Stablecoins Are Not Cash

Ask traders how much risk they carry and they will usually leave out the stablecoin balance. It is the safe part, the dry powder, the number that does not move.

It is also a set of claims: on an issuer, on a venue and on a chain. Each of those claims can fail, and each has done so within recent memory.

Three reminders

Issuer risk: March 2023. After Silicon Valley Bank failed, Circle disclosed that about $3.3 billion of the reserves behind USDC were held there. Over that weekend USDC traded down to around 88 cents. It recovered within days, once US authorities said that the bank’s depositors would be made whole. The lesson is not that USDC broke. It is that even a well-regarded, fully reserved stablecoin depends on the banks and the people behind it, and that the market can price that doubt in hours.

Design risk: May 2022. TerraUSD was an algorithmic stablecoin, held to its peg by a mechanism rather than by reserves. When confidence broke, it fell far below a dollar and did not come back, taking tens of billions of dollars of value with it. A token with the word “stable” in its description can go to nearly zero.

Venue risk: November 2022. FTX halted withdrawals and then filed for bankruptcy. Customers who held stablecoins there found that it did not matter how sound the coin itself was. Their balance was a claim on a failed company, and it would take years to resolve.

Three questions for every dollar

For each stablecoin balance, you should be able to answer three things.

Who stands behind it? Look at how the coin is backed, who holds the reserves, and how often that is reported and verified. Different stablecoins carry very different risks.

Where does it sit? A balance on an exchange is a promise from that exchange. A balance in your own wallet removes that risk and adds others, including the security of your keys and of the contracts you approve.

On what chain, and in what form? A bridged version of a stablecoin is not the same asset as the native one. If you hold a wrapped token, you depend on the bridge as well. Bridges have been among the most frequently exploited systems in crypto.

Keeping the powder dry

A few habits remove most of the danger without much effort.

• Set limits per issuer and per venue. Decide the most you are willing to lose to any single failure. Then keep your balances beneath that figure, even when convenience argues otherwise.
• Watch the peg. A move of a few tenths of a percent on a large stablecoin is worth your attention. Weekends deserve special care, since banks are closed and liquidity is thin.
• Know your exit before you need it. Find out which pairs and venues you would use to leave a position in a hurry, and check that they have real depth at the size you hold.
• Be careful with yield. A return on a dollar is paid for somehow. If you do not know how, you may be the one taking the risk that earns it.

None of this is a reason to avoid stablecoins. They are among the most useful tools in the market. Just count them as positions. When you add up your exposure, the dry powder belongs on the list.