Stablecoins are the least exciting-sounding part of crypto and one of the most heavily used — a large share of on-chain trading and DeFi activity runs through them. "Stable" is doing a lot of work in that name, though, and it means different things depending on how a given stablecoin is actually built.

The three main designs

  • Fiat-collateralized: Backed by reserves of real-world dollars (or equivalents like short-term treasuries) held by the issuing company, roughly one-to-one. This is the most common model for the largest stablecoins by market cap. The peg's strength here depends entirely on the trustworthiness and transparency of the reserves.
  • Crypto-collateralized: Backed by other cryptocurrencies locked in a smart contract, typically over-collateralized (e.g., $150 of ETH backing $100 of the stablecoin) to absorb price volatility in the collateral. More decentralized than fiat-backed models, but exposed to the volatility and liquidity of the crypto collateral itself.
  • Algorithmic: Attempts to maintain the peg through supply adjustments and market incentives rather than holding collateral one-to-one. This model has produced some of the highest-profile stablecoin failures in crypto history, because the peg depends on continued market confidence rather than a redeemable reserve.

Why a peg can actually break

A stablecoin "depegs" when its market price moves meaningfully away from its target (usually $1). This can happen from a loss of confidence in the reserves backing it, a liquidity crunch that makes redemption difficult, or — in algorithmic designs — a feedback loop where falling confidence and falling price reinforce each other faster than the mechanism can correct it.

The key question for any stablecoin isn't "is it currently at $1" — it's "what happens to the peg under stress," whether that's a bank run on reserves, a sharp drop in collateral value, or a loss of market confidence.

Why stablecoins matter for DeFi specifically

Stablecoins function as the unit of account across much of DeFi — the asset used to price loans, denominate liquidity pools, and move value between protocols without exposure to the price swings of a volatile token. Understanding which stablecoin a protocol relies on, and how that stablecoin is collateralized, is part of understanding the protocol's actual risk — a lending market denominated in an undercollateralized or opaque stablecoin carries risk beyond the lending protocol's own code.

What to check before relying on one

At minimum: what backs it, how often (and how transparently) reserves are reported, and whether it has a track record of holding its peg during periods of broader market stress rather than just during calm markets.