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Stablecoins: How They Work, Where the Yield Comes From and What Can Go Wrong
Stablecoins are crypto tokens designed to keep a steady value, usually one US dollar. They are the main currency of crypto lending: most loans are paid out in stablecoins and most lending pools pay interest in them. This hub explains how they work and where the risks are.
What a stablecoin is
A stablecoin is a token that aims to trade at a fixed price against another asset, most often the US dollar. Holders use them to move value between exchanges and wallets, to park money between trades, and to lend or borrow without exposure to the price swings of bitcoin or ether.
The main types of stablecoins
| Type | What backs it | Main risk |
|---|---|---|
| Fiat-backed | Cash, bank deposits and short-term government bills held by an issuer | Issuer, custody and banking risk |
| Crypto-collateralized | Crypto locked in smart contracts, usually worth more than the stablecoins issued | Collateral crashes and liquidation failures |
| Algorithmic | Mainly a mechanism and a second token rather than full reserves | Loss of confidence leading to a collapse |
Fiat-backed coins such as USDT and USDC dominate trading and lending. Crypto-collateralized coins such as DAI are created by borrowing against crypto. Algorithmic designs proved fragile: TerraUSD lost its peg and collapsed in May 2022.
Where stablecoin yield comes from
A stablecoin itself usually pays nothing. Yield appears when you lend it out: to traders who borrow for leverage, to lending pools, to centralized platforms or to on-chain credit pools that finance businesses. Some issuers and platforms also pass on part of the interest earned on reserves. Higher advertised rates almost always mean more risk or temporary token incentives. Read more in stablecoin yield explained.
How stablecoins lose their peg
A depeg happens when the market price moves away from one dollar. Causes include doubts about reserves, a bank holding reserves getting into trouble, collateral crashing faster than it can be liquidated, or a run on an algorithmic design. Even well-known coins have briefly lost their peg. See stablecoin depeg risk.
Stablecoins in crypto lending
- Borrowers usually receive their crypto loan in stablecoins.
- Lenders deposit stablecoins into lending pools to earn interest.
- On-chain credit pools fund real businesses in stablecoins; see on-chain credit.
When to be careful
- Check who issues the coin, what backs it and how often reserves are reported.
- Do not assume one dollar in a token equals one dollar in a bank account.
- Spread holdings across issuers if you keep large balances.
- Rules for stablecoins are changing in many countries, which can affect availability.
Frequently asked questions
They are designed to be stable, not risk-free. Risks include reserve problems, depegs, frozen funds and smart contract bugs.
Not by themselves. You earn yield only by lending or depositing them, which adds risk.
USDT and USDC are issued by companies that hold reserves. DAI is created by users who lock crypto collateral in smart contracts.
This page is for educational purposes only and is not financial, investment or tax advice. Crypto assets are volatile; you can lose all of your money.