assets. Historical data shows that elevated stablecoin ratios have generally preceded periods of price appreciation, as this cash seeks yield and return opportunities.
The distribution of stablecoin supply across different blockchains is also informative. Stablecoin flows to Ethereum typically indicate activity in DeFi and decentralised trading protocols. Large flows to Tron — Tether’s largest deployment chain by volume — often reflect retail demand in Asian markets and payment use cases rather than trading activity. Flows to Solana and newer chains indicate shifts in where on-chain activity is concentrated, which has implications for gas costs and liquidity depth on those networks.
The Tether premium on offshore exchanges — the difference between USDT’s trading price and 1.00 USD — is a closely watched sentiment indicator. When USDT trades above parity, it indicates strong demand for dollar-denominated settlement, often reflecting high trading activity and risk appetite. When it trades at a discount, it can indicate reduced risk appetite or liquidity stress. This metric is most useful as a real-time stress indicator during volatile market conditions.
Regulatory Outlook
The regulatory environment for stablecoins has moved from ambiguity to active framework development across most major jurisdictions. The EU’s MiCA regulation, fully effective from December 2024, requires stablecoin issuers operating in Europe to maintain segregated reserves, publish regular audited reports, and maintain redemption rights for holders. Issuers that do not comply by the deadline are not permitted to offer services to EU users.
In the United States, the GENIUS Act — which at the time of writing is moving through Congress — would create a federal framework for payment stablecoins, requiring full backing by cash or liquid short-term Treasuries and regular audited attestations. If enacted, this would represent a significant legitimisation of the stablecoin category and would likely accelerate adoption by banks and payment companies that have been waiting for regulatory clarity.
The direction of travel is toward more regulated, more transparent, and ultimately more bank-like stablecoin issuers. This reduces certain risks (reserve opacity, redemption uncertainty) while potentially concentrating the market in fewer, larger, regulated issuers at the expense of more decentralised alternatives.
Conclusion
Stablecoins are not boring infrastructure. They are the medium through which the majority of crypto value flows, and their failure modes — when they occur — are fast-moving and severe. Understanding the differences between fiat-backed, crypto-backed, and algorithmic models, and the specific risk profile of the stablecoins you hold, is fundamental to managing crypto market exposure responsibly.
The good news is that the most robust models are well understood after several years of real-world stress testing. The bad news is that new designs continue to emerge, and the history of algorithmic stablecoin failures suggests that not all of them have been adequately stress-tested before launch. Scepticism toward novelty in this particular corner of the market is a healthy default.
