What Makes a Good Stablecoin?

Introduction

In a space obsessed with yield, speed, and speculation, it’s easy to forget what truly holds value: trust. Not the kind whispered in Discord or hyped in Telegram pumps — but the kind built on verifiable reserves, clear rules, and accountability when things go wrong. Stablecoins were supposed to be the calm in crypto’s chaos. But not all stables are created equal. Behind every peg is a question: Can I trust this? Can I see what backs it? And if it breaks — who’s responsible? That’s where the real story begins. It’s about compliance that protects, and transparency that empowers.

The Best of Both Worlds

The Web2 world is built on compliance, comfort in its predictability, and efficiency in its structure. There are rules, oversight, and accountability. When you interact with a Web2 system, you can expect things to work as promised. If they don’t, there are customer service lines, legal protections, and regulatory backstops. This order allows people to trust systems they don’t fully understand, and that trust keeps the whole machine running.

But beneath that structure lies a deep opacity. Decisions are made behind closed doors, processes are locked away in proprietary systems, and access is controlled by powerful gatekeepers. Innovation is often stifled by red tape, and users rarely know what happens to their data, their money, or even their digital identity. It’s a world that works—until you start asking questions.

Web3, by contrast, feels like the Wild West—open, permissionless, and bursting with possibility. Anyone can launch a token, spin up a DAO, or build financial tools without asking for permission. It’s a playground for innovation, a place where the rules are still being written, and the pace is set by the community rather than corporations. That freedom is thrilling—but it comes with a cost.

Without clear oversight or enforceable guardrails, the ecosystem can be dangerously chaotic. Scams aren’t just possible—they’re frequent. Fraudsters appear, drain wallets, then vanish into anonymity, only to resurface under new aliases. There’s often no one to report to, no court to turn to. According to Chainalysis, crypto addresses tied to illicit activity received an estimated $40.9 billion in 2024 — a figure that could climb to $51 billion as more addresses are identified, accounting for 0.14% of all on-chain transaction volume.

Type of Stablecoins

To understand how stablecoins function, it’s important to explore the different types and the categories they fall into

1. By Collateral Type

Fiat-backed stablecoins are the most common. They’re backed 1:1 by real-world fiat currency like USD held in bank reserves. Each unit of stablecoin is redeemable for an equivalent dollar. Examples include USDC, USDT, and PYUSD. These offer strong price stability but are fully centralized and subject to regulatory oversight.

Crypto-backed stablecoins use crypto assets (like ETH or BTC) as collateral. To account for volatility, they’re often overcollateralized — for example, you might need to deposit $150 of ETH to mint $100 of DAI. These are more decentralized and transparent since they operate on-chain, but they can face liquidation risks during sharp market downturns. DAI, LUSD, and crvUSD fall into this category.

Commodity-backed stablecoins are tied to physical assets like gold or oil. Their value tracks the price of the underlying commodity. For example, PAXG and XAUT represent 1 ounce of gold per token. These are ideal for those looking to hedge against inflation, but they’re less common and come with centralized custodial risks.

Algorithmic stablecoins have no collateral or only partial backing. They use smart contracts and algorithms to control the token supply, expanding it when the price is high and contracting it when the price drops. In theory, this keeps the price stable. However, many have failed, with UST and USDN being high-profile examples. They’re capital-efficient but notoriously fragile.

Hybrid models combine multiple elements — for instance, FRAX initially blended fiat reserves with algorithmic controls. These try to get the best of both worlds but come with added complexity.

Yield-bearing stablecoins represent a new class. These not only hold value but also earn yield passively. Tokens like sDAI, aUSDC, and USD* by Perena are examples. They’re pegged to $1 but accrue value from lending, staking, or RWA strategies, allowing holders to earn yield automatically.

2. By Peg Stability Mechanism

The way a stablecoin maintains its $1 peg can vary widely.

Some rely on off-chain collateral and redemptions — for example, USDC can be redeemed for actual USD through Circle. This straightforward model ensures price stability but relies on trust in the issuer.

On-chain collateralized models (like DAI or LUSD) use smart contracts to lock collateral and maintain solvency. If the collateral value falls too low, positions are liquidated to protect the peg.

Algorithmic peg mechanisms don’t use collateral at all. Instead, they adjust the token supply automatically based on price data, minting when the price goes above $1 and burning when it falls below. While theoretically elegant, these systems (like UST) often fail under stress.

Rebasing models work differently — they maintain a stable value by increasing or decreasing the number of tokens in your wallet. For example, if USD* appreciates due to yield, it can either rebase your balance or increase the token's internal value. You always see your balance grow instead of the price changing.

3. By Level of Decentralization

Stablecoins vary in how much control is held by centralized entities.

Centralized stablecoins like USDC and USDT are issued and managed by companies. They provide legal clarity, are widely accepted, and often regulated, but they require full trust in the issuer.

Semi-decentralized models like GHO or FRAX are DAO-controlled but may still rely on centralized oracles, custodians, or fiat reserves.

Fully decentralized stablecoins like DAI (after its move toward decentralized collateral) or LUSD are governed by protocols and smart contracts without any central point of failure. These are more censorship-resistant but may offer less stability during market volatility.

Transparency is a design decision. It’s not about who controls the system — it’s about how visible and verifiable that system is to the public. We can use FRAX as an example, some off-chain RWA yield sources are not fully clear, making it decentralized but not transparent.

4. By Yield Potential

Many early stablecoins didn’t offer any return — you held USDC or USDT just to stay out of volatility. But now, stablecoins are evolving into yield-bearing assets. Non-yielding stablecoins are those like USDT, USDC, and PYUSD. You only earn yield by manually deploying them into DeFi strategies.

Yield-bearing stablecoins automatically accrue interest. Tokens like sDAI (which taps into Maker’s DSR), aUSDC (from Aave), and USD* (from Perena) grow in value over time or adjust balances via rebasing. They’re perfect for users who want passive returns while staying in stable assets.

Some models require manual staking to earn yield — for example, locking DAI in a DSR vault. Others are auto-compounding by design, making them more user-friendly and gas-efficient.

Compliance And Transparency

Irrespective of these classifications, what truly stands out is how transparent a stablecoin is — and whether it’s regulated. A good stablecoin needs the best of both worlds: compliance and transparency. However, the challenge with compliance lies in the fact that some regulatory bodies, which are meant to foster trust, have instead contributed to distrust through a lack of clarity, slow implementation, oversight gaps, overregulation, anti-innovation policies, and jurisdictional turf wars.

When it comes to regulation, the New York Department of Financial Services (NYDFS) stands as the gold standard for stablecoin compliance, offering real-world enforcement, high levels of transparency, and robust consumer safeguards — all while enabling regulated innovation.

In this article, I’ll be focusing on fiat-backed stablecoins — the most widely used and arguably the most trusted type of stablecoin. These assets aim to combine the stability of fiat currency with the efficiency of blockchain technology.

I’ll also highlight key depegging events throughout history, showing how lapses in compliance and a lack of transparency have consistently played a central role in undermining trust.

Case Study I

The March 2023 depeg of USDC and DAI was not caused by smart contract failure or algorithmic malfunction; it was caused by a lack of real-time transparency into fiat reserves and banking exposure.

• Circle held $3.3B of USDC reserves in Silicon Valley Bank, and this wasn’t fully known by the public until after SVB collapsed.

• The delay in disclosing exposure triggered panic selling. Without live or auditable proof of reserve liquidity, markets assumed the worst — that Circle wouldn’t be able to redeem $1 of USDC for $1.

• DAI followed because over 50% of its collateral was USDC or USDC-based assets — a direct risk from overconcentration in a non-transparent asset.

Lesson:

“If transparency had been real-time and complete — including bank counterparty disclosures — fear and irrational exits could have been mitigated.”

Stablecoins like USDC operate within a regulated framework, but the SVB failure showed that banking compliance does not equal risk management:

• SVB was a regulated U.S. bank, yet its sudden failure created a systemic shock in the crypto world.

• Circle and Coinbase had to pause redemptions to avoid a bank run-style scenario, but doing so introduced centralized gatekeeping, which broke trust in convertibility.

This incident highlighted that traditional financial regulation can’t guarantee 24/7 access, solvency, or redemption, especially in volatile markets that move faster than bank hours.

In practice:

“Compliance alone doesn’t protect users if it's opaque, relies on fragile third parties, or creates black boxes around risk exposure.”

Case Study II

BUSD experienced the longest depeg event above the $1.1 threshold, lasted 47 consecutive minutes, and for USDP, 26 consecutive minutes in February 2023.

Both BUSD (Binance USD) and USDP (Pax Dollar) are regulated by the New York Department of Financial Services (NYDFS) and issued by Paxos, a licensed trust company. Ironically, it was their compliance status that caused the peg pressure:

• In February 2023, NYDFS ordered Paxos to stop issuing BUSD, citing "unresolved issues" related to Binance’s use of the token.

• That regulatory crackdown, though framed as a compliance measure, immediately shook market confidence in BUSD’s longevity, despite full fiat reserves.

• Traders began to speculate that BUSD could be delisted, restricted, or no longer redeemable, which triggered price surges above $1 as users tried to exit or front-run a redemption freeze.

Lesson:

“Even when reserves are intact, unclear or abrupt regulatory actions can distort prices by disrupting redemption confidence — effectively punishing compliant issuers.”

The short-lived depegs of BUSD and USDP weren’t caused by insolvency or bank exposure (unlike USDC/SVB) — they were caused by credibility gaps:

• Users had no transparent forward guidance on what a regulatory freeze meant.

• Even fully backed, redeemable tokens can trade off-peg if markets can’t verify redemption guarantees in real time.

• When redemptions slow, halt, or seem at risk, arbitrage breaks, and traders treat stablecoins as speculative assets, not stable money.

In practice:

“Compliance should reinforce transparency. But when compliance results in uncertainty and silence, it disrupts the very price stability regulation claims to protect.”

Case Study III

On December 30, 2017, USDT traded at $10 per USD on EXMO. On that day, $213,000 cleared on EXMO’s USDT/USD trading pair.

EXMO was a relatively small, loosely regulated exchange at the time, operating with minimal KYC/AML enforcement and limited oversight. This made it vulnerable to:

• Low liquidity and shallow order books

• Poor pricing infrastructure

• Wash trading or price manipulation

• Sudden withdrawal halts or operational hiccups

In the absence of strong compliance standards, EXMO became a weak link in the stablecoin ecosystem. A thin order book or sudden user panic could drive massive price deviations — in this case, 10x the peg — without any real relationship to Tether’s reserves or the broader market.

Lesson:

“Compliance isn’t just about AML/KYC — it’s also about ensuring orderly, fair market functioning. When exchanges lack oversight, price discovery breaks.”

In 2017, Tether (USDT) had virtually no transparency about its reserves. There were:

• No public audits

• No real-time attestations

• Ongoing speculation that Tether was minting unbacked USDT

• Legal clouds hanging over Tether’s relationship with Bitfinex

At that time, the market had zero clarity about whether 1 USDT equaled 1 USD, especially when redemption paths were limited or opaque.

So when users were trying to exit EXMO or move capital out of USDT during low liquidity, some were willing to pay $10 in USD to get $1 of USDT, just to get their funds into a more liquid or accessible form — even irrationally.

In practice:

“When a stablecoin issuer isn’t transparent about reserves or redemption, price stability becomes a rumor. Market participants trade on fear, not fundamentals.”

Case Study IV

PayPal USD saw one super weird price swing soon after its launch, trading as high as $236,493.17 on August 20, 2023, and as low as $0.09621 on August 21, 2023 — showing that it is anything but immune to a depeg despite the well-established business backing it.

PayPal USD is issued by Paxos, a highly regulated entity under the New York Department of Financial Services (NYDFS). From a compliance standpoint, it's:

• Fully fiat-backed

• Regularly attested

• Issued under strict oversight

But here's the catch: despite all this, the price of PYUSD still experienced a massive, irrational spike, not because the reserves failed, but because market structure and price discovery mechanisms failed. Regulatory compliance at the issuer level doesn't automatically translate to price stability at the exchange or liquidity level.

Lesson:

Compliance ensures solvency. It does not guarantee sane market pricing; it’s just one half of the puzzle.

That absurd $236K price likely occurred on an illiquid or unregulated exchange, where:

• Liquidity was shallow

• Order books were thin

• Price oracles may have glitched

• Buyers (or bots) placed orders without checking the price impact

Most likely, someone fat-fingered a market order on a low-volume pair, and with no liquidity or circuit breakers in place, it executed at absurd prices.

This highlights a transparency issue at the exchange level, not the issuer:

• No clear visibility on real market depth

• No warnings to users about slippage

• No price sanity checks (a standard in more compliant markets)

In practice:

“A stablecoin can be 100% backed — but if it’s trading in a black box, the price can still go to the moon or fall into the dirt.”

How to Pick a Good Stablecoin Based on Transparency and Compliance

1. Reserve Transparency: Can you verify what backs it, and where?

Ask:

• Does the issuer publish regular reserve attestations or audits?

• Are the reserves fully disclosed (cash, T-bills, commercial paper, etc.,)?

• Are these audits done by a reputable third-party?

• Is real-time data on reserves available (like Circle’s USDC dashboard)?

Be cautious of:

• Coins with no audits or irregular reporting

• Hidden exposure to volatile or synthetic assets (like algorithmic coins)

2. Redemption Clarity: Can you always redeem $1 for $1?

Ask:

• Does the issuer guarantee redemption of the stablecoin for fiat or collateral?

• Are redemptions open to the public or limited to institutions?

• Is there any history of paused redemptions?

Watch out for:

• Coins that pause redemptions during stress events (BUSD, USDC during SVB panic)

• Algorithmic coins with no guaranteed collateral (e.g., UST, USDN — now defunct)

3. Compliance & Regulatory Oversight: Who's watching them?

Ask:

• Does a recognized financial regulator license the issuer?

• Are they operating under a clear legal framework?

• Is their jurisdiction trustworthy (i.e. U.S., Europe, Singapore)?

Be cautious of:

• Offshore issuers with no regulatory presence or opaque affiliations

• Coins with histories of regulatory enforcement actions (e.g., Tether was fined by the CFTC in 2021)

Final Thought:

What backs a stablecoin explains how it works. Transparency shows whether you can trust it. Compliance makes it clear who’s accountable when things go wrong. In crypto, the difference between a hero and a villain often comes down to how open and responsible the system is. As The Dark Knight puts it: ‘You either die a hero, or live long enough to see yourself become the villain.’ Without transparency and accountability, even the most trusted stablecoin can cross that line.

If a stablecoin isn’t transparent, you’re relying on faith. If it isn’t compliant, you have no legal fallback. Only when both are present, across any classification, can a stablecoin be truly considered “stable.”

References

1. Paxos. “Paxos Applauds New York Department of Financial Services on New Guidance on the Issuance of U.S. Dollar‑Backed Stablecoins.” Paxos Newsroom, June 8, 2022. https://www.paxos.com

2. NYDFS. “Notice Regarding Paxos‑Issued BUSD.” NYDFS Consumer Alert. February 13, 2023. https://www.dfs.ny.gov.

3. Roth, Emma. “Crypto Firm Paxos Ordered to Stop Issuing Binance Stablecoin.” The Verge, February 13, 2023. https://www.theverge.com

4. Winston & Strawn LLP. “SEC and the NYDFS Take Aim at Paxos.” Winston Alert, February 2023.

5. Paxos. “Paxos Prevails in SEC Investigation of BUSD Stablecoin.” Paxos Newsroom, July 11, 2024. https://www.paxos.com

6. European Central Bank. “Digital Euro – Investigation Phase.” ECB Website. Accessed June 2025. https://www.ecb.europa.eu

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11. Monetary Authority of Singapore. “MAS Finalises Stablecoin Regulatory Framework.” MAS Press Releases, August 2023.

12. Financial Stability Board. “Regulation, Supervision and Oversight of Global Stablecoin Arrangements.” FSB Final Report, October 2023.

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15. Circle. 2023. USDC Attestation Reports. https://www.circle.com/transparency

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17. Paxos Trust Company. 2023. Monthly Reserve Reports for PYUSD and PAXG.

    https://www.paxos.com/

18. Tether. 2023. Tether Reserves Transparency Reports. https://tether.to/en/transparency/

19. CFTC (U.S. Commodity Futures Trading Commission). 2021. CFTC Orders Tether to Pay $41 Million for Misleading Statements. https://www.cftc.gov/PressRoom/PressReleases/8450-21

20. MakerDAO. 2024. DAI Collateral Overview and Risk Dashboard. https://daistats.com/

21. Liquity. 2024. LUSD Protocol Documentation and Collateral Transparency. https://www.liquity.org/

22. NYDFS (New York Department of Financial Services). 2023. Virtual Currency Regulatory Framework. https://www.dfs.ny.gov/apps_and_licensing/virtual_currency_businesses

23. FinCEN (Financial Crimes Enforcement Network). 2023. Registration Requirements for Money Services Businesses. https://www.fincen.gov/

24. EXMO. 2017. USDT/USD Historical Data on December 30, 2017. [Archived Trading Data]

25. CoinMarketCap. 2023. PayPal USD (PYUSD) Price History. https://coinmarketcap.com/currencies/paypal-usd/

26. U.S. Federal Reserve. 2023. Statement by Federal Reserve Regarding Support for SVB Depositors. https://www.federalreserve.gov

27. CoinDesk. 2023. USDC Depegs as Circle Confirms $3.3B Exposure to SVB.

    https://www.coindesk.com/

28. DeFiLlama. 2024. Stablecoin Market Overview and Depeg Events. https://defillama.com/stablecoins

29. FRAX Finance. 2023. Hybrid Stablecoin Model Documentation. https://docs.frax.finance/

30. Aave. 2024. aUSDC and aDAI Interest-Bearing Stablecoin Mechanics. https://docs.aave.com/

31. Curve Finance. 2024. crvUSD Collateral and Peg Mechanism. https://docs.curve.fi/crvusd/