Stablecoins: How They Actually Work

The stablecoin market now exceeds $170 billion. Tether holds $115+ billion, USDC around $35 billion. Over 99% of fiat-backed stablecoins are pegged to USD. This isn't a niche anymore—it's critical financial infrastructure.

The GENIUS Act, signed into law in July 2025, created federal rules for how stablecoins work. Anyone evaluating stablecoins—whether as an issuer, institutional user, or investor—needs to understand what separates legitimate operators from the rest.

Running a regulated stablecoin issuer isn't that different from running a traditional trust company. The crypto part—the blockchain, the smart contracts—is almost incidental. What matters is reserve management, audit quality, and regulatory compliance.

Here's what actually distinguishes well-run stablecoin operations.

There are three fundamentally different approaches to stablecoins. Understanding the differences matters for risk assessment.

Type 1: Fiat-Backed

The mechanism is straightforward: for every token issued, the issuer holds equivalent reserves. When someone deposits a dollar, a token is minted. When they redeem, the token is burned and the dollar returned. The peg is maintained through arbitrage—if the token trades below $1, traders buy it and redeem for full value.

Permitted reserve assets under NYDFS (now largely codified by GENIUS Act):

• U.S. Treasury bills (≤3 months to maturity)
• Overnight reverse repurchase agreements backed by Treasuries
• Government money-market funds (with approved caps)
• Deposit accounts at FDIC-insured institutions

What's NOT permitted: commercial paper, corporate bonds, crypto assets, loans to affiliates. This specificity matters. "Cash equivalents" can mean many things—regulators define exactly what counts.

Type 2: Crypto-Collateralized (DAI Model)

MakerDAO's DAI works differently. Users deposit crypto (like ETH) as collateral, then borrow DAI against it. The system requires overcollateralization—typically 150% or more. If ETH price drops and the collateral ratio falls below threshold, the position gets automatically liquidated.

The advantage: decentralized, transparent, no counterparty on reserves. The disadvantage: capital inefficient and vulnerable to liquidation cascades during market crashes.

Type 3: Algorithmic (What Killed Terra)

Algorithmic stablecoins attempt to maintain peg through supply adjustments rather than collateral. Terra/UST used a companion token (LUNA) that absorbed volatility through mint/burn arbitrage.

In May 2022, Terra collapsed. UST broke its peg, triggering a death spiral. $40 billion in value evaporated in days. Do Kwon was sentenced to 15 years in federal prison in December 2025 for fraud on "epic, generational scale."

The Terra collapse directly influenced NYDFS's June 2022 stablecoin guidance—issued one month after the crash.

Every institutional conversation about stablecoins eventually gets to Tether. Here are the facts:

The Market Position

Tether (USDT) is the largest stablecoin at $115+ billion. It's the dominant trading pair on crypto exchanges globally. It works—traders use it constantly, and it has maintained its peg through multiple crises.

The History

The CFTC found that Tether held sufficient reserves only 27.6% of the days during a 26-month sample period from 2016-2018. The New York Attorney General found that "starting no later than mid-2017, Tether had no access to banking, anywhere in the world."

In September 2017, the morning of an attestation, $382 million was transferred from Bitfinex's account to Tether's account at Noble Bank—just in time for verification.

Tether paid $18.5 million to settle with the NY AG in February 2021. The CFTC ordered a $41 million penalty in October 2021.

The Definition Change

Before February 2019, Tether's website said: "Every tether is always backed 1-to-1, by traditional currency held in our reserves."

After February 2019: "Tether Tokens are 100% backed by Tether's Reserves"—with reserves redefined to include "other assets and receivables from loans made by Tether to third parties, which may include affiliated entities."

Tether has never submitted to an independent audit—only point-in-time attestations. They operate from the British Virgin Islands.

The uncomfortable truth: the market chose convenience over compliance. Tether handles enormous volume despite its history. Offshore issuers can serve the global market without U.S. regulation.

People talk about NYDFS regulation as a badge of credibility. Here's what that actually means in practice.

The June 2022 Guidance

NYDFS issued comprehensive stablecoin guidance on June 8, 2022—one month after Terra collapsed. The core requirement: "The stablecoin must be fully backed by a Reserve of assets, meaning that the market value of the Reserve is at least equal to the nominal value of all outstanding units of the stablecoin as of the end of each business day."

Reserve Segregation

Reserve assets must be segregated from the issuer's proprietary assets, held in custody at U.S. depository institutions or NYDFS-approved custodians, and held for the benefit of stablecoin holders.

Redemption Rights

The guidance requires "clear redemption policies that confer on any lawful holder of the stablecoin a right to redeem units from the Issuer in a timely fashion at par."

Monthly Attestations

Management assertions examined by a U.S.-licensed CPA, made public, with copies to NYDFS within 30 days. This is ongoing verification, not point-in-time snapshots.

The Examination Process

NYDFS examiners examine reserve composition, reconciliation processes, redemption procedures, IT security, BSA/AML compliance, governance, and internal controls.

Why This Matters

The NYDFS model became the template for federal legislation. When the GENIUS Act passed, the requirements looked familiar—because they were based on what NYDFS had already established.

The GENIUS Act, signed by President Trump on July 18, 2025, created the first comprehensive federal framework for stablecoins. The vote: 68-30 in the Senate, 308-122 in the House.

Who Can Issue Payment Stablecoins

Three categories of permitted issuers:

1. Subsidiaries of FDIC-insured depository institutions
2. Nonbank institutions supervised by the OCC
3. State-chartered entities meeting federal standards

The state option is limited: issuers with more than $10 billion in outstanding stablecoins must transition to federal supervision.

Reserve Requirements

One-to-one backing with specified assets:

• Cash and coin
• Deposits at FDIC-insured institutions
• Short-dated Treasury bills
• Repos and reverse repos backed by T-bills
• Government money market funds
• Central bank reserves

The Securities Law Exemption

A critical provision: "A payment stablecoin issued by a permitted payment stablecoin issuer is not a 'security' under the US federal securities laws or a 'commodity' under the Commodity Exchange Act."

This removes SEC and CFTC jurisdiction over compliant payment stablecoins. That clarity is valuable.

What's Prohibited

Issuers cannot pay interest or yield solely for holding stablecoins—this distinguishes them from bank deposits. Non-financial public companies are generally prohibited from issuing stablecoins. And stablecoin holders get priority status in bankruptcy, with reserve assets excluded from the debtor's estate.

Foreign Issuers

Can operate in the U.S. if they register with the OCC, maintain reserves in U.S. financial institutions, and come from a country with comparable regulatory regime. This could affect offshore issuers' U.S. access.

Here are the stablecoin risks that have actually materialized:

The SVB Crisis: Even "Compliant" Stablecoins Can De-Peg

In March 2023, Circle announced $3.3 billion of USDC reserves were held at Silicon Valley Bank. SVB was seized by regulators. Circle couldn't wire out funds in time.

USDC fell to ~$0.87 on secondary markets. It only recovered because the federal government guaranteed all SVB deposits. If they hadn't, USDC would have been permanently impaired.

The lesson: even well-managed stablecoins with proper reserves face banking concentration risk.

Banking Relationship Risk

During Operation Chokepoint 2.0, banks were pressured to cut off crypto companies. Silvergate, SVB, and Signature all collapsed or were closed in March 2023. The industry's main banking partners disappeared within weeks.

The Terra Cascade

Terra's collapse didn't just destroy $40 billion directly. It triggered contagion: Three Arrows Capital bankruptcy (they had Terra exposure), which contributed to Celsius, Voyager, and other failures. The interconnections in crypto mean one failure can cascade.

Redemption Risk

What happens if everyone wants to redeem at once? Regulated issuers are required to have redemption capabilities that match outstanding tokens. But redemption under stress is different from redemption under normal conditions.

When evaluating stablecoins, here's the framework:

Question 1: Who's the Regulator?

Post-GENIUS Act, the hierarchy is clearer:

• Federal supervision (OCC/Fed) = highest standard
• NYDFS = equivalent to federal standards
• State money transmitter licenses = lower bar
• Offshore = minimal U.S. oversight

Question 2: What Are the Reserves?

Demand specifics. Under GENIUS Act, permitted reserves are defined. "Cash equivalents" without specifics should raise questions.

Circle's S-1 filing (April 2025) disclosed that 88% of USDC reserves are in U.S. Treasuries and overnight reverse repos, with all maturities under 2 months. That's specific and verifiable.

Question 3: How Often Are Reserves Verified?

Monthly attestations are the standard. Point-in-time snapshots can be gamed. Regular, ongoing verification is harder to manipulate.

Above $50 billion in outstanding stablecoins, the GENIUS Act requires audited annual financial statements—not just attestations.

Question 4: What's the Redemption Process?

Can you redeem directly with the issuer or only through exchanges? What are the minimums? What are the timelines?

Question 5: What's the Governance?

Who runs this company? What's their track record? Who's on the board? What oversight exists?

Question 6: What's the Bankruptcy Protection?

Under GENIUS Act, stablecoin holders have priority status, with reserve assets excluded from the debtor's estate. Verify the issuer is structured to provide this protection.

The Dollar Dominance Strategy

The GENIUS Act isn't just about consumer protection—it's geopolitical strategy. The White House fact sheet stated: "By driving demand for U.S. Treasuries, stablecoins will play a crucial role in ensuring the continued global dominance of the U.S. dollar as the world's reserve currency."

Stablecoins backed by Treasuries create structural demand for U.S. government debt.

Circle's IPO and the Maturation Signal

Circle filed its S-1 in April 2025, targeting a ~$5 billion valuation. Key disclosures: 2024 revenue of $1.68 billion (99% from reserve income), 2024 net income of $156 million. Working with JPMorgan and Citi on the IPO.

A major stablecoin issuer going public signals maturation.

OCC Trust Bank Charters

In December 2025, the OCC granted conditional trust bank charters to BitGo, Circle, Fidelity Digital Assets, Paxos, and Ripple. This brings stablecoin and custody infrastructure inside the federal banking perimeter.

Integration With Traditional Payments

Over 70% of Layer 2 blockchain payments already use stablecoins. Visa and Mastercard are settling in stablecoins. The line between "crypto payments" and "payments" will blur until it disappears.

The fundamental value proposition—programmable dollars that settle instantly, 24/7—isn't going away. The stablecoin market is approaching $200 billion and still growing.