By - A peg is not enforced by the issuer. It is enforced by arbitrageurs who profit from correcting the price.
- The three designs are fiat-backed, crypto-collateralised and algorithmic, and they fail in completely different ways.
- Redemption access is the variable that matters most. A peg holds when large holders can reliably exchange one token for one dollar.
A stablecoin is supposed to be worth a dollar. Nothing about a token makes that automatic. The price holds because of a mechanism, and understanding that mechanism tells you exactly when it will stop holding.
What actually keeps the price at a dollar?
Arbitrage. Not the issuer’s promise, and not the reserves themselves.
The Bank for International Settlements has made the same point in its research: a peg is a market outcome, not a design guarantee.
If a fiat-backed stablecoin trades at $0.98, someone with redemption access buys it on the open market and redeems it with the issuer for a full dollar. Two cents of profit per token, repeated at scale, and the buying pressure pushes the price back up. If it trades at $1.02, the reverse: create new tokens by depositing a dollar, sell them at a premium.
The reserves matter because they make redemption credible. But the mechanism doing the work is a trade that only exists when redemption is genuinely available.
This is why the important question is never “is it backed?” It is “who can redeem, how fast, and at what size?” A stablecoin fully backed by assets nobody can access on demand will not hold its peg.
Fiat-backed: the simplest design
The issuer holds dollars, treasury bills and equivalents, and issues one token per dollar held.
The design is easy to reason about and its risks are conventional financial risks rather than crypto ones. Are the reserves real? Are they liquid enough to meet redemptions in a stressed week? Who audits them, and how often? Is the custodian bank sound?
The failure mode is a bank run, and it looks like a bank run: doubt about reserves triggers redemptions, redemptions strain liquidity, strained liquidity confirms the doubt. What resolves it is the issuer demonstrating access to cash quickly.
Crypto-collateralised: overcollateralised by design
Here the backing is other crypto assets, locked in contracts, and deliberately worth more than the stablecoins issued against them. Deposit $150 of collateral, mint $100.
That cushion exists because the collateral is volatile. If its value falls toward the debt, the position is liquidated automatically and the collateral sold to cover it.
These positions are managed with the same collateral logic that governs on-chain lending generally, and the mechanics are visible to anyone who wants to read the contracts. If you are new to the underlying asset, our explainer on what cryptocurrency actually is is the place to start.
The strength is transparency. Anyone can verify the collateral on-chain at any moment, which is not true of a bank statement. The weakness is reflexivity: a sharp market drop triggers liquidations, liquidations mean forced selling, forced selling deepens the drop. The system is sound in normal conditions and procyclical in bad ones.
Algorithmic: the design that mostly failed
No meaningful collateral. The peg is held by a mint-and-burn relationship with a second, volatile token: burn the volatile token to mint the stablecoin, burn the stablecoin to mint the volatile token.
The arbitrage works while the volatile token has market value. If confidence in it drops, the arbitrage inverts. Redeeming stablecoins mints more of a falling token, which pushes it lower, which makes redemption less attractive, which breaks the peg further.
That reflexive loop is not a bug that better code fixes. It is the design. It is why this category has largely disappeared from serious use, and why any new version of it deserves scepticism proportional to its promised yield.
What actually breaks a peg?
Rarely the reserves alone. Usually redemption friction.
A peg wobbles when the arbitrage that defends it becomes slow, expensive or uncertain. Redemption windows that close. Minimum sizes that exclude most holders. A banking partner that stops processing. Network congestion that makes the corrective trade too costly to bother with.
Custody of the reserves is its own question, and a live regulatory one. The SEC has a rewrite of its custody rules under White House review, and how a qualified custodian is defined will shape which institutions can hold reserves at all. The Federal Reserve has flagged the same run dynamics in its financial stability reporting.
Watch the depth of the order book and the size of the discount rather than the headline price. A stablecoin at $0.995 with deep two-way liquidity is functioning normally. The same price with thin bids and a queue at the redemption desk is not.
What this means practically
Treat a stablecoin as a credit instrument, because that is what it is. You are holding someone’s obligation, and its value depends on their ability to honour it under stress rather than on the number printed on the token.
Know which design you are holding. Know who can redeem and on what terms. And treat a peg as something maintained by incentives every day, not a property the token possesses.
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