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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.

Articles in this chapter​

📄️ USDC: The Regulated Stablecoin

USDC, issued by Circle, represents a different approach to stablecoins—one emphasizing regulatory compliance and institutional relationships. While USDT dominates by market share, USDC has grown to become the second-largest stablecoin by a significant margin, appealing to users and institutions concerned about regulatory risk and reserve transparency. USDC's design and backing reflect an intentional strategy to build stablecoin infrastructure that works alongside traditional finance rather than in opposition to it.

📄️ DAI: Decentralized Stablecoin from MakerDAO

DAI represents a fundamentally different approach to stablecoins: a decentralized system where no single organization controls the stablecoin and collateral is locked in transparent smart contracts rather than held in corporate reserves. Issued by MakerDAO, DAI is the most successful example of a crypto-collateralized stablecoin—one backed by cryptocurrencies rather than traditional dollars. This approach eliminates dependency on centralized institutions and traditional banking relationships while introducing new technical risks and complexities.

📄️ Crypto-Collateralized Stablecoins

Crypto-collateralized stablecoins represent a different approach to achieving price stability: backing stablecoins with cryptocurrencies rather than traditional fiat currency. This approach eliminates dependency on traditional banking relationships and enables fully transparent, blockchain-verifiable reserves. However, it introduces unique challenges that fiat-collateralized stablecoins avoid. Understanding how crypto-collateralized stablecoins work, why they exist despite their added complexity, and what risks they introduce is essential for comprehensive stablecoin knowledge.

📄️ Bridging Stablecoins Across Chains

The rise of multiple blockchains has created unprecedented opportunity and complexity. Bitcoin, Ethereum, Solana, Arbitrum, Polygon, and dozens of other chains each offer unique advantages—faster transactions, lower fees, or specialized functionality. But they also fragment liquidity. A stablecoin that exists only on Ethereum cannot easily settle payments on Solana. Users want to move value across chains seamlessly, but traditional finance solved this through intermediaries: you deposit dollars at Bank A, wire them to Bank B, and withdraw at the destination. Blockchain demands a better answer. Bridging stablecoins across chains has become essential infrastructure for a multi-chain crypto economy, yet it introduces new risks that even experienced investors often underestimate.

📄️ When Stablecoins Lose Their Peg

The fundamental promise of a stablecoin is encoded in its name: stability. A stablecoin pegged to the US dollar should be worth $1.00. In practice, stablecoins frequently deviate from their peg, sometimes by cents, sometimes by dollars. These deviations—called "depegging events"—can last from minutes to weeks or months. Understanding what causes a stablecoin to lose its peg, why the market allows it, and how systems recover is essential for anyone holding stablecoins or using them in financial strategies.

📄️ Terra/Luna: The Algorithmic Stablecoin Collapse

On May 7, 2022, Terra's UST stablecoin began its death spiral. Two weeks later, both UST and Luna—the ecosystem's native token—had collapsed from tens of billions in value to a fraction of a cent. What began as a promising experiment in algorithmic stablecoins ended as one of crypto's most instructive catastrophes. The collapse wiped out tens of billions in investor value and demonstrated why most algorithmic stablecoins are fundamentally fragile. Understanding Terra's failure is essential for anyone evaluating stablecoin technology or crypto risk.

📄️ Comparing Major Stablecoins

The stablecoin landscape has evolved from a niche experiment to a multi-hundred-billion-dollar asset class dominated by a handful of major players. USDC, USDT, DAI, and a few others now serve as essential infrastructure for cryptocurrency finance. But these stablecoins differ significantly in design, backing, regulation, and risk profile. For anyone holding or using stablecoins, understanding these differences is critical to choosing the right tool for the job and sizing risk appropriately.

📄️ Stablecoins and the Future of Money

Money has always been about stability. Throughout history, humans have sought media of exchange that preserve value over time—from commodity-backed currencies to fiat systems to the digital money of today. Stablecoins represent a new chapter in that story: the first privately-issued digital currencies that maintain stable value through technological and financial mechanisms. Whether stablecoins become essential infrastructure for a digital economy or a temporary experiment depends on regulatory clarity, technological maturation, and adoption by both institutions and individuals. The implications extend far beyond crypto to reshape how money itself functions.

📄️ Stablecoins in Traditional Finance

For most of stablecoins' history, they existed in a parallel world: crypto people used them on decentralized exchanges and DeFi protocols while traditional finance ignored them. That separation is ending. Banks, payment networks, asset managers, and financial institutions are increasingly integrating stablecoins into their operations. This integration marks a critical shift—stablecoins are moving from crypto-only infrastructure to mainstream finance infrastructure. The implications are profound for how money settles, how payment systems work, and how financial institutions compete.