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These reasons are important because they determine how stable the value of a stablecoin actually is- the more demand there is, the better the coin is able to withstand supply and demand shocks. When consumers decide to exchange, for example, USD for USDC, they judge that USDC is either necessary to purchase goods and assets, that it is wise to hold it in case they need to make an emergency cash payment in USDC, or because USDC is a better asset to hold than others. This could be because money is needed to buy goods and services (transaction demand for money), in case of emergencies (precautionary demand), or because it is a better alternative to holding other assets (speculative demand). The other part of this equation is demand- when people opt to hold money instead of other assets.

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This is why collateral is seen as important- if for whatever reason, consumers decide not to hold their stablecoins, and redeem them for fiat, the stablecoin issuer must have enough left in reserve in order to fulfil the redemption request.ĭifferent stablecoin issuers have different ideas on what amount of collateral is sufficient- leading to partial-reserve coins like FRAX, full reserve stablecoins like USDT, and over-collateralised coins like DAI.įundamentally, however, the amount of collateral they manage to obtain would limit the amount of stablecoins that they can issue. The stablecoin functions as money because people who accept it as payment are confident that they can eventually exchange the stablecoin back to fiat on demand, either through the open market, or directly with the stablecoin issuer, who will return them the fiat that was deposited. Of course, the health of the stablecoin issuer can often be a single point of failure when it comes to the token’s value. Even algorithmic stablecoins like UST were collateralised in Luna, which in turn could be exchanged on the open market for fiat currencies. Most stablecoins are backed essentially with fiat currency- some may be backed with assets that can be exchanged with fiat, or with fiat currency directly, but there is no stablecoin that does not have collateral. Instead, stablecoins are created when someone deposits money with the stablecoin issuer- who then issues the depositor an equivalent amount of stablecoins. While you might mine Bitcoin or Ethereum, stablecoins are not. Supply works in a similar way- if more people sell the currency, the price that each unit of currency can fetch decreases, and if less people sell the currency, the price of each unit of currency increases.īut how stablecoins are supplied is different from how other tokens are supplied. It is therefore important to understand what creates demand for a currency, and how stablecoins are supplied.Ī very basic overview is that when more people want to hold a particular currency, the price of that currency appreciates as people are willing to pay more for it, causing the currency to appreciate and gain value.Ĭonversely, when less people want to hold a particular currency, demand falls and people hoping to sell the currency are forced to lower prices if they want to sell it. And in every market, it is demand and supply that determines the price and quantity of every good sold- even for tokens and coins.

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These coins were held by everyday consumers, who were free to buy and sell these tokens on the free market. While many have argued that Do Kwon was just out to rug people, and have blamed the USDC depegging as part of the US governments’ attacks on crypto, it was ultimately the market that decided to dump the coins when they felt these coins were not worth holding on to. This will be the focus of today’s exploration- to understand where stablecoins get their stability from, and how we can avoid further implosions. The spectacular collapse of the UST ecosystem, as well as the USDC depegging that occurred not long ago, show that perhaps stablecoins are not as stable as their name implies- but why? Stablecoins are supposed to be stable- they are supposed to remain pegged to a certain value, most commonly the US Dollar.īut, as the past few months have demonstrated, stablecoins do not always fulfil this expectation.