Stablecoins
A cryptocurrency whose price is pegged to $1. What keeps it stable? And what happens when the reserves run short?
Risk warning: forex, CFDs, options, futures and crypto assets usually involve leverage or high volatility, and you can lose more than you put in. This lesson only teaches the concepts; all numbers are for illustration and are not investment advice.
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Text version · Crypto Basics, lesson 5: “Stablecoins”
A cryptocurrency whose price is pegged to $1. What keeps it stable? And what happens when the reserves run short?
Every coin backed by $1 of reserves
A stablecoin is backed by reserves such as dollars and Treasury bills for 1:1 redemption, which keeps its price stuck to its $1 peg.
Off the peg? Arbitrageurs pull it back
When the price is below $1, buying and redeeming earns the difference on each coin, and that buying pushes the price back to $1. But when reserves run short and trust collapses, the mechanism breaks down.
Stable ≠ risk-free
Check whether reserves are complete, whether they're audited publicly and regularly, and whether the issuer can freeze addresses. Stablecoins with no full reserves, held up only by an algorithm, have in the past lost their peg and fallen to nearly zero.
Key takeaways
- Stablecoins hold reserves like dollars and Treasury bills to keep 1:1 redemption.
- When the price drifts, arbitrageurs "buy low and redeem, mint and sell high" to pull it back to the peg.
- If reserves fall short or trust collapses, the peg breaks, so stablecoins aren't risk-free. Check whether reserves are fully backed and audited.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click "Panic selling": how low does the price go? How much do arbitrageurs make per coin?
- Drag the timeline and watch whether the reserve ratio changes when arbitrageurs redeem.
- Click "Reserves fall short": what does the reserve ratio slide from? Where does the price end up?
- Compare the two events: why does the price get back to $1 the first time but not the second?
Quiz and explanations
- 1. A stablecoin drops to $0.98 but can still be redeemed for $1. Arbitrageurs will…
- Answer: Buy the stablecoin and redeem it for $1.They make $0.02 per coin, and their buying pushes the price back to $1.
- 2. What's most likely to make a stablecoin lose its peg?
- Answer: Insufficient reserves or a loss of market trust.The ability to redeem is the foundation of the peg.
- 3. A stablecoin rises to $1.02 and the issuer still mints new coins at $1. Arbitrageurs will…
- Answer: Mint new coins for $1 and sell them on the market at $1.02.They make $0.02 per coin, and the extra selling pushes the price back to $1.
Terms in this lesson
- peg (Peg): How a stablecoin keeps its 1:1 exchange rate with the dollar; drifting clearly away from it is called a depeg.
- stablecoin (Stablecoin): A cryptocurrency pegged to a fiat currency (usually $1) and backed by reserve assets.