# Stablecoins 101: What They Are, Types, and How the $1 Peg Works By [Meriem Barhoumi](https://paragraph.com/@meoumi) · 2026-01-01 stablecoins, 101, usdc, tether, dai, rai --- Imagine you walk into a crypto city. In this city, everything is noisy and dramatic. One day, **ETH is up 20%**. The next day, **ETH is down 30%**. That’s exciting if you’re gambling… but if you’re trying to **save money**, **pay someone**, **set prices**, or **borrow**, it’s a nightmare. So people in this city created something boring on purpose: ### A “digital dollar” that lives on the blockchain. That’s a **stablecoin**. A stablecoin’s job is simple: > Try to stay close to $1. That target is called the **peg**. * * * The $1 magnet (how stability works) ----------------------------------- Think of $1 as a **magnet**. When the coin goes to **$0.98**, something should pull it **back up**. When it goes to **$1.02**, something should push it **back down**. A good stablecoin isn’t “stable by magic”… It’s stable because it has **a system that fights to bring it back to $1**. And different stablecoins fight in different ways. * * * Primary market vs secondary market (the part beginners miss) ------------------------------------------------------------ Before the types, one key idea: * **Secondary market** = where most people buy/sell stablecoins (DEXs, exchanges). The price can move to $0.99, $1.01, etc. * **Primary market** = where stablecoins are created or cashed out at the source (issuer/protocol). This is where **minting** and **redemption** usually happen. This matters because not every stablecoin lets _everyone_ redeem directly. Some only let big institutions do it, and everyone else trades on the secondary market. * * * Type 1: Fiat-backed stablecoins (the “bank vault” story) -------------------------------------------------------- Picture a big company with a vault. Inside the vault: real dollars (or dollar-like assets). On the blockchain: tokens that represent those dollars. So the company says: > “Give me $1, I’ll give you 1 token. > > Give me 1 token, I’ll give you $1 back.” That “swap it back for $1” is called **redemption**. ### Why does that keep it near $1? Because people love easy profit. * If the coin is trading at **$0.98**, traders buy it cheap, redeem it for **$1**, and make **$0.02 profit**. That buying pushes the price back up. * If the coin is trading at **$1.02**, traders create new coins for **$1**, sell them for **$1.02**, and profit. That selling pushes the price back down. That profit-driven balancing is called **arbitrage**. **Pros:** usually the most stable and widely used **Cons:** you must trust the company and the banking system behind it ### Quick “what could go wrong?” * If people fear reserves aren’t solid, or redemption becomes limited, confidence drops → price can drift below $1. * Some designs can freeze funds (issuer/policy risk). * * * Type 2: Crypto-collateralized stablecoins (the “pawn shop” story) ----------------------------------------------------------------- Now imagine a smart-contract pawn shop. You walk in with your ETH. The shop says: > “If you lock up $150 worth of ETH, I’ll let you borrow $100 worth of stablecoins.” That extra safety cushion is called **overcollateralization**. The safety level is often described by a **collateral ratio** (how much collateral backs the debt). ### How does it stay near $1? * If the stablecoin becomes **too expensive** (like $1.05): people are tempted to **mint/borrow more**, sell it for $1.05, and profit. More supply pushes it back toward $1. * If the stablecoin becomes **too cheap** (like $0.95): borrowers buy it cheap, repay their debt, and unlock their ETH. Buying reduces supply and pushes it back toward $1. ### What if ETH crashes? If your collateral becomes too low, the system **forces a sale** to protect itself. That forced sale is called **liquidation**. **Pros:** more transparent (you can often see collateral on-chain) **Cons:** relies on liquidations + price feeds working during chaos ### Quick “what could go wrong?” * A fast crash can overload liquidations. * Bad price feeds (oracles) can cause incorrect liquidations or under-backing. * Smart contract risk is always real. * * * Type 3: Algorithmic stablecoins (the “robot central bank” story) ---------------------------------------------------------------- Now we enter the risky neighborhood. Here, there is no simple “always redeem for $1” promise. Instead, there’s a robot that tries to manage the price using rules. Think: > “If the price is low, I’ll do things to push it up.” > > “If the price is high, I’ll do things to push it down.” How? * Some designs **mint more coins** when price is above $1 * Some designs **reduce supply** when price is below $1 * Some use a **second token** as a shock absorber * Some use incentives that try to “force” good behavior ### The big weakness: This system depends heavily on **confidence**. If people stop believing the robot can defend $1, they rush to exit — and the peg can break fast. That’s why algorithmic stablecoins are usually considered the **highest risk** category. ### Quick “what could go wrong?” * Confidence breaks → selling accelerates → peg defense can’t keep up. * Some designs can spiral (“death spiral”) when the helper token collapses. * * * A special word: PCV (Protocol Controlled Value) ----------------------------------------------- Some algorithmic/hybrid stablecoins create a “protocol treasury”. That treasury is called **PCV**. **PCV = money the protocol controls** to defend the peg. Mental picture: > A central bank keeping reserves to buy/sell in the market to protect the price. Important detail: * Users usually **can’t directly redeem** PCV like a normal $1 redemption system. PCV can help defend the peg… but it’s still a strategy, not a guarantee. * * * Where stablecoins show up in DeFi (why you should care) ------------------------------------------------------- Stablecoins are the “cash” of crypto. You’ll see them everywhere: * **Trading pairs:** most crypto trades happen through stablecoins * **Lending/Borrowing:** borrow stablecoins using ETH as collateral * **Yield strategies:** “stablecoin vaults” that pay interest (with risk) * **Payments:** quick transfers that don’t swing like ETH * * * Stable ≠ safe (the most important beginner reminder) ---------------------------------------------------- Stablecoins try to stabilize **price**, not eliminate **risk**. Different stablecoins come with different risks: * Fiat-backed: issuer/bank/regulatory risk (and sometimes freeze risk) * Crypto-backed: smart contract/oracle/liquidation risk * Algorithmic: reflexive/confidence risk (can break fast) So don’t ask only: **“Is it stable?”** Ask: **“What makes it stable?”** * * * How to judge a stablecoin in 10 seconds --------------------------------------- When you see a stablecoin, ask: 1. **What backs it?** Cash in banks? Crypto in smart contracts? Mostly incentives? 2. **Who can redeem?** Everyone, or only institutions? 3. **What happens at $0.95?** Who is guaranteed to buy it back, and with what money? 4. **What’s the worst-case failure?** Freeze risk? Liquidation failure? Death spiral? * * * Mini glossary ============= * **Peg:** the target price (usually $1) * **Depeg:** when it drifts away (like $0.97 or $1.04) * **Mint:** create new tokens * **Burn:** destroy tokens (reduce supply) * **Redemption:** swapping 1 coin back for $1 (or $1 equivalent) * **Collateral:** assets backing the stablecoin * **Collateral ratio:** how much collateral backs the debt (safety buffer) * **Overcollateralized:** backed by more than 1:1 (like $150 backing $100) * **Liquidation:** forced selling of collateral when a loan becomes unsafe * **Liquidity:** how easily you can buy/sell without moving the price much * **Arbitrage:** people making profit by buying cheap and selling/redeeming higher * **PCV:** protocol-controlled treasury used to defend the peg * * * Final takeaway -------------- Whenever you see a stablecoin, ask this one question: > If it drops to $0.95, what force pushes it back to $1? * “You can redeem it for $1” → strongest * “It’s backed by collateral + liquidations” → strong if the system is robust * “The protocol will defend it with incentives/treasury” → depends, riskier --- *Originally published on [Meriem Barhoumi](https://paragraph.com/@meoumi/stablecoins-101)*