Stablecoins: Holding a Peg

A token designed to stay worth about a dollar — which works only as long as whatever stands behind it actually holds.

Crypto & Tokenization · Lesson 11 · 9 min read

You love that crypto can move money instantly, worldwide, and programmably — but you can’t pay rent in something that might drop 20% by Friday. What if a token could ride those same rails yet always be worth about a dollar? That’s a stablecoin. But “stable” is a promise, and promises can break. Hold the question: how do you actually keep a token pegged to $1 — and how would you check whether the peg will hold?

What a stablecoin is, and why

A stablecoin is a token engineered to hold a steady value — almost always pegged to $1 — so you get crypto’s speed, reach, and programmability without the volatility. People use them to pay, save, trade, and move value between other cryptos without cashing out to a bank.

Everything about a stablecoin comes down to one question: how does it hold the peg? There are three main answers, and they differ entirely in what you have to trust.

Three ways to hold a peg

• Fiat-collateralized (custodial): a company holds about $1 of real dollars or short-term bonds for each token and lets you redeem 1:1. The peg rests on real reserves + redemption — so you trust (and should verify) that the issuer truly holds the reserves.
• Crypto-collateralized (over-collateralized): you lock excess volatile crypto in a smart contract — say $150 — to mint $100 of stablecoin, and the contract auto-liquidates collateral if its value falls. Decentralized and on-chain-verifiable, but capital-heavy.
• Algorithmic: tries to hold the peg with code and incentives and little or no hard collateral. Structurally fragile — if confidence drops, it can enter a “death spiral,” and several designs have collapsed exactly that way.

Minting a crypto-collateralized stablecoin:
• You want $100 of stablecoin, so you lock $150 of volatile crypto into its contract (150% collateral).
• The contract mints you 100 coins, each targeting $1.
• Your collateral falls toward $110 — near the safety threshold.
• If it drops below the required ratio, the contract auto-sells your collateral to buy back and cancel enough coins to stay safe — keeping every remaining coin backed by more than $1.

Stable is a goal, not a guarantee — so check the backing

The peg holds only as long as the backing or mechanism holds. So the honest questions for any stablecoin are always the same: What actually backs it? Can you redeem 1:1, and from whom? Can you verify the reserves?

Fiat-backed → you’re trusting an issuer you can (and should) audit. Crypto-backed → you can verify the collateral directly on-chain. Algorithmic → you’re trusting a mechanism that has repeatedly failed under stress. Same verify-don’t-trust habit from lesson 5, now aimed at the dollar behind the token.

Reading two stablecoins that both “equal $1”:
1. Coin A is fiat-backed: an issuer claims to hold $1 of reserves per coin and to redeem on demand.
2. Coin B is algorithmic: it holds $1 mostly through a mint/burn mechanism and market incentives, with little hard collateral.
3. Both trade at ~$1 today, so the price tells you nothing about safety.
4. The difference is the backing: A’s peg is only as good as the issuer’s real reserves and willingness to redeem (verifiable via audits/attestations); B’s peg is only as good as ongoing confidence, which can vanish in a panic.
5. The test isn’t the label “stable” — it’s tracing what stands behind the dollar and whether you can check it.