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Stablecoins

Pomegra Learn

Stablecoins

Bitcoin's extreme volatility—swinging 20% in a day—makes it poor as a unit of account or medium of exchange. You can't price a coffee in Bitcoin if the cup's cost doubles by noon. Stablecoins attempt to solve this by anchoring themselves to something stable: a fiat currency like the US dollar, a basket of cryptocurrencies, or an algorithmic rule. The result is an asset you can hold in a smart contract or transfer across blockchains while reasonably expecting its value to remain near $1.

But stablecoins are not neutral bridges between fiat and crypto. Each design embeds assumptions and risks. Tether (USDT), the oldest and largest, claims to be backed 1:1 by US dollar reserves—but for years refused independent audits, revealing little about whether those reserves truly existed. USD Coin (USDC), issued by Circle and backed by actual dollars held in FDIC-insured accounts, trades transparency and regulatory compliance for slower innovation. MakerDAO's DAI achieves stability without a central issuer by locking crypto collateral into a smart contract, but in return requires its collateral to be over-collateralized by 50% or more. Terra's LUNA, which promised algorithmic stability without collateral, collapsed catastrophically in 2022, erasing over $40 billion in a week and standing as crypto's clearest object lesson in mechanism design failure.

This chapter teaches you to evaluate stablecoins. You'll understand the three fundamental models—fiat-collateralized, crypto-collateralized, and algorithmic—and their tradeoffs. You'll learn how peg mechanisms work and what breaks them. You'll examine reserve disclosure, auditing practices, and the regulatory landscape emerging around stablecoins as central banks recognize them as potential threats to monetary sovereignty. You'll study the Terra collapse in detail, not to mock its designers but to internalize the specific failure modes that claimed such a large sum so quickly.

Why this matters​

Stablecoins are the working capital of decentralized finance. You can't use Bitcoin as collateral for a loan if you don't know whether it will halve in value next week. You can't build a DeFi protocol on volatility. But the stability you gain is only as solid as the mechanism behind it—and history shows that many mechanisms fail catastrophically when tested by market conditions. Distinguishing between robust stability and engineered illusion is essential for allocating capital safely.

What you'll learn​

This chapter begins with the mechanics of fiat-collateralized stablecoins: why Tether dominated for so long despite regulatory grey areas, how USDC's FDIC insurance works, and what "reserve" actually means. You'll study crypto-collateralized systems by working through DAI's mechanism in detail: how collateralization ratios prevent underbacking, what happens during liquidations, and why you need a large surplus buffer to handle volatility. We'll examine algorithmic stablecoins from first principles, see why early designs failed, and understand exactly what went wrong with Terra—the specific feedback loop that broke the peg and triggered the death spiral. You'll learn how stablecoins relate to central bank digital currencies (CBDCs), and what competition from CBDCs might mean for private stablecoins. Finally, you'll develop a framework for evaluating any new stablecoin: What's backing it? Who controls the reserves? What happens if the collateral crashes? What audit and regulatory scrutiny can you verify?

How to read this chapter​

Start with the fiat-collateralized models; they're the simplest and most widely used. Move through the crypto-collateralized mechanics carefully—DAI requires attention but rewards it with deep understanding. The Terra section is crucial; don't treat it as history. Instead, use it as a template for identifying similar risks in new protocols. By the end, you should be able to hold a stablecoin in your hand (metaphorically) and articulate exactly what keeps its value stable and what could break it.

Stablecoins sit at the boundary between finance and technology, between decentralization and regulation. They're also where many investors first experience the gap between a whitepaper's promise and on-chain reality. This chapter equips you to navigate that boundary with confidence.

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