# Stablecoin risks: what every user and business should know

> Stablecoins carry real risk despite the word 'stable.' The risks vary by design — reserve quality and issuer solvency for fiat-backed coins, collateral crashes for crypto-backed, and reflexive collapse for algorithmic. Understanding the risk class behind a specific coin is the starting point for any serious exposure decision.

6 min read · Updated 2026-06-09 · Topic: stablecoins

Canonical: https://tempo.dataos.so/articles/stablecoin-risks-explained

Stablecoins are not risk-free. The word "stable" describes the peg target, not a guarantee. Every stablecoin carries a specific set of risks determined by its design, its issuer, the quality of its reserves, and the legal framework around it. Users and businesses who treat all stablecoins interchangeably are conflating assets with very different risk profiles.

The analysis below maps the main risk classes to the three stablecoin designs, then addresses the risks that apply across all of them.

## Risk by design

The design is the first and most important risk filter.

| Design | Peg mechanism | Main risks | Failure examples |
|---|---|---|---|
| **Fiat-backed** | Cash + Treasuries, redeemable 1:1 | Issuer insolvency, reserve illiquidity, custodian failure | USDC SVB depeg (temporary, March 2023) |
| **Crypto-backed** | Over-collateralised on-chain assets | Collateral crash outpacing liquidation | DAI partial stress during 2020 Black Thursday |
| **Algorithmic** | Incentive loops, little or no reserve | Reflexive death spiral, total loss | TerraUSD/UST (~$40B loss, May 2022) |

Fiat-backed coins dominate the stablecoin market and are the design recommended for payments and treasury use by the GENIUS Act and EU MiCA regulatory frameworks. Algorithmic designs carry the highest risk and are now restricted or prohibited for payment stablecoin use under both regimes.

## Fiat-backed risks in detail

### Reserve quality

A stablecoin is only as strong as what backs it. Reserves that consist entirely of overnight US Treasury bills and cash at FDIC-insured banks are substantially more liquid than reserves that include corporate bonds, secured loans, precious metals, or cryptocurrency. When a large redemption demand hits, illiquid reserves create a delay — or in extreme scenarios, an inability — to meet redemptions at par.

Circle publishes monthly attestations by Deloitte showing USDC reserves held primarily in the Circle Reserve Fund (a BlackRock-managed SEC-registered government money market fund) and bank cash. As of Q1 2026, the composition was approximately $77 billion, almost entirely in short-duration US Treasuries and cash equivalents.

Tether's quarterly BDO attestations show a more diverse composition: the Q1 2026 report showed approximately $141 billion in Treasury exposure but also significant holdings in gold, Bitcoin, secured loans, and other investments. That diversity means Tether's reserve value can fluctuate more than a pure Treasury-and-cash portfolio, and the quarterly reporting frequency leaves a larger unverified window.

### Issuer insolvency

If an issuer fails before reserves can be distributed, users become creditors in a bankruptcy proceeding. The GENIUS Act (signed July 18, 2025) now requires that stablecoin holders receive priority over all other creditors in US issuer insolvency — a meaningful legal protection for coins issued by GENIUS Act-compliant entities. That protection did not exist uniformly before 2025.

### Custodian and banking risk

The USDC March 2023 event illustrates this vividly. Circle held $3.3 billion — roughly 8% of USDC's reserves at the time — in cash deposits at Silicon Valley Bank when US regulators shut SVB down on March 10, 2023. USDC fell to $0.87 on secondary markets within hours of Circle's disclosure. The peg recovered when federal regulators confirmed all SVB depositors would be protected. Had that guarantee not arrived, the outcome could have been worse. The event demonstrated that even a well-managed, transparent issuer carries the counterparty risk of its banking partners.

### Freeze and blacklist risk

Fiat-backed issuers retain the technical and legal ability to freeze or blacklist addresses. Circle and Tether have both exercised this in response to law enforcement requests. For most payment use cases this is not a concern, but it is a risk factor for certain business models.

## Crypto-backed risks

Crypto-backed stablecoins like DAI (MakerDAO) hold more than $1 of crypto collateral per $1 of stablecoin issued. The system works under orderly conditions. The failure mode is a rapid, correlated collapse in collateral prices that outpaces the automated liquidation engines. In March 2020 ("Black Thursday"), ETH prices dropped around 50% in hours; MakerDAO's liquidation auctions misfired under congestion, and the protocol briefly became undercollateralised before emergency governance backstops were activated. The system survived but required a governance rescue rather than autonomous resolution.

## Algorithmic risks

The Federal Reserve documented the dynamics in a June 2022 note after Iron Finance's IRON/TITAN collapse in June 2021, which wiped out approximately $2 billion. The pattern is consistent: the system works while confidence holds, and confidence evaporates fastest under the conditions the system most needs to function — a classic bank run structure with no reserve to absorb it.

TerraUSD (UST) is the largest failure: approximately $40 billion in combined UST/LUNA market capitalisation erased within days in May 2022, triggered by a large coordinated redemption that broke the arbitrage loop. The collapse spread contagion to other parts of the crypto market, contributing to the failure of hedge fund Three Arrows Capital and lending platform Celsius later that year.

## Risks that cross all designs

**Smart contract risk.** Even fiat-backed stablecoins can have vulnerabilities in the contracts that govern minting, burning, and bridging. A bug in a bridge contract can drain token reserves from a chain without triggering issuer-level redemptions.

**Chain and bridge risk.** A stablecoin's security on one chain does not guarantee security on bridged versions. Wrapped or bridged stablecoins add the bridge operator as an additional counterparty. Native issuance on a target chain is lower risk than a bridged version.

**Regulatory and compliance risk.** Stablecoins face regulatory change in every jurisdiction. An issuer compliant today may face licensing changes, asset composition requirements, or distribution restrictions. MiCA's June 2024 stablecoin provisions, for example, required operational changes from issuers serving EU users.

**Exchange custody risk.** Holding stablecoins at a centralised exchange adds the exchange as a counterparty. The FTX collapse in November 2022 resulted in customers losing access to stablecoins — assets that were technically stable — because the exchange became insolvent.

## A practical risk ranking

For businesses evaluating which stablecoins to hold or accept, a rough framework:

1. **Lowest risk:** Fiat-backed, US-regulated issuer, monthly Deloitte or Big Four attestation, reserves in Treasuries and cash, GENIUS Act-compliant (USDC, PYUSD, RLUSD)
2. **Moderate risk:** Fiat-backed but quarterly attestation, more diverse reserve composition, offshore incorporation (USDT)
3. **Higher risk:** Crypto-backed with transparent on-chain collateral and active liquidation (DAI)
4. **Highest risk:** Algorithmic or partially-algorithmic designs, regardless of past track record

No rating agency has given any stablecoin its highest possible score. S&P Global's Stablecoin Stability Assessment gave USDC a "2 (strong)" — the top mark any stablecoin received in their initial assessments — and USDT a "4 (constrained)."

## What to read next

Reserve quality is the central variable for fiat-backed coins. [How to read a stablecoin reserve report](/articles/how-to-read-stablecoin-reserve-report) gives the tools to evaluate specific disclosures. For the record of how algorithmic and other designs have failed in practice, see [The biggest stablecoin failures](/articles/biggest-stablecoin-failures).

## FAQ

**Can stablecoins lose their peg permanently?**

Yes. Algorithmic stablecoins like TerraUSD (UST) have lost their pegs permanently and without recovery. Fiat-backed stablecoins can also depeg temporarily — USDC fell to $0.87 in March 2023 when $3.3 billion in reserves were trapped at Silicon Valley Bank — but recovered within days once deposit insurance was confirmed. Permanent failure in fiat-backed coins would require issuer insolvency and reserve shortfalls simultaneously.

**What is the biggest risk with Tether (USDT)?**

S&P Global rated USDT a '4 (constrained)' — the second-lowest score — in its Stablecoin Stability Assessment, citing reserve composition opacity, reliance on quarterly rather than monthly attestations, non-USD reserve assets including gold and Bitcoin, and limited regulatory oversight compared to US-chartered issuers. Tether holds a substantial excess reserve buffer, but the reserve composition is more diverse than pure cash and Treasuries.

**Are stablecoin reserves protected if the issuer goes bankrupt?**

It depends on the jurisdiction and legal structure. The US GENIUS Act (signed July 2025) requires stablecoin holders to receive priority over all other creditors in insolvency. For coins issued before or outside that framework, protections are less certain. The USDC case — reserves legally segregated from Circle's corporate assets — is a stronger structure than most. Verifying this segregation in an issuer's legal disclosures matters.

**Is it risky to hold stablecoins on an exchange?**

Holding any asset on an exchange adds exchange counterparty risk to the underlying asset's risk. If the exchange fails, users become unsecured creditors. This is separate from the stablecoin issuer's risk. The collapse of FTX in late 2022 resulted in customers losing assets, including stablecoins, held in exchange custody.

**What risks do businesses face that accept stablecoin payments?**

Businesses face the same issuer and peg risks as individual holders, plus operational risks: wallet key management, smart contract vulnerabilities, on/off-ramp counterparty risk, and regulatory uncertainty in their jurisdiction. The practical risk for a business accepting USDC or USDT in a market with clear stablecoin law is lower than for one accepting crypto-backed or algorithmic coins.

## Sources

1. [S&P Global — Stablecoin Stability Assessment product page](https://www.spglobal.com/ratings/en/products/stablecoin-stability-assessment)
2. [CoinDesk — Tether scores second-lowest rank in S&P stablecoin assessment (Dec 2023)](https://www.coindesk.com/policy/2023/12/13/tether-scores-second-lowest-rank-in-sp-global-stablecoin-stability-assessment)
3. [CNBC — USDC breaks dollar peg after $3.3B exposure to SVB (March 2023)](https://www.cnbc.com/2023/03/11/stablecoin-usdc-breaks-dollar-peg-after-firm-reveals-it-has-3point3-billion-in-svb-exposure.html)
4. [Federal Reserve — Runs on Algorithmic Stablecoins: Evidence from Iron, Titan, and Steel](https://www.federalreserve.gov/econres/notes/feds-notes/runs-on-algorithmic-stablecoins-evidence-from-iron-titan-and-steel-20220602.html)
5. [White House — Fact Sheet: President Trump Signs GENIUS Act into Law (July 2025)](https://www.whitehouse.gov/fact-sheets/2025/07/fact-sheet-president-donald-j-trump-signs-genius-act-into-law/)

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Neutral, sourced explainer from tempowiki. Index: https://tempo.dataos.so/llms.txt