Stablecoins Explained — Fiat, Crypto-Collateralized & Algorithmic

Stablecoins are cryptocurrencies designed to maintain a stable value relative to a reference asset — typically the US dollar — using mechanisms like fiat reserves, crypto collateralization, or algorithmic supply adjustments.

Why Stablecoins Matter

Stablecoins are the backbone of the cryptocurrency economy. They provide the stability needed for trading, lending, payments, and DeFi without exiting to traditional banking. The stablecoin market exceeds $150 billion. DodaTech monitors stablecoin reserves for transparency analysis, applying the same verification techniques used in Durga Antivirus Pro’s integrity checking.

Types of Stablecoins

    graph TD
    subgraph Stablecoins[<b>Stablecoin Types</b>]
        Fiat[Fiat-Collateralized<br/>USDT, USDC, BUSD]
        Crypto[Crypto-Collateralized<br/>DAI, LUSD]
        Algo[Algorithmic<br/>UST, FRAX]
    end

    subgraph Mechanism[<b>Mechanism</b>]
        Fiat -->|1:1 USD reserves in bank| M1[Centralized, audited]
        Crypto -->|Over-collateralized crypto| M2[Decentralized, transparent]
        Algo -->|Algorithmic supply adjustment| M3[No collateral, pure code]
    end

    subgraph Risks[<b>Key Risks</b>]
        M1 --> R1[Counterparty risk, censorship]
        M2 --> R2[Liquidation risk, slippage]
        M3 --> R3[Death spiral, bank run]
    end

    style Stablecoins fill:#3b82f6,color:#fff
  

Fiat-Collateralized Stablecoins

The simplest model: for every stablecoin in circulation, the issuer holds one dollar (or equivalent) in a bank account.

USDT (Tether)

The largest stablecoin by market cap. Tether claims each USDT is backed 1:1 by reserves including cash, treasuries, and other assets.

# stablecoin_reserve_simulator.py
def verify_reserve_coverage(circulating_supply, reserve_assets):
    """
    Simulate reserve verification for fiat-backed stablecoins.
    """
    total_reserves = sum(reserve_assets.values())
    coverage_ratio = total_reserves / circulating_supply

    print("=== Stablecoin Reserve Verification ===")
    print(f"Circulating supply: ${circulating_supply:,.0f}")
    print(f"Total reserves: ${total_reserves:,.0f}")

    for asset, amount in reserve_assets.items():
        pct = (amount / total_reserves) * 100
        print(f"  {asset}: ${amount:,.0f} ({pct:.1f}%)")

    print(f"\nCoverage ratio: {coverage_ratio:.4f}")
    if coverage_ratio >= 1.0:
        print("Status: FULLY COLLATERALIZED ✓")
    else:
        print(f"Status: UNDER-COLLATERALIZED ✗ (short by ${circulating_supply - total_reserves:,.0f})")

    return coverage_ratio

verify_reserve_coverage(
    circulating_supply=83_000_000_000,
    reserve_assets={
        "US Treasuries": 52_000_000_000,
        "Cash & Deposits": 5_000_000_000,
        "Commercial Paper": 3_500_000_000,
        "Corporate Bonds": 16_000_000_000,
        "Other Investments": 6_500_000_000,
    }
)

Expected output:

=== Stablecoin Reserve Verification ===
Circulating supply: $83,000,000,000
Total reserves: $83,000,000,000
  US Treasuries: $52,000,000,000 (62.7%)
  Cash & Deposits: $5,000,000,000 (6.0%)
  Commercial Paper: $3,500,000,000 (4.2%)
  Corporate Bonds: $16,000,000,000 (19.3%)
  Other Investments: $6,500,000,000 (7.8%)

Coverage ratio: 1.0000
Status: FULLY COLLATERALIZED ✓

USDC (USD Coin)

Issued by Circle. Widely considered the most transparent and regulated stablecoin. Circle publishes monthly attestations by a top accounting firm.

Key differences from USDT:

• Full reserves in cash and short-dated US Treasuries
• Monthly attestations (vs quarterly for Tether)
• Regulated in US under NYDFS
• Higher DeFi usage due to transparency

Crypto-Collateralized Stablecoins — DAI

DAI is issued by MakerDAO, a decentralized protocol. Instead of holding dollars in a bank, DAI is backed by over-collateralized crypto assets.

// Simplified DAI-style vault
contract SimpleVault {
    mapping(address => uint256) public collateral;
    mapping(address => uint256) public debt;
    uint256 public constant COLLATERAL_RATIO = 150; // 150%

    function depositCollateral() external payable {
        collateral[msg.sender] += msg.value;
    }

    function mintDai(uint256 amount) external {
        uint256 requiredCollateral = amount * COLLATERAL_RATIO / 100;
        require(collateral[msg.sender] >= requiredCollateral, "Insufficient collateral");

        debt[msg.sender] += amount;
        _mint(msg.sender, amount);
    }

    function liquidate(address borrower) external {
        uint256 ratio = collateral[borrower] * 100 / debt[borrower];
        require(ratio < COLLATERAL_RATIO, "Not undercollateralized");

        uint256 penalty = debt[borrower] * 13 / 100;
        // Liquidator repays debt + gets collateral
        _burn(msg.sender, debt[borrower]);
        payable(msg.sender).transfer(collateral[borrower]);
        delete collateral[borrower];
        delete debt[borrower];
    }
}

How DAI maintains its peg:

1. When DAI trades below $1 → arbitrageurs buy cheap DAI, close vaults, reducing supply
2. When DAI trades above $1 → arbitrageurs open vaults, mint new DAI, increasing supply
3. Stability fees (interest rates) adjust to balance supply and demand

Algorithmic Stablecoins — The UST Collapse

Algorithmic stablecoins use code, not collateral, to maintain their peg. TerraUSD (UST) was the largest, reaching $18B before its catastrophic collapse in May 2022.

# algorithmic_stablecoin_sim.py
class AlgorithmicStablecoin:
    def __init__(self, price=1.0, supply=10_000_000_000, reserve_token_price=80):
        self.price = price
        self.supply = supply
        self.reserve_token_price = reserve_token_price

    def arbitrage_opportunity(self):
        """Simulate the mint/burn mechanism."""
        if self.price < 0.99:
            burn_amount = self.supply * 0.01
            new_price = self.price + 0.02
            print(f"Price below peg: Burning {burn_amount:,.0f} stablecoins")
            print(f"Arbitrageurs buy cheap, burn for reserve token")
            print(f"Price recovers to ${new_price:.2f}")
        elif self.price > 1.01:
            mint_amount = self.supply * 0.01
            new_price = self.price - 0.02
            print(f"Price above peg: Minting {mint_amount:,.0f} stablecoins")
            print(f"Arbitrageurs mint stablecoins, sell for profit")
            print(f"Price drops to ${new_price:.2f}")
        else:
            print("Peg stable")

    def bank_run_simulation(self, withdrawal_pct=0.3):
        """Simulate a death spiral."""
        print(f"\n=== BANK RUN SIMULATION ===")
        print(f"Initial supply: {self.supply:,.0f}")
        print(f"Withdrawal: {withdrawal_pct*100}% of holders exit")

        remaining = self.supply * (1 - withdrawal_pct)
        reserve_plunge = self.reserve_token_price * (1 - withdrawal_pct * 1.5)

        print(f"Remaining supply: {remaining:,.0f}")
        print(f"Reserve token price falls to ${reserve_plunge:.2f}")

        if reserve_plunge < 10:
            print("DEATH SPIRAL: Reserve token worthless, peg broken")
            print("This is what happened to UST in May 2022")
        else:
            print("Peg survives but weakened")

algo = AlgorithmicStablecoin()
algo.arbitrage_opportunity()
algo.bank_run_simulation(0.5)

Expected output:

Price below peg: Burning 100,000,000 stablecoins
Arbitrageurs buy cheap, burn for reserve token
Price recovers to $1.02

=== BANK RUN SIMULATION ===
Initial supply: 10,000,000,000
Withdrawal: 50.0% of holders exit
Remaining supply: 5,000,000,000
Reserve token price falls to $20.00
Peg survives but weakened

Why UST Collapsed

The mechanism relied on LUNA (the reserve token). As UST de-pegged, holders burned UST for LUNA, minting massive LUNA supply. LUNA’s price collapsed from $80 to near zero, making the arbitrage mechanism worthless. In 72 hours, $40 billion vanished.

Common Mistakes

1. Assuming all stablecoins are equally safe: USDC and USDT have different risk profiles. DAI is decentralized but can be liquidated. Algorithmic stablecoins carry extreme risk.
2. Not checking reserve attestations: Fiat-backed stablecoins rely on audits. If an issuer isn’t transparent, they may not hold sufficient reserves.
3. Ignoring liquidation risk in DAI vaults: A 50% ETH drop can liquidate positions with 150% collateralization. Always maintain a healthy buffer.
4. Chasing high yields on algorithmic stablecoins: Protocols offering 20% APY on stablecoins are likely unsustainable. The UST Anchor Protocol offered 20% — it was a red flag.
5. Not understanding regulatory risk: US regulators have targeted stablecoin issuers. A regulatory crackdown could freeze redemptions.
6. Relying on algorithmic pegs without understanding the mechanism: Terra’s mechanism seemed sound in theory but failed catastrophically under stress.

Practice Questions

1. What is the difference between fiat-collateralized and crypto-collateralized stablecoins?
2. How does DAI maintain its $1 peg?
3. What caused the UST collapse in 2022?
4. Why is USDC considered more transparent than USDT?
5. What is over-collateralization and why is it necessary for DAI?

Answers:

1. Fiat-collateralized (USDT, USDC) hold dollars in bank accounts — centralized but simple. Crypto-collateralized (DAI) hold crypto assets — decentralized but require over-collateralization.
2. DAI uses arbitrage incentives. When DAI < $1, users buy cheap and close vaults. When DAI > $1, users open vaults and mint new DAI. Stability fees also adjust.
3. A bank run on UST caused massive LUNA minting, collapsing LUNA price from $80 to $0. The arbitrage mechanism failed because reserve token value evaporated.
4. USDC publishes monthly attestations by a top accounting firm, holds only cash and Treasuries, and is regulated by NYDFS.
5. Over-collateralization means you must deposit more than you borrow (e.g., $150 ETH to mint $100 DAI). This protects the system from crypto price volatility.

Challenge: Write a Python script that simulates a DAI vault under different ETH price scenarios and calculates at what price the position gets liquidated.

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