What Are Stablecoins and Should You Hold Them?

The Basics: What Are Stablecoins?

Stablecoins are cryptocurrencies engineered to maintain a constant value—almost always pegged to 1 US dollar. While Bitcoin (BTC) swings 20-30% in a week and Ethereum (ETH) can drop 40% in a month, stablecoins are designed to stay near $1.00 at all times.

The core problem they solve is simple: crypto markets operate 24/7, but traditional banking doesn't. When you want to exit a volatile position at 3 AM on a Sunday, you can't wire money to your bank. Stablecoins eliminate that friction. You can instantly convert your crypto to a dollar-pegged token and hold that value without leaving the blockchain.

Think of stablecoins as digital cash on the blockchain. They inherit crypto's settlement speed (minutes) while borrowing the dollar's stability. This makes them essential infrastructure for trading.

Why Stablecoins Matter to Traders

Before stablecoins, traders faced a dilemma: stay in volatile crypto assets between trades, or withdraw to fiat (slow and expensive). The first $100 million in USDT trading volume came from traders needing this bridge.

Today, the use case is different but equally critical:

• Avoid liquidations without exiting crypto: Instead of selling your BTC position outright (triggering a taxable event), move into USDC to wait out a downturn. You keep your spot on-chain but reduce portfolio volatility.
• Rapid position rotation: Swap between altcoins without waiting for fiat transfers. BTC to USDC to ETH to USDC takes minutes; fiat transfers take 1-3 days.
• Dollar-cost averaging into alts: Receive USDC paycheck, deploy it daily into smaller positions rather than buying one lump sum at the top.
• Yield without directional bet: Earn 3-5% APY on stablecoins via lending protocols (Aave, Compound) with zero price risk.

How Stablecoins Work: Three Mechanisms

Stablecoins use three fundamentally different approaches to maintain their $1 peg. Understanding these differences is critical because they carry different risks.

Fiat-Backed Stablecoins (USDC, USDT)

The simplest design: the issuer holds $1 in a bank account for every $1 stablecoin in circulation. You give the issuer dollars, they mint stablecoins on your behalf. You redeem stablecoins, they burn them and return your dollars.

USDT (Tether) example: As of January 2025, Tether holds over $112 billion in stablecoins in circulation and claims to back each one with $1 of reserves. The company publishes quarterly attestations (not full audits) showing their reserve composition. In 2023, USDT's backing shifted from primarily cash to a portfolio including US Treasury bills, commercial paper, and other liquid assets.

USDC (Circle) example: Circle, backed by major VCs and financial institutions, took a different approach. USDC is fully backed by dollar reserves or short-term US Treasury bonds. Circle underwent a full third-party audit by Grant Thornton in 2022, and publishes weekly reserve reports on-chain. As of early 2025, over $35 billion USDC are in circulation.

Trade-off matrix:

For traders, USDC is the "safer" choice if you value regulation and transparency. USDT is the pragmatic choice if you need maximum liquidity and every exchange support.

Crypto-Backed Stablecoins (DAI)

Instead of holding fiat reserves, crypto-backed stablecoins are overcollateralized by other cryptocurrencies. MakerDAO's DAI is the prime example: you lock $1,500 in ETH as collateral, the protocol mints $1,000 in DAI, and you hold a position earning fees on the locked collateral.

How DAI maintains its peg: If DAI drops below $1.00, it becomes profitable to buy DAI and redeem it for $1 of collateral (arbitrage). This buying pressure pushes DAI back to $1. If DAI rises above $1.00, users mint more DAI to sell it, increasing supply until the price returns to $1.

Risks unique to DAI:

• If ETH crashes 50%, users' collateral becomes underwater, and the protocol faces undercollateralization risk.
• DAI requires at least 150% collateralization (you lock $1,500 to mint $1,000), which is inefficient compared to fiat-backed options.
• Regulatory risk: MakerDAO is decentralized, so no single entity can freeze DAI. But governance tokens (MKR) may face regulation.

DAI is best for traders who want to avoid counterparty risk from centralized issuers. The trade-off is lower capital efficiency and exposure to collateral volatility.

Algorithmic Stablecoins (Terra/Luna — the Cautionary Tale)

Algorithmic stablecoins have no collateral. Instead, they use economic incentives (minting/burning tokens) to maintain the peg. Terra's Luna (LUNA) was designed so that if UST (Terra's stablecoin) fell below $1, you could burn $1 of UST and mint $1 of LUNA—a profit mechanism that should theoretically restore the peg.

In May 2022, this mechanism spectacularly failed. UST depegged to $0.10, LUNA hyperinflated from $80 to $0.0002, and $40 billion in value evaporated in 72 hours. This was the worst crypto collapse of the cycle and created the term "death spiral."

Why did it fail? The peg mechanism assumes rational actors always arbitrage inefficiencies. But when confidence collapses (a bank run), rational arbitrage can't compete with mass redemptions. Algorithmic stablecoins rely entirely on belief.

Practical takeaway: Avoid algorithmic stablecoins entirely. The risk is existential, not marginal.

Stablecoins vs. Other Alternatives

As a trader, you have multiple ways to park capital between positions. Here's how stablecoins compare:

Real-World Use Cases for Traders

Case 1: Riding Out Market Volatility

You bought ETH at $2,200 in September 2024. By December, it's $3,500—a 59% gain. You want to take profits but don't want to sell to fiat (taxes, withdrawal delay).

The move: Sell 50% of your ETH into USDC. You now hold $87,500 in USDC and $87,500 in ETH. If ETH crashes to $2,000, you've protected half your gains. If ETH climbs to $4,500, you still participate in 50% of the upside. Your USDC can now earn 4% APY on Aave while you wait for your next entry point on an altcoin.

Tax advantage: Swapping ETH to USDC is a taxable event (you're realizing gains), but you can execute it at your own pace on-chain, at 3 AM on a Sunday, without waiting for banking hours.

Case 2: Dollar-Cost Averaging Into Positions

You have $10,000 to deploy into Bitcoin, but BTC is up 40% in the last 3 months and you're wary of catching a falling knife. You also expect your monthly paycheck in USDC.

The move: Instead of deploying all $10,000 immediately, buy $1,000 of BTC every 10 days for the next 100 days. Stablecoins let you sit idle between buys, earning yield, rather than holding BTC and exposing yourself to 10-20% swings.

Historical context: If you had DCA'd $1,000/month into BTC from January 2022 (the start of a bear market) through December 2023, you would have bought at an average price of ~$18,500 and held a position worth $42,000 by year-end 2023. The same $24,000 invested as a lump sum in January 2022 would have been worth only $21,000.

Case 3: Earning Yield on Idle Capital

You're between trades and holding $50,000 in cash. In traditional finance, your bank offers 0.01% APY. On Aave, you can deposit USDC and earn 3.8% APY (as of January 2025). Over a year, that's $1,900 in passive income with minimal additional risk beyond the lending protocol's smart contract code.

The real trade-off: Aave carries smart contract risk (bugs, hacks) that traditional banks don't. But the yield differential (3,800x higher) compensates many traders for this risk, especially on smaller positions.

Risks and Pitfalls to Avoid

Mistake 1: Assuming "Pegged" Means "Never Depegs"

Every stablecoin has depegged at least once. USDC fell to $0.87 on March 11, 2023, when Silicon Valley Bank (which held USDC reserves) collapsed. Traders who thought USDC was risk-free suffered real losses. DAI regularly trades $0.98-$1.02, not $1.00 flat.

Reality check: Stablecoins are stable *relative to crypto*, not in absolute terms. Price slippage of 0.5-2% is normal during high volatility.

Mistake 2: Holding Stablecoins on Risky Platforms

FTX held $8 billion in customer stablecoins. When FTX collapsed in November 2022, customers lost access to them. This wasn't a stablecoin failure—it was an exchange failure. But the outcome was identical: your money was gone.

Best practice: If you're not actively trading, move stablecoins off exchanges to your own wallet or to lending protocols. If you're trading actively on a single exchange, it's acceptable to hold some USDC/USDT there for instant order execution—but never your entire stack.

Mistake 3: Overweighting Yield Farming

In 2021-2022, platforms like Celsius and Voyager Digital offered 10-15% APY on stablecoins. Traders deployed millions. Both platforms collapsed in 2022, and customers are still litigating recovery. The yield was real, but the risk was hidden (leverage abuse, poor risk management).

Safe yield targets: Accept 3-5% APY on established protocols (Aave, Compound, Curve). Anything higher than 5% should trigger deep diligence into the issuer's business model.

Mistake 4: Ignoring Regulatory Risk

In June 2023, the US Senate passed a bill requiring stablecoin issuers to be federally chartered banks. While the bill hasn't passed the full Congress, it signals regulatory intent. Tether faces ongoing legal scrutiny; Paxos (PAXG's issuer) handed off its stablecoin business to PayPal under regulatory pressure.

Scenario planning: If regulatory crackdowns accelerate, USDT (the most exposed) could face restrictions, while USDC and PYUSD (PayPal) might benefit. This isn't price risk—it's tail risk. Size your stablecoin holdings accordingly.

Mistake 5: Not Understanding Exchange Risk

USDC and USDT trade on different blockchains: Ethereum, Solana, Polygon, Arbitrum, etc. USDC on Ethereum is not the same token as USDC on Solana. If you bridge USDC from Ethereum to Solana via a faulty bridge, you could lose the entire amount. This happened to Poly Network in 2021 ($611 million hack).

Rule: Use official bridges or exchanges. Avoid third-party bridges unless you fully understand the smart contract risk.

Which Stablecoin Should You Hold?

USDC: The "Safest" Option

When to use: You prioritize regulatory clarity and transparency. You're willing to accept slightly lower liquidity on some smaller exchanges.

Pros: Full audits, weekly on-chain reserves, licensed in multiple jurisdictions, backed by strong institutions (Coinbase, Circle investors).

Cons: Lower total liquidity than USDT; some exchanges have lower USDC trading pairs; regulatory dependence on Circle's license.

Current holding (Jan 2025): $35 billion in circulation. Likely to grow if regulatory environment favors licensed stablecoins.

USDT: The Pragmatist's Choice

When to use: You need maximum liquidity and exchange support. You accept higher counterparty risk in exchange for universal availability.

Pros: Highest total circulation ($112B+); available on literally every exchange; deepest trading pairs; best for large position rotations.

Cons: Least regulated; opaque reserve composition; Tether has faced multiple legal challenges; concentration risk (Tether is a single point of failure).

Reality check: Tether is "too big to fail" in the crypto ecosystem. Every major exchange depends on USDT. But this also means regulatory intervention could be sudden and disruptive.

DAI: The Decentralization Play

When to use: You want to avoid counterparty risk from centralized issuers. You have deep knowledge of DeFi.

Pros: Fully decentralized; no central issuer risk; can be minted/redeemed on-chain; Maker DSR yields 5-8%.

Cons: Lower liquidity than USDC/USDT; collateral risk if ETH crashes; more volatile (regular depegs of $0.98-$1.02); smart contract risk.

Best use case: Holding long-term on DeFi protocols for yield. Not ideal for active trading.

PYUSD (PayPal Stablecoin)

When to use: You have a PayPal account and want bridge between traditional finance and crypto. You believe PayPal's regulatory standing will strengthen the token.

Pros: PayPal backing (global payment infrastructure); strong regulatory compliance; easy on/off-ramp for traditional users.

Cons: Only $1B+ in circulation (small); limited exchange support; custody through PayPal (centralized).

Future outlook: Likely to grow if PayPal expands crypto services. But for crypto-native traders, USDC is a better choice today.

FAQs: Common Questions About Stablecoins

Are stablecoins FDIC-insured like bank deposits?

No. USDC and USDT are not bank deposits—they are cryptocurrency tokens. While Circle and Tether claim their reserves are FDIC-insured, that insurance only covers the issuer's bank deposits, not your stablecoins. If Circle went bankrupt, FDIC insurance would protect Circle's bank account, not your USDC. This is a key risk distinction.

Can I earn yield on stablecoins without smart contract risk?

Not in crypto. Your options are: (1) Keep stablecoins on your exchange and earn 0% (exchange risk), (2) Lend via centralized platforms like Celsius (counterparty risk, now defunct), (3) Deposit in DeFi protocols (smart contract risk). Every yield source carries risk. Aave's USDC yields are among the safest because Aave is battle-tested and audited, but smart contract risk is never zero.

What happens if USDT or USDC loses their peg permanently?

If a stablecoin loses its peg and can't recover (like UST/Luna), the issuer becomes insolvent. Your USDT/USDC becomes worth whatever the market will pay for it—potentially pennies on the dollar. This is why regulatory oversight matters. USDC's $1 peg is backed by Circle's willingness to redeem it at par value. If Circle disappears or becomes insolvent, USDC becomes worthless. This is counterparty risk.

Should I diversify across multiple stablecoins?

For active traders on a single exchange, holding one stablecoin (usually whatever the exchange offers with best liquidity) is pragmatic. For longer-term holdings, splitting between USDC and USDT reduces concentration risk. A common approach: 60% USDC (safer), 40% USDT (deeper liquidity). This balances regulatory safety with practical usability.

Are stablecoins taxable events in the US?

Yes. Swapping BTC to USDC is a taxable trade. The IRS treats it as a sale of BTC, and you owe capital gains tax on the difference between your cost basis and the price when you swapped. You cannot "reset your cost basis" by moving to stablecoins. This is a common misconception.

Can I lose money on a stablecoin?

Yes, in several ways: (1) The stablecoin depegs and you're forced to sell at a loss, (2) The issuer becomes insolvent (Luna/UST), (3) The exchange holding your stablecoins fails (FTX), (4) Smart contract exploits on lending platforms drain your balance. Stablecoins are "stable" in price, not risk-free.

Next Steps: Building Your Stablecoin Strategy

Now that you understand stablecoins, here's how to apply this knowledge:

1. Choose your primary stablecoin: Pick USDC (safety) or USDT (liquidity) based on where you trade. If you're on Solana, check if the exchange supports both and choose the one with tighter spreads.

2. Set a stablecoin reserve target: Decide what % of your portfolio sits in stablecoins at all times. Conservative traders: 20-30%. Active traders: 10-20%. This provides dry powder for opportunities without overexposing you to issuer risk.

3. Decide on yield: If you have stablecoins idle for more than a week, consider Aave (3.8% APY on USDC) or Curve (similar yields). If you're actively trading, keep them on your exchange. The extra 3-4% isn't worth liquidation delays if you need to move quickly.

4. Monitor regulatory changes: Follow SEC and CFTC announcements about stablecoin regulation. If Tether faces sanctions or restrictions, USDT's value could drop (liquidity crisis) even if the peg holds. Stay informed.

This article is part of Ticker Daily's How to Trade Crypto: A Complete Guide for 2026. For deeper dives into specific trading strategies, see our guides on position sizing, leverage, and altcoin analysis.

Disclaimer: Stablecoins are not risk-free. While designed to maintain $1 peg, they carry counterparty risk (issuer failure), smart contract risk (if used on DeFi), and regulatory risk. This article is educational. Always conduct your own research and consult a financial advisor before making investment decisions.