Stablecoin Risks for Everyday Use

Stablecoins are designed to maintain a stable value, typically pegged to a fiat currency like the US dollar, making them one of the most practically useful tools in the cryptocurrency ecosystem. They enable trading without exiting to fiat, holding value within the crypto ecosystem, earning yield through DeFi protocols, and sending payments across borders efficiently. For everyday crypto users, stablecoins often function as the on-ramp and off-ramp between the volatile crypto market and the stability of fiat.

But the label “stable” creates a false sense of security. Stablecoins are not bank deposits, they are not government-backed, and they are not free from the risks that affect other crypto assets. The collapse of TerraUSD (UST) in May 2022 erased approximately AUD 60 billion in value in a matter of days. Multiple other stablecoins have temporarily or permanently broken their peg. Understanding the specific risks of different stablecoin types is essential for anyone using them beyond brief, transitory trades.

 

Types of Stablecoins and Their Core Risk Profiles

Fiat-backed stablecoins (USDT/Tether, USDC/Circle, AUDD) maintain their peg by holding reserves of fiat currency, treasury securities, or equivalent assets in traditional financial institutions. The dominant risk for these stablecoins is counterparty risk: you are trusting that the issuer actually holds the claimed reserves, that those reserves are safely custodied, and that you can redeem your stablecoins for fiat if you need to. The issuer can freeze or blacklist individual wallets, making these stablecoins less censorship-resistant than other crypto assets.

Crypto-backed stablecoins (DAI, LUSD) maintain their peg by holding an overcollateralised position in crypto assets (typically ETH or other established assets) in smart contracts. The overcollateralisation (typically 150 to 200 per cent or more) provides a buffer against the value of the collateral declining before liquidations occur. The risk is that in a severe market crash, collateral values fall faster than liquidations can be processed, potentially leaving the stablecoin undercollateralised. The quality of the liquidation mechanism and the diversity of accepted collateral types determines how resilient these stablecoins are to market stress.

Algorithmic stablecoins (like the now-collapsed TerraUSD) attempt to maintain their peg through algorithmic mechanisms, often using a companion token as a shock absorber. These have no direct collateral backing and depend on market confidence in the algorithm. They have proven extremely fragile in practice: once confidence falters, the peg breaks in a reflexive spiral that is nearly impossible to stabilise. No major algorithmic stablecoin has successfully maintained its peg through significant market stress without a hybrid collateral structure.

 

Depeg Risk

Depeg risk is the risk that a stablecoin loses its target peg value, either temporarily or permanently. For USDT and USDC, depegs have been temporary and relatively minor (a few per cent), typically triggered by concerns about reserve quality or issuer solvency and resolved as confidence returned. The March 2023 USDC depeg, when Silicon Valley Bank (which held a portion of Circle’s reserves) was seized by regulators, saw USDC trade as low as AUD 0.88 cents on the dollar before recovering to peg once Circle confirmed reserve safety.

For crypto-backed stablecoins, depeg risk increases during sharp market downturns when collateral values fall rapidly. Monitoring the collateralisation ratio of crypto-backed stablecoins (DAI’s collateral ratio is publicly visible on-chain and through interfaces like Maker’s official dashboard) provides early warning of depeg pressure. A collateral ratio approaching the minimum liquidation threshold is a signal for caution.

For anyone holding a significant amount of stablecoins, diversifying across more than one issuer reduces the risk that a single issuer’s problem (reserve concerns, regulatory action, technical failure) creates a concentrated loss. Holding both USDC and DAI, for example, means the risks are different and do not perfectly overlap.

 

Counterparty and Custodial Risk

Centralised stablecoins (USDT, USDC) rely on centralised issuers who hold the underlying reserves in traditional financial institutions. This creates counterparty risk at two levels: the stablecoin issuer and the financial institutions holding their reserves. The issuer can freeze or blacklist individual wallet addresses (both USDT and USDC have exercised this ability in the past in response to law enforcement requests), which means possession of the stablecoin does not guarantee unconditional access to the funds.

Reserve quality is a persistent concern for Tether (USDT), which has not provided a complete and independent reserve audit at the level of detail that would resolve questions about whether it holds sufficient high-quality liquid assets to support full redemption demand. Circle (USDC) publishes regular attestations and holds reserves in US Treasuries and cash, providing a clearer (though not perfect) picture of reserve quality. For large stablecoin holdings, understanding the reserve composition of your chosen stablecoin matters more than for small transitory holdings.

 

Regulatory and Compliance Risk

Regulatory risk for stablecoins is increasing globally and in Australia. The Australian Securities and Investments Commission (ASIC) and Treasury are progressing frameworks that will impose licensing and reserve requirements on stablecoin issuers operating in or targeting Australian users. Stablecoins that do not meet upcoming regulatory requirements may be restricted, de-listed from Australian exchanges, or have their redemption capacity reduced.

An AUDD-pegged stablecoin (a stablecoin denominated in Australian dollars rather than US dollars) would eliminate the USD/AUD exchange rate exposure that Australian holders of USDC and USDT carry, and would operate under Australian regulatory oversight if licensed appropriately. Watching the development of Australian stablecoin regulation through the Australian crypto regulation guide is relevant for anyone using stablecoins as a significant component of their crypto strategy.

 

Smart Contract Risk

Crypto-backed and decentralised stablecoins operate on smart contracts, inheriting all the risks of smart contract security. A vulnerability in the smart contract code that governs stablecoin minting, collateral management, or liquidation can be exploited to drain reserves, manipulate the peg, or freeze the system. The history of DeFi includes multiple incidents where stablecoins were directly or indirectly affected by smart contract exploits.

For smart-contract-based stablecoins, the quality and currency of audits, the age of the contract (more battle-tested is generally safer), and the existence of active security monitoring and bug bounty programs are all indicators of security quality. Newer stablecoins with limited audit history should be treated with more caution than established protocols like DAI (which has been operating since 2017 and has an extensive audit history). The smart contract risks guide covers how to evaluate these risks for any DeFi protocol.