Stablecoins Explained: Pegs, Reserves and Depegging Risk

A stablecoin labeled “$1” is not automatically the same thing as a dollar. It is a crypto asset intended to maintain a stable value relative to a reference asset rather than become that asset itself. The name describes a design goal, not a guarantee.

That distinction matters because every stablecoin needs a mechanism to keep its market value near the reference value. Some issuers hold reserve assets and offer redemptions. Others rely on collateral made up of different crypto assets or use algorithms intended to adjust supply. If the mechanism fails—or users doubt that it will work—the market price can move away from its target. The potential for depegging remains a core risk even when a token normally trades close to its peg.

A peg is the target, not the support system

The peg answers one question: What value is the stablecoin trying to track? A U.S. dollar-referenced coin, for example, generally aims to represent $1 per token. Stablecoins can also reference commodities, other currencies or baskets of assets. Fractions normally preserve the same relationship, so 0.5 of a dollar-referenced stablecoin would represent $0.50 under a one-for-one design.

The support system answers a different question: What is supposed to keep the token near that target?

Reserve-backed issuers generally sell tokens at the reference value, place the proceeds into a reserve and use assets held in reserve to fund one-for-one redemptions. In the strongest version of this model, reserve value meets or exceeds the redemption value of outstanding coins, and the assets are sufficiently liquid to meet redemption requests.

Other stablecoins use commodities, crypto collateral or supply-adjustment algorithms. These structures do not create identical risks:

These categories are broad rather than interchangeable labels. For example, crypto-backed stablecoins may use over-backing to absorb some collateral volatility, but doing so ties up additional capital and does not eliminate verification difficulties. An algorithmic design, meanwhile, depends on the behavior of its rules rather than a conventional pool of reserve assets.

How reserves and redemptions reinforce a peg

A reserve-backed peg is easiest to understand as a balance between tokens outstanding and resources available for redemption. If one token can reliably be exchanged for $1, a market price materially below $1 may appear unattractive compared with redeeming it at the stated value. But that stabilizing logic depends on the redemption arrangement actually functioning.

The example highlights two separate tests. Reserve adequacy asks whether the assets are worth enough to cover outstanding redemption value. Reserve liquidity asks whether those assets can be turned into the required payment promptly. A reserve can appear adequate by stated value while still raising questions about how readily its assets can be used for redemptions.

Asset custody and permitted use matter too. A more protective reserve structure would keep assets segregated, avoid lending or pledging them, and limit their use to honoring redemptions rather than funding business operations or speculative trading. Those controls help address the possibility that apparently sufficient assets may be unavailable when holders want to redeem.

Why a stablecoin can depeg

A depeg is a move away from the intended reference price. It need not mean that a token has permanently failed, but it does show that the targeted relationship is not holding at that time.

Several vulnerabilities can weaken the peg:

• Insufficient reserves: The assets backing outstanding tokens may not equal the promised redemption value.
• Illiquid reserves: Assets may be difficult to sell or use quickly enough to satisfy redemption demand.
• Uncertain verification: The public may be unable to confirm the amount, composition or custody of collateral. It can be difficult for the public to verify reserves with enough detail to assess the backing claim.
• Collateral volatility: Crypto-backed designs rely on digital assets whose values can change, even when the structure starts with collateral worth more than the stablecoins outstanding.
• Algorithm failure: A supply-adjustment mechanism may not restore the intended price when demand shifts.
• Operational or cybersecurity problems: Stablecoins share cybersecurity and regulatory uncertainty risks with other crypto assets, and some designs introduce additional technical dependencies.
• Trading and liquidity conditions: Crypto assets can be less liquid than traditional instruments, which may make selling more difficult and intensify price movements.

The practical point is that the market price reflects confidence in the whole arrangement—not just the stated peg. The reserve assets, redemption process, custody structure, technology and issuer all contribute to whether one token is treated as being worth the reference amount.

What reserve disclosures can—and cannot—show

A reserve report can provide useful information, but the label on the report matters less than its scope. Readers should look for the date covered, assets included, liabilities compared, valuation method and whether an independent party performed meaningful procedures.

“Proof of reserves” is not necessarily equivalent to an audited set of financial statements. The term commonly describes a voluntary, point-in-time method of showing aggregate reserve assets. A proof of reserves is generally less comprehensive than a financial statement audit and may operate without standardized engagement requirements. The entity can have considerable discretion over what is examined and reported.

That creates a common misconception: evidence that some assets existed at one moment does not, by itself, establish that all obligations were included, the assets remained available afterward or the issuer could honor every redemption. Reserve assets should therefore be considered alongside liabilities and the rules governing custody and use—not viewed as a standalone wallet balance.

A practical way to interpret a stablecoin claim

Before treating “stable” as a description of risk, separate the claim into five questions:

1. What is the reference asset? Identify whether the token targets a dollar, commodity, crypto asset or basket.
2. What maintains the peg? Determine whether the design uses fiat reserves, commodity holdings, crypto collateral, an algorithm or a combination.
3. What does one-for-one mean in practice? Examine how issuance and redemption are supposed to work, including what asset is delivered when a token is redeemed.
4. What supports the disclosure? Distinguish a full financial statement audit from a narrower attestation or proof-of-reserves presentation.
5. What could block access or value? Consider reserve shortfalls, illiquidity, cybersecurity problems, withdrawal restrictions and limited market liquidity.

Stablecoins also exist within the broader crypto marketplace, where registration is limited and some traditional investor protections may not apply. Crypto assets can be volatile and less liquid than stocks and bonds, while an entity holding customer assets may create additional access and custody risks. A token’s ability to track $1 during ordinary trading does not answer what happens if its issuer, reserve custodian, platform or technical mechanism fails.

The most useful misconception test is simple: replace the statement “this coin is worth $1” with “this coin is designed to track $1 using this particular mechanism.” That wording forces attention onto the reserves, redemption terms and failure points that determine whether the peg is credible.

Sources

1. SEC.gov | Statement on Stablecoins — sec.gov
2. Crypto Assets | FINRA.org — finra.org
3. 3 Things to Know About Stablecoins | FINRA.org — finra.org
4. Exercise Caution with Crypto Asset Securities: Investor Alert | Investor.gov — investor.gov