Stablecoin Study Guide

📖 Core Concepts Stablecoin – a crypto token designed to keep its price stable relative to a reference asset (fiat, commodity, or crypto). Peg – the target exchange rate between the stablecoin and its reference asset (e.g., 1 USDT ≈ 1 USD). Collateral – assets held (fiat, crypto, commodity) that back the stablecoin and enable redemption at the peg. Redemption risk – the danger that holders cannot exchange the stablecoin for its underlying asset when they want to. Algorithmic mechanism – a code‑based rule that expands or contracts supply to keep the peg, without full reserves. 📌 Must Remember Market dominance – 90 % of stablecoin market cap is held by Tether (USDT) and USD Coin (USDC). Fiat‑backed share – 95 % of all stablecoins are fiat‑backed; 97 % of those are USD‑pegged. Key risks – counterparty risk, solvency risk (interest‑rate impact on bond reserves), technology risk, and “death spiral” for algorithmic models. Regulatory stance – GENIUS Act (US), MiCAR (EU), and Singapore framework all prohibit or tightly restrict yield‑bearing stablecoins. Algorithmic death spiral – heavy redemptions trigger minting of a linked token, flooding the market and crashing the stablecoin’s price (e.g., TerraUSD/ LUNA, May 2022). 🔄 Key Processes Issuance & Redemption (Fiat‑backed) User deposits fiat → issuer holds reserve assets (treasury bonds, deposits). Issuer mints stablecoins 1:1 to deposit amount. User redeems stablecoins → issuer burns tokens and returns fiat. Over‑collateralization (Crypto‑backed) Deposit crypto collateral > value of stablecoins minted (e.g., 150 % DAI). Smart contract continuously monitors collateral price; triggers liquidation if collateral falls below a safety threshold. Supply‑adjustment (Algorithmic) If price > peg → mint new stablecoins, sell on market to increase supply. If price < peg → buy back/burn stablecoins, reduce supply. 🔍 Key Comparisons Fiat‑backed vs. Crypto‑backed Collateral type: fiat deposits vs. over‑collateralized crypto. Redemption: direct fiat redemption possible vs. redemption via smart‑contract liquidation. Algorithmic vs. Reserve‑backed Reserves: none or minimal vs. full‑reserve holdings. Stability method: supply‑side algorithms vs. asset‑side backing. Stablecoin vs. CBDC Issuer: private entity vs. central bank. Legal claim: holder’s claim on custodian’s assets vs. direct claim on central bank. ⚠️ Common Misunderstandings “All stablecoins are fully collateralized.” Many are algorithmic or only partially backed; they can lose the peg. “Stablecoins earn interest automatically.” Most do not pay interest; yield comes from third‑party lending or DeFi farms, which may be regulated or risky. “Peg is guaranteed forever.” Peg can break due to redemption storms, reserve devaluation, or algorithmic failure. 🧠 Mental Models / Intuition “Digital cash drawer” – Think of a stablecoin as a cash drawer that should always contain the exact amount of cash (reserve) matching the tokens inside. If the drawer is empty (reserve loss) or the cash is counterfeit (algorithmic), the drawer fails. “Supply‑demand thermostat” – Algorithmic stablecoins act like a thermostat: they turn supply up when the “temperature” (price) is too high and down when too low. If the thermostat is broken, the room overheats or freezes. 🚩 Exceptions & Edge Cases Partial‑reserve algorithmic coins – Some have a small reserve cushion (e.g., 10 % of peg) to smooth volatility. Hybrid models – Coins that combine fiat reserves with algorithmic supply adjustments (e.g., some “elastic supply” designs). Bank‑run scenario – During a banking crisis, even fiat‑backed coins can temporarily lose the peg if custodial banks freeze assets (e.g., Circle USDC in 2023). 📍 When to Use Which Fast, low‑risk trading → Choose major fiat‑backed coins (USDT, USDC). Decentralized finance (DeFi) lending → Crypto‑backed coins (DAI) give on‑chain collateralization. Speculative or high‑yield strategies → Algorithmic or yield‑bearing stablecoins, but only if you accept high failure risk. Regulated environment → Prefer stablecoins that comply with local legislation (e.g., EU‑registered e‑money tokens). 👀 Patterns to Recognize Redemption pressure → price drop – Large on‑chain redemption requests often precede a peg breach. Interest‑bearing offers + regulatory flag – When a stablecoin advertises “interest,” check jurisdiction; many regulators label this as a security. Cross‑chain deployment → liquidity fragmentation – Multiple versions of the same coin on different chains usually mean lower depth on each chain. 🗂️ Exam Traps Distractor: “All algorithmic stablecoins are risk‑free because they have no reserves.” Reality: Lack of reserves is the core risk; they can enter a death spiral. Distractor: “Stablecoins and CBDCs are functionally identical.” Reality: Issuer, legal claim, and regulatory treatment differ dramatically. Distractor: “Higher interest = safer stablecoin.” Reality: Yield often introduces securities regulation and adds counterparty/technology risk. Distractor: “If a stablecoin is backed by US Treasury bonds, it can never become insolvent.” Reality: Rising interest rates reduce bond market value; issuers must hold short‑duration bonds to mitigate solvency risk.