Stablecoins: What Backs Them and Where the Risk Hides
A one-dollar peg is a claim, not a guarantee. Reserve composition, attestations and redemption rights decide whether it holds.
Stablecoins are the plumbing of crypto markets: settlement, trading pairs, cross-border transfers. They promise stability, but stability is produced by a specific mechanism, and the mechanisms differ enormously in quality.
The three designs
Fiat-collateralised. Each token is backed by reserves — cash, short-term government bills, repos — held by the issuer. The peg depends on the reserves being real, liquid and redeemable. These dominate the market.
Crypto-collateralised. Backed by other digital assets, over-collateralised to absorb volatility, with automated liquidation when collateral falls. Transparent on-chain, but exposed to cascading liquidations in sharp declines.
Algorithmic. Maintained by supply mechanics rather than assets. Several have failed catastrophically, including one that erased tens of billions of dollars in days. Treat this category as experimental regardless of current stability.
Reading the reserve report
Most large issuers publish monthly attestations. Read for:
- Composition. Treasury bills maturing within three months are the strongest backing. Commercial paper, corporate bonds, secured loans and other digital assets are progressively weaker.
- Attestation versus audit. An attestation confirms a snapshot at one moment. A full audit examines controls over a period. Most publish the former.
- Custody. Which banks hold the cash, and how concentrated is it? A stablecoin that briefly depegged during a regional banking failure did so because a portion of reserves sat at a single failing bank.
- Redemption terms. Who may redeem directly, at what minimum, with what fee and what delay? If only large institutions can redeem at par, the peg for everyone else depends on secondary market liquidity.
How depegs actually happen
A depeg is a run. Doubt about reserves triggers redemptions, redemptions force asset sales, sales at a discount confirm the doubt. Most recover; recovery is not guaranteed, and the discount during the episode is real for anyone who must transact.
Yield is not interest
Products paying yield on stablecoin deposits are lending your tokens to someone. That yield is compensation for credit risk, not a deposit rate, and it is not covered by deposit insurance. Several platforms offering high stablecoin yields have failed, and depositors became unsecured creditors.
Regulation is arriving
Major jurisdictions are moving toward reserve, disclosure and licensing requirements for payment stablecoins. This should improve the quality of the largest issuers and push weaker ones out. Until frameworks are fully in force, issuer choice remains the main risk control available to users.
Practical takeaways
- Backing quality varies enormously — read the composition.
- Attestations are snapshots, not audits.
- Know whether you can actually redeem at par.
- Stablecoin yield is credit risk with a friendly name.
LumosPay publishes general information only. Nothing here is personalised financial, tax or legal advice.
