Stablecoins Explained: How USDT and USDC Hold Their Peg

What a Stablecoin Actually Does

A stablecoin is a cryptographic token whose value is designed to remain constant relative to a reference asset — almost always the United States dollar. Unlike bitcoin or ether, whose prices fluctuate continuously in response to supply, demand, and market sentiment, a well-functioning stablecoin trades at or very close to one dollar regardless of broader market conditions.

The economic purpose is straightforward. Participants in crypto markets need a medium of exchange and store of value that does not expose them to daily price swings. Stablecoins serve that function: they allow traders to move in and out of risk positions, settle transactions, and earn yield on decentralised finance platforms without converting back to a bank account. They also act as a practical on-ramp for users in countries where access to the banking system is limited or the local currency is volatile.

Two issuers dominate the category. Tether (USDT) has been in operation since 2014 and consistently holds the largest market capitalisation in the stablecoin sector. USD Coin (USDC), issued by Circle and launched in 2018, is the second largest by most measures and is often described as the more transparent of the two.

Reserve Models: Where the Backing Comes From

The central mechanism behind any fiat-backed stablecoin is the reserve. When a user deposits one US dollar with the issuer and receives one token in return, the issuer is supposed to hold that dollar — or an equally liquid, dollar-denominated asset — in custody. When the token is redeemed, the issuer releases the corresponding reserve and burns the token.

In practice, the composition of those reserves matters enormously. Tether‘s reserves have historically included a mix of assets: US Treasury bills, cash and cash equivalents, commercial paper, secured loans, and small allocations to assets such as bitcoin and corporate bonds. The commercial paper allocation attracted regulatory attention in the early 2020s because commercial paper carries credit risk that cash does not. Tether has since reduced that exposure and has shifted the portfolio towards short-duration US Treasury bills, which are widely regarded as the nearest thing to risk-free dollar assets.

USDC has pursued a narrower reserve strategy from an earlier stage. Circle publishes monthly attestations — prepared by a major accounting firm — confirming that USDC tokens in circulation are backed entirely by cash held at regulated US financial institutions and short-dated US Treasury instruments held in segregated accounts. The narrower composition reduces credit risk and makes the reserve easier to audit, though no attestation is a full audit in the accounting sense of the word.

How the Peg Is Maintained in Practice

The mechanism that keeps either stablecoin trading at one dollar is arbitrage. If USDT falls below a dollar on a secondary market, traders can purchase it cheaply and redeem it with Tether Limited for one dollar, locking in a risk-free profit and pushing the price back up. If it trades above a dollar, issuers can mint new tokens for large institutional clients and sell them into the premium, compressing the price back to parity.

This arbitrage loop functions smoothly when two conditions hold: the issuer has sufficient liquidity to honour redemptions promptly, and market participants trust that the reserves are what the issuer claims. Both conditions have been tested at different moments in the history of both tokens.

During the market stress of May 2022 — triggered by the collapse of the Terra/LUNA algorithmic stablecoin — USDT briefly traded at around $0.995 on some venues as redemption demand spiked. Tether processed several billion dollars of redemptions within days, and the peg recovered. USDC experienced a separate episode in March 2023 when it was disclosed that Circle held a portion of its cash reserves at Silicon Valley Bank, which had just failed. USDC fell to approximately $0.87 before recovering once the US Federal Deposit Insurance Corporation guaranteed all deposits at the failed institution.

Both episodes illustrate that even well-backed stablecoins carry some tail risk — primarily liquidity risk (can the issuer process large redemptions quickly?) and counterparty risk (are the custodians holding the reserves solvent?).

Key Differences Investors Should Understand

Several distinctions separate the two issuers in ways that matter for risk assessment:

• Transparency: Circle publishes monthly attestations from a named accounting firm. Tether has historically provided quarterly attestation reports prepared by the Cayman Islands-based firm BDO Italia. Critics have long called for a full independent audit of Tether’s books; one has not been published as of this writing.
• Regulatory engagement: USDC is issued under US money transmission licences and Circle has sought to operate within federal and state regulatory frameworks. Tether is incorporated in the British Virgin Islands and has faced enforcement actions in the United States, including a 2021 settlement with the Commodity Futures Trading Commission over claims that its reserves were not fully backed at all times.
• Redemption access: Both issuers allow direct redemption, but minimum thresholds and onboarding requirements mean retail users typically access secondary market liquidity through exchanges rather than redeeming with the issuer directly.
• Adoption patterns: USDT has historically been dominant on international and offshore trading venues, while USDC has seen stronger adoption in institutional and decentralised finance contexts in the United States.

Understanding these differences does not make either token categorically safer than the other — both have demonstrated resilience under stress. It does, however, allow market participants to assess which form of reserve risk they are more comfortable accepting.