Fiat, Crypto-Backed or Synthetic: Stablecoin Types

Stablecoins keep their peg in one of four ways. Fiat-backed coins such as USDC hold cash and short-term government assets and redeem approved customers at $1. Crypto-collateralized coins such as DAI lend against more crypto than they issue and liquidate the collateral when it falls. Synthetic dollars such as USDe hold crypto plus an offsetting short futures position. Algorithmic designs such as TerraUSD leaned on a sister token, and that design collapsed in May 2022. Each type fails in a different way, so the useful question is not "is it pegged" but "what has to keep working for the peg to hold."

This guide compares the four designs side by side, using the issuers' and protocols' own documentation, a Federal Reserve analysis of how primary and secondary stablecoin markets interact, the SEC's complaint against Terraform Labs, and the text of the GENIUS Act. Every figure in the worked examples is hypothetical unless a source is named next to it. For the full set of stablecoin guides on this site, see the stablecoins topic hub. Whether an issuer can freeze balances is a design feature that differs by token; the contract-level comparison is in can Tether or Circle freeze your stablecoins.

What "Pegged" Actually Means

A stablecoin's price on an exchange is set by trading, like any other token. Nothing in the token contract forces the price to be $1.00. What pulls the price back toward $1 is a mechanism that makes it profitable for someone to buy when the price is below $1 and sell when it is above. The four designs differ in who that someone is, what they get when they redeem, and what has to stay solvent behind the scenes.

The Federal Reserve's February 2024 FEDS Note on primary and secondary stablecoin markets draws the distinction that matters most for ordinary holders. The primary market is where the issuer creates and redeems tokens directly against its reserves. The issuers' own minimums, fees and account rules are tabulated in how stablecoin redemption works. For fiat-backed coins, access to that market is usually limited to approved institutional customers. Everyone else buys and sells on the secondary market, on centralized or decentralized exchanges, and that is where most holders actually experience the price. The note's point is that arbitrage by the small set of direct customers, who can buy cheap on an exchange and redeem at par with the issuer, is what links the two markets. If that arbitrage channel is interrupted, the exchange price can drift even when the reserves are fine.

That one idea explains most of what follows. A peg is a promise plus a pathway. The promise is what the issuer or protocol says a token is worth. The pathway is the route by which someone can turn a token into that value, quickly enough and cheaply enough to close a price gap. Each design builds the pathway differently.

The Four Designs Compared

The table below is the core comparison. Read across a row to see how one design works end to end, or down a column to compare the same feature across designs.

The rest of the guide takes each column in turn, then covers commodity-backed tokens, the legal definitions, and a checklist for working out which kind of coin you are actually holding.

Fiat-Backed Coins: A Claim on an Issuer

A fiat-backed stablecoin is the simplest design to describe and the one whose risks sit furthest from the blockchain. The issuer takes in dollars, issues tokens, and invests the dollars in assets that are meant to be worth at least as much as the tokens outstanding. When an approved customer returns tokens, the issuer pays out dollars and destroys the tokens.

Circle's USDC page describes the reserve as 100% backed by highly liquid cash and cash-equivalent assets. Cash sits at regulated financial institutions. Most of the reserve is invested in the Circle Reserve Fund, an SEC-registered government money market fund that can hold short-dated U.S. Treasuries, overnight Treasury repurchase agreements, and cash. The fund is managed by BlackRock and custodied at The Bank of New York Mellon, and its holdings are reported daily through BlackRock. Circle publishes monthly reserve attestations from an accounting firm.

The redemption pathway is narrower than many holders assume. Circle Mint, the service through which USDC is created and redeemed directly at $1, is for exchanges, institutional traders, banks, and large financial institutions. Circle's own page states that Mint is not available to individuals or small businesses. Individuals get dollars out by selling USDC on an exchange, a neobank, or a wallet's off-ramp, which means their exit price is a secondary-market price.

Tether's terms make the same point with numbers. Its fees page lists a verification fee of $150, paid in Tether tokens, a minimum redemption of $100,000, and a redemption fee of the greater of $1,000 or 0.1% per redemption. The page also says Tether keeps sole discretion over whether to approve an account. The transparency page states that Tether tokens are backed 100% by Tether's reserves and that the issuer's assets exceed its liabilities. For a closer reading of how the two largest issuers' reserves and attestations differ, see the USDT vs USDC comparison.

Worked example: why the redemption gate matters

Suppose a fiat-backed coin trades at $0.95 on an exchange while the issuer is still redeeming at par. All figures are hypothetical, except the fee formula, which is Tether's published schedule.

The direct customer's purchase is what pushes the exchange price back up. The retail holder either waits for that to happen or sells into the discount. Two lessons follow. First, a fiat-backed peg is only as fast as the arbitrage channel, which depends on banks being open and the issuer processing redemptions. Second, the holder who cannot redeem bears the price gap in the meantime.

The March 2023 example

The Federal Reserve note records what happens when the channel is interrupted. In March 2023, Circle reported that it was unable to wire out $3.3 billion of USDC reserves held at Silicon Valley Bank before regulators took control of the bank. Total reserves were roughly $40 billion at the time. Circle said issuance and redemption are constrained by the working hours of the U.S. banking system, and redemptions were paused from Friday, March 10, until Monday, March 13. Over that weekend, USDC's secondary-market price fell to lows under 90 cents.

What failed here was not the token contract and not most of the reserve. It was access to one bank, at the worst possible moment, combined with a weekend when the arbitrage pathway was closed. That is the characteristic risk profile of the fiat-backed design: credit and operational risk in the traditional financial system, transmitted into an on-chain price. The stablecoin proof of reserves checklist covers how to read the reserve reports that would show this kind of concentration.

Crypto-Collateralized Coins: Overcollateralized Loans

A crypto-collateralized stablecoin is closer to a pawnshop than to a bank. A user locks crypto in a smart-contract vault and draws stablecoins against it, always less than the collateral is worth. The stablecoin is a debt that the vault owner must repay to get the collateral back. The peg holds because the system as a whole has more collateral than debt, and because vaults that slip below the safety line are liquidated before the collateral is worth less than the debt.

The Sky protocol, formerly MakerDAO, issues DAI and its successor token USDS this way. Sky's developer documentation describes a converter that swaps DAI and USDS one for one, with no fee, and states that fees cannot be enabled on that route in the future. Each collateral type has its own parameters, including a collateralization ratio set per asset. When a vault falls below that line, a liquidation contract called the Dog confiscates the collateral and sends it to an auction module called the Clipper, which runs a Dutch auction: the price starts high and falls with time, and the auction settles instantly when a bidder accepts. Independent operators called keepers trigger these liquidations and are paid incentives to do so.

Liquidation is not free for the vault owner. Sky sets a liquidation penalty per collateral type. The documentation's own example uses a 1,000 DAI debt with a 13% penalty, which means the auction tries to raise up to 1,130 DAI from the seized collateral.

Worked example: where a vault gets liquidated

All inputs below are hypothetical, chosen to make the arithmetic visible. Real ratios differ by collateral type and change by governance vote.

The vault starts at 200% collateralization ($30,000 of collateral against 15,000 of debt). It becomes eligible for liquidation when collateral value falls to 150% of the debt, which is $22,500. Dividing by 10 ETH gives a liquidation price of $2,250 per ETH, a 25% fall from the deposit price. If it is liquidated, the auction aims to recover the debt plus the 13% penalty, or 16,950 stablecoins' worth of ETH. Whatever collateral is left after the auction returns to the vault owner.

The holder of the stablecoin, as opposed to the vault owner, does not care which vault is liquidated. They care whether the system as a whole recovers enough from auctions to cover all the debt. That is where the design can break. The crypto liquidations guide explains the same cascade mechanics in futures markets; the difference here is that the protocol, not an exchange, is the counterparty that absorbs any shortfall.

The March 2020 example

On March 12, 2020, the price crash that crypto users call Black Thursday tested exactly that. The MakerDAO community's response thread, opened that day, records that some vaults fell under 150% collateral, that for two to three hours only one keeper was triggering liquidations and was bidding $0 for the ETH with no competition, and that the system went from a surplus of more than $500,000 to a deficit of about $4 million. The thread noted that DAI was off-peg and that the protocol expected to mint and auction its governance token, MKR, to raise DAI and cover the bad debt.

The lesson for holders is that overcollateralization protects the peg only if liquidations actually happen at fair prices. A crash fast enough to congest the network and thin out the bidders can leave the system holding debts with nothing behind them. The backstop in that case was dilution of the governance token, which is a promise from the token's holders, not a reserve.

The stablecoin inside the stablecoin

Crypto-collateralized systems also hold fiat-backed coins. Sky's LitePSM, its peg stability module, swaps between DAI, USDS, and external stablecoins such as USDC without slippage, using a pool of pre-minted DAI or USDS. The documentation states that fees have not been activated on the DAI to USDC route in either direction, and that fees could change in the future. Anyone can call the module's stabilizing functions.

This is a useful pathway for the peg: if DAI trades above $1, someone can swap USDC in at par and sell the DAI; if it trades below, someone can buy DAI and swap it out for USDC. But it also means a crypto-collateralized coin with a large stability module carries some of the fiat-backed design's risk. A problem at the external stablecoin's issuer reaches the crypto-backed coin through the module.

Synthetic Dollars: A Hedge Instead of a Reserve

A synthetic dollar does not hold a dollar or lend against collateral. It holds an asset whose dollar value is kept roughly constant by pairing it with an offsetting short position. If you own one ETH and are also short one ETH of perpetual futures, a fall in the ETH price reduces the value of your ETH and raises the value of your short by about the same amount. The combined position is described as delta-neutral.

Ethena's documentation calls USDe "a crypto-native synthetic dollar" rather than a stablecoin. It says USDe derives its relative peg stability from holding a diversified portfolio of backing assets and hedging the price-change risk of any volatile holdings, with volatile assets paired with short positions in approximately the same notional size. Stable assets, such as liquid stablecoins and short-duration real-world assets, are held without a hedge. Backing assets stay with off-exchange custodians: Ethena delegates, but does not transfer, custody of backing assets to derivatives exchanges.

The peg pathway looks like the fiat-backed one but with a different gate. Ethena's peg arbitrage page says USDe can be minted and redeemed on demand by authorized, whitelisted users. If USDe trades below $1 on an exchange, a whitelisted user can buy it there and redeem it with the protocol; if it trades above, they can mint at $1 and sell. Its minting page says Ethena checks balances and signed approvals and can reject an order, and that most users get USDe through exchanges and decentralized pools rather than by minting.

Worked example: the hedge and its running cost

The inputs are hypothetical.

Price moves cancel. What does not cancel is funding, the periodic payment between long and short holders of perpetual futures. When funding is positive, shorts are paid, which is the main source of the synthetic dollar's income. When it turns negative, shorts pay. On the same hypothetical $30,000 position, an annualized funding rate of minus 10% sustained for 13 days costs about $30,000 x 10% x 13 / 365, or roughly $107. The funding rates guide explains how those rates are set.

Ethena's funding-risk page addresses this directly. It says a reserve fund steps in when combined revenue is negative and that negative revenue is not passed on to users who stake USDe. It also says that in periods of low or negative funding, more of the backing shifts into liquid stablecoins. Its historical statistics, with charts dated December 31, 2024, report that 17.5% of days for ETH and 15.9% of days for BTC perpetual futures had a negative summed return over the period studied, that the longest negative-funding streak was 13 days, and that the longest positive streak was 176 days, from late 2023 to early 2024. The page itself notes that this history predates Ethena and does not reflect its own effect on the market.

Where the synthetic design is exposed

The design concentrates risk in derivatives market structure rather than in a bank. Ethena's documentation lists funding risk, liquidation risk, custodial risk, exchange failure risk, and backing-asset risk as separate categories. On exchange failure, it says positions on a failed venue are treated as closed, with Ethena owing nothing further to the exchange estate, and that it spreads positions across multiple exchanges to limit the impact. On custody, it says backing is never deposited on exchanges and stays with off-exchange settlement providers, limiting exposure to any one exchange to the outstanding profit and loss between settlements.

Those mitigations are design choices described by the issuer. They are not the same as a regulated reserve, and a holder should read them as the protocol's account of its own controls.

Algorithmic and Endogenous Designs: The Reflexive Loop

The fourth design tried to hold a dollar peg without holding dollars or excess outside collateral. TerraUSD, or UST, was the largest example. The SEC's February 16, 2023 press release announcing charges against Terraform Labs and its founder Do Kwon describes UST as a stablecoin that supposedly maintained its peg by being interchangeable for another of the defendants' crypto assets, LUNA. The release also says Terraform marketed UST as yield-bearing, advertising returns of as much as 20% through the Anchor Protocol, and that in May 2022 UST depegged from the dollar and the price of it and its sister tokens fell close to zero, devastating retail and institutional investors. The SEC's enforcement director was quoted saying the price was controlled by the defendants, not any code.

The mechanism is easy to state and easy to see failing. When UST traded below $1, holders could swap it for $1 worth of newly minted LUNA. That burns UST, shrinking its supply, and was supposed to restore the price. But each swap also creates more LUNA, and if holders sell the LUNA, its price falls. A lower LUNA price means more LUNA must be minted for each dollar of UST redeemed, which means more selling. The backing is the market's willingness to hold the sister token. When that willingness goes, the loop runs in reverse.

The GENIUS Act, enacted in July 2025 as Public Law 119-27, writes this category into federal law without approving it. Section 14 directs the Treasury Secretary, consulting with the banking agencies, the SEC, and the CFTC, to study non-payment stablecoins, including what the Act calls endogenously collateralized payment stablecoins, and to report within 365 days of enactment. The statute defines that term as a digital asset whose originator has represented that it will be converted, redeemed, or repurchased for a fixed amount of monetary value, and which relies solely on the value of another digital asset created or maintained by the same originator to maintain the fixed price. That definition describes the UST and LUNA relationship almost exactly.

Commodity-Backed Tokens: Stable in Something Else

Some tokens are fully backed but are not pegged to a currency at all. Paxos describes PAX Gold, or PAXG, as backed by one fine troy ounce of gold stored in LBMA vaults in London, held in custody by Paxos Trust Company, which Paxos says is regulated by the Office of the Comptroller of the Currency. Holders can exchange PAXG for LBMA-accredited Good Delivery bars, and institutional customers can also redeem for unallocated gold or for dollars at the current gold price. Paxos says the gold is audited and attestation reports are published monthly.

A gold token is "stable" only in ounces. Its dollar value moves with the gold price, so it does nothing for someone who needs a stable dollar balance. It belongs in the comparison because it shares the fiat-backed design's structure, a custodian holding a real asset and an issuer redeeming approved customers, and therefore shares its risks: custody, redemption access, and the issuer's legal standing.

Where the Law Draws Lines

Calling something a stablecoin in marketing does not make it one in law. The GENIUS Act's Section 2 defines a payment stablecoin as a digital asset that is used, or designed to be used, as a means of payment or settlement, whose issuer is obligated to convert, redeem, or repurchase it for a fixed amount of monetary value and represents that it will maintain, or creates the reasonable expectation that it will maintain, a stable value relative to a fixed amount of monetary value. The definition excludes national currencies, bank deposits including deposits recorded on a distributed ledger, and securities.

Read against the four designs, the definition turns on an issuer's obligation to redeem for a fixed amount of money. That fits the fiat-backed model most naturally, and the Act's reserve rules, covered in our GENIUS Act explainer, restrict permitted issuers' reserves to cash, deposits, short-dated Treasuries, and similar instruments. Whether a particular crypto-collateralized or synthetic design falls inside or outside the definition is a question for regulators and courts, and this guide does not answer it. A gold token, denominated in ounces rather than a fixed amount of money, sits outside the plain wording. The European Union takes a different approach under MiCA, which our MiCA stablecoin analysis covers. For what MiCA means for an individual holder, including how to look a provider up in ESMA's register, see our MiCA guide for EU crypto users.

The Bank for International Settlements adds a wider frame. Its Annual Economic Report chapter of June 29, 2025 assesses stablecoins against three tests for money: singleness, elasticity, and integrity. It concludes that stablecoins perform poorly on all three, noting that because each coin is a claim on a particular issuer, stablecoins often trade at varying exchange rates, and that they have seen substantial deviations from par. The BIS view is that stablecoins may at best serve a subsidiary role in the monetary system. That is an institutional opinion, not a rule, but it is a useful reminder that even a well-run stablecoin is a private promise with its own price.

Depeg Timeline by Design

The three events have different causes, and that is the point of the table. A crash in crypto prices hit the crypto-collateralized coin. A loss of confidence in the project's own token destroyed the algorithmic one. A traditional bank failure hit the fiat-backed coin. A portfolio of two stablecoins of the same type does not diversify against that type's failure mode; two coins of different types at least fail for different reasons.

Checklist: Identify the Design Before You Rely on a Coin

Run these questions against any dollar token before you treat it as cash. Each one points to a document the issuer or protocol should publish.

Common Mistakes and Edge Cases

Treating "backed 1:1" as a redemption right. A reserve can be fully adequate while you personally have no way to redeem against it. Both the Circle and Tether pages above restrict direct redemption to approved customers, and Tether sets a $100,000 minimum.

Assuming overcollateralized means safe in a crash. Overcollateralization is a buffer, not a guarantee. The March 2020 thread shows a buffer failing because the liquidation process, not the collateral ratio, broke down.

Reading a synthetic dollar's yield as interest. The income comes from funding payments and the yield on its backing assets. It can turn negative. Ethena's own documentation describes the reserve fund that exists for that case.

Confusing supply growth with safety. A growing supply tells you demand is rising, not that the reserves or mechanism got better. Our stablecoin supply guide explains what the supply numbers can and cannot show.

Ignoring contract permissions. A stablecoin's peg design says nothing about what other contracts are allowed to move your balance. Any token you have used in DeFi may carry spending approvals you granted months ago, and a drained wallet loses its stablecoins at par whatever their backing. Our token approvals guide explains how to check and revoke them.

Forgetting the compliance layer. Moving stablecoins between an exchange and a private wallet can trigger travel rule questions, which the travel rule explainer walks through.

Edge case: a coin that changes type. Designs evolve. A crypto-collateralized protocol can add more fiat-backed collateral, and a synthetic dollar can shift more of its backing into stablecoins during negative funding, as Ethena says it does. Re-read the documentation periodically; the label you learned last year may no longer describe the coin.

Where to Go Next

If you already hold a fiat-backed coin and want to know whether its issuer's reports actually support the 1:1 claim, work through our stablecoin proof of reserves checklist next: it shows which lines of an attestation to read first and which gaps an attestation is not designed to catch.

Frequently Asked Questions

How do stablecoins keep their peg?

Through arbitrage that rewards someone for buying below $1 and selling above it. In fiat-backed coins, approved customers buy cheap on exchanges and redeem with the issuer at par. In crypto-collateralized coins, liquidations keep collateral above debt and a stability module lets traders swap against another stablecoin. In synthetic dollars, whitelisted users mint and redeem against a hedged portfolio. Algorithmic designs relied on minting a sister token, which fails if that token loses value.

What are the main types of stablecoins?

Four designs cover nearly every dollar token: fiat-backed, crypto-collateralized, synthetic or delta-neutral, and algorithmic or endogenous. Commodity-backed tokens such as gold tokens use the fiat-backed structure but track an asset other than a currency, so they are stable in ounces rather than in dollars.

Which type of stablecoin is safest?

No design is free of risk, and this guide does not rank them. Each concentrates risk somewhere different: fiat-backed coins in banks, custodians and the issuer; crypto-collateralized coins in collateral prices and liquidation machinery; synthetic dollars in derivatives venues and funding rates; algorithmic coins in confidence in a sister token. The useful question is which of those risks you are able to monitor.

Can I redeem my stablecoins for dollars directly with the issuer?

Usually not as an individual. Circle says its Mint service is not available to individuals or small businesses, and Tether's fee schedule sets a $100,000 minimum redemption, a $150 verification fee and a fee of the greater of $1,000 or 0.1%. Most holders exit by selling on an exchange or through a wallet's off-ramp, at the market price.

Is DAI backed by USDC?

Partly connected, rather than simply backed. DAI is created against collateral in vaults, and Sky's peg stability module lets anyone swap between DAI or USDS and external stablecoins such as USDC. A large stability module means some of the system's assets are USDC, so a problem at Circle would reach DAI holders through that module.

Is USDe a stablecoin?

Ethena itself describes USDe as a crypto-native synthetic dollar and does not use the word stablecoin on its explainer page. Its value comes from hedged crypto positions and stable assets, and its main ongoing risk is funding rates on the short positions. Whether it meets any legal definition of a stablecoin is a question for regulators, not something its marketing settles.

Why did TerraUSD collapse?

According to the SEC's 2023 charges, UST relied on being interchangeable with LUNA, a sister token from the same project. When UST fell below $1, swapping it for LUNA created more LUNA, which pushed LUNA's price down and made each later swap worse. In May 2022, UST and its sister tokens fell close to zero. The GENIUS Act now names this category, endogenously collateralized payment stablecoins, and orders a Treasury study of it.

Sources

CryptosEyes publishes general educational research, not investment, legal or tax advice. Nothing here recommends holding, buying or selling any stablecoin or token. Stablecoin designs, reserve compositions and issuer terms change; read the issuer's current documentation before relying on any coin for savings or payments.