How does a stablecoin work? Minting, reserves, and the peg

A stablecoin is a token whose supply expands and contracts to track a reference price. That single sentence contains the whole design problem. The token contract can enforce supply changes. Nothing onchain can enforce that a dollar sits in a bank account for every token minted, or that the market price stays at $1. So every stablecoin is a machine built from three parts: a mint-and-burn mechanism, a reserve that backs the supply, and a set of incentives that pulls the market price back to the peg when it drifts.

This article walks through each part. For the definitional basics, see what a stablecoin is. For how backing models differ across coins, see types of stablecoins.

Supply changes are the one thing a stablecoin controls completely. The token contract has a mint function and a burn function, and who can call them defines the system.

For a fiat-backed coin like USDC, minting is permissioned. An institutional customer wires dollars to Circle, and Circle's minter address creates the corresponding tokens. Redemption reverses it: the customer sends tokens to the issuer, the issuer burns them and wires dollars back. Retail users never touch this loop. They buy and sell on exchanges, and the institutions who can mint and redeem arbitrage the exchange price against the $1 redemption value. USDT works the same way, with a minimum redemption size that keeps the direct loop institutional.

For a crypto-backed coin like DAI, minting is permissionless. Anyone can open a vault, deposit collateral, and mint against it up to the collateral ratio. Burning happens when the borrower repays, or forcibly when a liquidation closes an undercollateralized position. There is no issuer in the loop. The contract is the issuer.

Either way, mint and burn events are public. They land onchain as transactions, which makes supply the most reliable stablecoin metric that exists. Reserve reports arrive monthly and depend on the attestor. Supply updates every block.

The reserve is what the token is a claim on. How it is managed differs more between coins than any other component.

A fiat-backed issuer runs the reserve like a money market fund. Circle holds most of USDC's reserves in a regulated fund of overnight repos and short-dated US Treasuries, with the rest in cash at banks. Tether publishes quarterly attestations breaking its reserves into Treasuries, secured loans, bitcoin, and other categories. The composition matters because reserves must satisfy two conflicting demands: earn enough to fund the business, and stay liquid enough to meet redemptions on the worst day. Duration risk is the classic failure. Assets that are worth 100 cents at maturity can be worth less today, and redemptions happen today.

A crypto-backed system manages reserves through parameters instead of a treasury desk. MakerDAO, now Sky, sets collateral ratios, debt ceilings per collateral type, and liquidation penalties through governance votes. The reserve is the sum of all vault collateral, visible onchain at any moment. Management means tuning the parameters so liquidations fire before positions go underwater.

Yield-bearing designs add a strategy layer. Ethena's USDe holds staked assets and shorts perpetual futures against them, so reserve management is an active hedging operation with exchange counterparties. The reserve is not a pile of assets sitting still. It is a position that must be maintained.

A peg is not a property of the token. It is an equilibrium that arbitrage maintains, and each backing model gives arbitrageurs a different tool.

The fiat-backed defense is redemption arbitrage. If USDC trades at $0.998 on an exchange, an authorized participant buys it there, redeems at $1.00 with Circle, and pockets the spread. Buying pressure lifts the price back. If it trades above $1, the trade reverses: mint at $1, sell higher. The defense is exactly as strong as the redemption channel. If redemptions are slow, gated, or doubted, the arbitrage weakens and the price can sit off-peg.

The crypto-backed defense works through borrowing incentives. When DAI trades above $1, minting new DAI and selling it is profitable, which expands supply and pushes the price down. When it trades below $1, borrowers buy cheap DAI to repay debt at a discount, which contracts supply. Maker added the Peg Stability Module in 2020 to sharpen this: it swaps DAI for USDC one-to-one, effectively borrowing the fiat-backed coin's redemption arbitrage.

A third defense operates on the demand side. Interest rates on holding the coin, like the Sky Savings Rate for USDS, raise demand when the peg is soft. Rates across coins and venues move constantly and are comparable in the stablecoin yields tool.

Every large depeg on record maps to one of three failures.

The first is reserve impairment. In March 2023, Silicon Valley Bank failed while holding $3.3 billion of Circle's cash reserves. USDC traded down to roughly $0.88 over the weekend, while redemptions were impossible because banks were closed. The peg recovered within days once US regulators guaranteed SVB deposits. The token contract never malfunctioned. The claim behind the token was briefly in doubt, and the price said so.

The second is a broken redemption channel. A coin can be fully backed and still trade off-peg if holders cannot reach the reserve. Gated redemptions, banking hours, and minimum sizes all widen the band the price can wander in. Tether traded below $0.95 in October 2018 during a period of banking uncertainty, with reserves later shown to be substantially intact.

The third is reflexive collapse, specific to designs backed by their own ecosystem's token. TerraUSD in May 2022 is the defining case. UST's peg depended on burning it for newly minted LUNA. As redemptions grew, LUNA's supply inflated and its price fell, which shrank the capacity to absorb further redemptions, which accelerated the run. UST fell below $0.10 within a week. The mechanism did exactly what it was coded to do. The failure was in the design, not the execution.

The pattern across all three: pegs fail at the point where the onchain token meets its off-chain or endogenous backing. Watching peg deviation data over time shows which coins wobble under stress and which hold, without anyone needing to assign a label to them.

The final mechanism is the one stablecoins inherit from the chains they live on. A stablecoin transfer is a token transfer: final in one block, global, and running around the clock. No correspondent bank, no cut-off time, no settlement date two days out. This is the property that made stablecoins the dominant medium of exchange in crypto markets and the reason they are pushing into payments.

Two mechanics matter in practice. First, the same stablecoin exists as separate deployments on many chains. USDT and USDC each live natively on more than a dozen networks, with distinct contract addresses and, for bridged versions, distinct trust assumptions. A coin's chain distribution tells you where its activity actually is. Second, issuer controls travel with the token. Fiat-backed contracts include freeze and blacklist functions that issuers use under legal orders. Both issuers have frozen hundreds of millions of dollars across sanctioned or stolen-fund addresses. Crypto-backed coins like DAI have no such function. Whether that is a feature or a flaw depends on who is asking, but it is a mechanical difference you can read in the contract code.

Everything in this article leaves a data trail. Mints and burns are transactions. Supply is a contract read. Peg deviation is a price series. Chain distribution is a set of balances. The stablecoin explorer tracks these across every major coin, with per-coin pages covering supply history, chains, contracts, and peg behavior. The mechanisms described here are abstract until you watch a coin's supply contract during a redemption wave. The data is where the design becomes visible.