Why Stablecoins Hold Their Peg—and How the Promise Can Fail
The subject of this chapter is the operating promise behind a fiat-backed stablecoin: a privately issued token should remain close to a reference currency, usually one dollar, while moving on a public blockchain. The useful question is not simply whether the token is backed. It is how funds become tokens, how tokens circulate, how holders obtain the reference currency, and which institutions or markets absorb stress. Following that lifecycle explains both why a stablecoin can look money-like and why its apparent stability can weaken even when reserves still exist.
From off-chain funds to an on-chain claim
A stablecoin differs from an unbacked cryptoasset because it has an identifiable issuer and a reference-currency promise. Bitcoin and Ether fluctuate in their own units and are not promises from an issuer to pay a sovereign currency at par. A fiat-backed stablecoin, by contrast, is issued when an entity receives funds and is intended to be redeemable for the reference currency under specified terms. The token is on-chain; the assets supporting the promise are generally off-chain.
That division of location is the first fact to keep straight. Users see and transfer tokens through public, permissionless blockchains. The reserves sit in the conventional financial system, and wallets, exchanges, custodians, and other intermediaries connect the two domains. A hosted wallet is controlled through an intermediary such as an exchange or wallet company. An unhosted wallet is controlled directly by the user. Both can hold the same kind of token while presenting different points of contact with the issuer and the banking system.
The normal lifecycle begins when an issuer—or, for major coins, an approved intermediary acting with the issuer—receives funds in the reference currency. The issuer mints the corresponding tokens. Minting is not merely a database entry: it creates a private claim that is supposed to be matched by reserve assets and a redemption commitment. The Federal Reserve note describes payment stablecoins in its U.S. scope as one-to-one backed by reserve assets. The BIS describes the broader fiat-backed arrangement as a promise of redemption at par, subject to contractual terms.
The newly minted token then circulates. A user can hold it in a wallet, send it to another wallet, trade it on a centralized or decentralized exchange, or use it in a protocol that accepts it as collateral or liquidity. The blockchain records ownership and transfer continuously, outside conventional banking hours. Exchanges and other intermediaries provide on-ramps and off-ramps between fiat currency and the crypto ecosystem. The token’s movement can therefore be faster and more geographically flexible than the reserve assets supporting it.
Circulation does not require every holder to have a direct account with the issuer. For the largest stablecoin issuers, minting and redemption are often limited to a smaller set of intermediaries that act as market-makers. Other users obtain liquidity through secondary markets.