Stablecoin Risks at Scale

7.1 Breaking the buck

In September 2008, during the global financial crisis, a large US money market fund, an investment considered almost as safe as cash, saw its share value fall below $1, to about $0.97. It had held debt issued by a bank that had just collapsed. Investors rushed to withdraw, and panic spread across the money market industry until the US government stepped in with guarantees.

"That's a fund that was supposed to be worth exactly $1," said Hash. "Sound familiar?"

"Like a stablecoin," said Mint.

"Stablecoins at scale face many of the same risks," said Hash. "Module 9 looked at how stablecoins work inside DeFi. This chapter looks at what could go wrong as they grow to the size of major financial institutions."

7.2 Stablecoins and bank runs

A run happens when many holders try to redeem at once, fearing they won't get full value if they wait. Runs can become self-fulfilling: if an issuer has to sell assets quickly to meet redemptions, it may sell at a loss, which makes remaining holders even more nervous.

Factor	Effect on run risk
Reserves in cash and very short-term government bonds	Lower: easy to sell quickly at full value
Reserves in longer-term or riskier assets	Higher: may need to be sold at a loss
Reserves in bank deposits at a single bank	Higher: exposed to that bank's failure
Frequent, independent reserve reporting	Lower: confidence is better informed
Clear redemption rights for all holders	Lower: arbitrage keeps the price near $1
Redemption only for large institutional users	Higher: smaller holders must sell on the market

7.3 A run in numbers

Illustrative scenario. A stablecoin has $100 billion in circulation. A rumour spreads about its reserves, and 10% of holders redeem within a week.

	Value
Redemptions	$10 billion in one week
Cash and overnight assets available	$5 billion
Bonds that must be sold	$5 billion

If the bonds are very short-term government debt, they can usually be sold quickly near full value, and the issuer survives. If reserves include longer-dated or riskier assets, selling $5 billion quickly might mean accepting losses, which could deepen fears and accelerate redemptions.

This is why regulators increasingly require stablecoin reserves to be held in highly liquid, short-term, safe assets.

Chapter 7 · A stablecoin run in numbers

A $100B stablecoin facing $10B of weekly redemptions meets the first $5B from cash and overnight holdings, then must sell $5B of bonds. Liquid Treasury reserves absorb the sales, but illiquid or risky reserves realise losses that can trigger a self-reinforcing run.

7.4 Historical stablecoin stress

Event	What happened	Lesson
TerraUSD, May 2022	Algorithmic design collapsed under redemption pressure; peg never recovered (Module 9, Chapter 12)	Without real reserves, confidence spirals can be fatal
USDC, March 2023	Exposure to a failed bank pushed it to about $0.88 briefly; recovered after depositors were protected	Even well-backed stablecoins depend on the banking system
Various smaller stablecoins	Depegs from weak collateral, exploits, or loss of confidence	Size and design matter; smaller stablecoins can break more easily

7.5 Other systemic risks

Freezing and censorship. Many fiat-backed stablecoin issuers can freeze tokens at specific addresses (Module 9, Chapter 7). This helps respond to theft and legal orders, but it means holders depend on the issuer's policies and the laws that apply to it.

Concentration. A small number of stablecoins account for most of the supply. A failure of a major stablecoin would affect exchanges, DeFi protocols, and traders across the entire crypto market.

Banking dependencies. Issuers depend on banks for deposits, redemptions, and payment rails. Banking partner problems can disrupt redemptions even when reserves are sound.

Legal and regulatory risk. Changes in regulation, enforcement actions, or legal disputes can affect an issuer's ability to operate in certain countries.

Transparency gaps. Attestations differ from full audits. The quality and frequency of reserve reporting varies by issuer.

Spillover to traditional finance. As stablecoins grow, a large run could force significant sales of government bonds, potentially affecting short-term funding markets. Policymakers have cited this as a reason for regulation.

7.6 How to evaluate a stablecoin's risk

Question	What to look for
What backs it?	Cash and short-term government bonds are safest
How often, and how independently, are reserves verified?	Frequent, detailed reports from reputable firms
Who can redeem, and how quickly?	Broad, fast redemption rights
Which banks hold its deposits?	Diversification across sound institutions
Is it regulated, and where?	Licensing in major jurisdictions with reserve requirements
Can it freeze tokens?	Most fiat-backed stablecoins can; understand the policy
How has it behaved under stress?	Depeg history and recovery speed
How large and liquid is it?	Deep liquidity across exchanges and DEXs

7.7 Diversifying stablecoin exposure

"If I hold most of my savings in one stablecoin, I'm trusting one issuer completely," said Node.

"Exactly," said Hash. "Many people treat stablecoins like cash, and forget they're promises from specific companies."

Some practical approaches:

1. Spread larger stablecoin holdings across more than one well-backed stablecoin.
2. Understand which stablecoins your DeFi positions depend on, including through other stablecoins (Module 9, Chapter 12).
3. Watch for stress signals: DEX price drift below $1, pool imbalances, and rapid redemptions (Module 6, Chapter 8).
4. Consider how much of your savings should be in stablecoins at all, versus regulated bank accounts or government bonds.

7.8 Try it yourself

Choose two major stablecoins. Answer the questions in section 7.6 for each, using their reserve reports and public information. Then find each one's lowest market price over the past three years. Which do you consider lower risk, and why?

Key takeaways from this chapter

1. Stablecoins at scale face risks similar to money market funds and banks, including runs.
2. Run risk depends on reserve quality, liquidity, banking exposure, transparency, and redemption rights.
3. Selling reserves quickly to meet redemptions can cause losses if reserves aren't highly liquid.
4. TerraUSD and USDC's 2023 depeg show the range of stablecoin stress, from total collapse to temporary wobble.
5. Other risks include freezing, concentration, banking dependencies, regulation, transparency gaps, and spillovers to bond markets.
6. Evaluate stablecoins on reserves, verification, redemption, banking, regulation, freeze policy, history, and liquidity.
7. Treat stablecoins as promises from specific issuers, and diversify larger holdings.