How stablecoins hold their peg — and when they don't

A stablecoin is a token designed to trade at a fixed value against a reference asset, usually a major currency. The design question is what makes the market believe the peg will hold.

Fiat-backed models

The issuer takes in currency, holds it in reserve assets such as short-dated government bills and bank deposits, and issues tokens against it. Approved counterparties can redeem tokens for currency at par. If the token trades below the peg, redeeming at par is profitable, and that arbitrage pulls the price back — provided redemption is genuinely open and prompt.

Crypto-collateralised models

Here tokens are issued against volatile crypto collateral held in overcollateralised positions, with automated liquidation if collateral value falls too far. The mechanism is transparent on-chain but depends on liquid markets during exactly the moments when liquidity tends to disappear.

Algorithmic models

These attempt to hold a peg by expanding and contracting supply, often with a companion token absorbing volatility, and without full reserve backing. The structure depends on continued demand for the companion token; when that demand reverses, the feedback loop runs the wrong way.

Regulation is closing the gap

MiCA introduced EU-wide requirements for asset-referenced and e-money tokens, including reserve, redemption and disclosure obligations for issuers. Other jurisdictions are moving at different speeds. A token widely used in one market may be unavailable or non-compliant in another.