You will be able to sort stablecoins by what backs them and name the risks of each type.
Farah keeps part of her crypto in a stablecoin between trades. To her it feels like cash: the balance sits at about one US dollar per coin, day after day, while everything else in her account swings. Then Darren asks her a simple question. If she wanted dollars back for every coin, who would pay her, and with what? She is not sure. That question is the whole of this lesson.
A stablecoin is a crypto token designed to keep a steady price against something else, usually the US dollar. People use stablecoins to park money between trades without leaving the crypto system, and to move dollar value across borders on a blockchain. That steady price is only a promise, and what stands behind it splits stablecoins into two very different types.
A reserve-backed stablecoin is issued by a company that says it holds cash and short-term assets, such as government treasury bills and bank deposits, at least equal to all the coins in issue. When you hand the company a dollar, it creates a coin. When a coin is handed back, it pays out a dollar and destroys the coin.
That redemption is what holds the peg. If the coin trades at 98 cents on an exchange, a trader who can redeem it for a full dollar buys it cheaply and redeems it, which pushes the price back up. The catch is that often only approved customers can redeem directly with the issuer, sometimes with minimum amounts. Everyone else, Farah included, sells on an exchange and relies on those traders to keep the price in line.
So the peg is only as good as the reserves and the issuer. Three things can go wrong. The reserves might be smaller than claimed. They might be in assets that cannot be sold quickly at full value. Or they might sit with a bank or custodian that runs into trouble. In March 2023, one large dollar stablecoin briefly traded well below a dollar after its issuer said part of its reserves were held at a US bank that had just failed. The price recovered once it became clear those deposits would be paid, but holders had a frightening weekend.
Because everything rests on the reserves, look at how they are reported. Reports vary a lot in quality, and three questions sort the useful ones from the rest.
First, who prepares the report? An independent accounting firm is more reassuring than the issuer's own blog post.
Second, how often does it come out? Monthly is better than quarterly, and a report from a year ago tells you little about today.
Third, is it an audit or an attestation? This difference matters more than it sounds. An attestation is an accountant confirming that, on a particular date, the reserves the issuer showed them matched what the issuer said, a snapshot of one day. An audit is a much deeper examination of the company's accounts and controls over a period, with the accountant forming an opinion on them. Many stablecoin issuers publish attestations, and an attestation is a weaker check than an audit. When an issuer calls a report an audit, read the accountant's own wording to see which it really is.
Also read what the reserves actually are. Cash and short-dated government bills are about as safe as reserves get. Commercial paper, loans, or other crypto tokens are riskier, because they can lose value or be hard to sell at the very moment holders want out.
An algorithmic stablecoin tries to hold its peg without a pile of reserves. Instead it uses code and incentives, usually tied to a second, linked token. The design behind TerraUSD worked like this: anyone could swap one TerraUSD for one dollar's worth of a sister token called Luna, newly created for the swap, and the reverse. If TerraUSD fell below a dollar, traders could buy it cheaply and swap it for a full dollar of Luna, which was meant to pull the price back up.
The weakness is that the mechanism depends on Luna keeping its value. When many holders want out at once, the swaps create more and more Luna, Luna's price falls, each swap delivers less real value, and confidence drains faster. Lesson 5.1, Terra and Luna: a peg held up by an algorithm, walks through what happened in May 2022. For now, the lesson is the category. A stablecoin with nothing but a mechanism behind it can fail completely, and quickly.
MAS has set out a regulatory framework for single-currency stablecoins issued in Singapore, covering matters such as the quality of reserves, redemption and disclosure. Only stablecoins that meet its requirements fall under it, and most of the stablecoins you will see quoted on exchanges are issued elsewhere and are not covered. The details, and which stablecoins currently qualify, change over time, so check the MAS website rather than relying on a platform's marketing or a news summary.
When you pick your two stablecoins for the activity, write down where the issuer is based, whether the MAS framework covers it, and what the latest reserve report says the coins are backed by. If you cannot find a reserve report at all, record that too, because it is an answer in itself.
Pick two stablecoins and write down what each claims backs it, who reports on the reserves, and how often.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).