ARK Invest: A Guide to Stablecoins: What Are Stablecoins and How Do They Work? 》

# Stablecoins: The ChatGPT Moment for the Crypto Industry  

By ARK Invest, Raye Hadi  

Compiled by Block Unicorn  

## Introduction  

This article is the first in a four-part series aiming to explain the complex mechanisms of the stablecoin sector. Stablecoin operating mechanisms are highly intricate, and currently, there is no comprehensive educational resource that integrates the mechanisms, risks, and trade-offs of various stablecoins. This series seeks to fill this gap. Based on issuer documents, on-chain dashboards, and explanations from project teams, this guide provides investors with a framework for evaluating stablecoins.  

The series consists of four parts. The first part introduces stablecoins, including their design and history. The remaining three parts will focus on the three major categories of mainstream stablecoins:  

- **Fiat-Majority-Backed Stablecoins (Part 2)**  

- **Multi-Asset-Collateralized Stablecoins (Part 3)**  

- **Synthetic Dollar Models (Part 4)**  

Each article outlines the management of stablecoin reserves, opportunities brought by yield and incentive mechanisms, accessibility of token acquisition and native integration, and token resilience based on governance and compliance. Additionally, each article explores external dependencies and pegging mechanisms—factors that determine whether a stablecoin can maintain its value during periods of market stress.  

The second part of the series will first introduce stablecoins primarily collateralized by fiat currency, the most mainstream and straightforward design currently available. Parts 3 and 4 will evaluate more complex types of stablecoins, including those backed by multi-asset collateral and synthetic dollar models. These in-depth analyses provide investors with a comprehensive framework to understand the underlying assumptions, trade-offs, and risk exposures of each stablecoin.  

We hope you enjoy the first part of this series.  

## Stablecoins: The ChatGPT Moment for the Crypto Industry  

The emergence of stablecoins marks a turning point in the history of the cryptocurrency industry. Today, governments, enterprises, and individual users worldwide recognize the advantages of using blockchain technology to streamline the global financial system. The development of cryptocurrencies has proven that blockchain can serve as a viable alternative to the traditional financial system, enabling digitially native, global, real-time value transfer—all through a unified ledger.  

This recognition, combined with global demand for the U.S. dollar, has created a unique opportunity to accelerate the integration of cryptocurrencies with traditional finance. Stablecoins stand at the intersection of this integration, whether for traditional institutions or governments. Key factors driving the adoption of stablecoins include:  

- As the global payment landscape modernizes, traditional institutions strive to maintain their relevance.  

- Governments seek new creditors to finance their fiscal deficits.  

While the motivations of governments and existing financial institutions vary, they all understand that stablecoins must be embraced—otherwise, they risk losing influence as the financial landscape shifts. Recently, Lorenzo Valente, Director of Digital Asset Research at ARK, published a detailed paper on this topic titled *Stablecoins May Become One of the U.S. Government’s Most Resilient Financial Allies*.  

Today, stablecoins are no longer just a niche tool for cryptocurrency traders; retail adoption has also accelerated. They have become a primary means for cross-border remittances, decentralized finance (DeFi), and accessing U.S. dollars in emerging markets (which lack stable fiat currencies). Despite the growing utility and adoption of stablecoins, the complex structures and mechanisms underpinning stablecoin systems remain obscure to many investors.  

## Understanding Stablecoins  

A stablecoin is a tokenized claim issued on a blockchain, entitling its holder to an asset worth one U.S. dollar—an asset that can be traded both on-chain and off-chain. Stablecoins are backed by collateral reserves, which are managed through traditional custodians or automated on-chain mechanisms and stabilized via arbitrage-based pegging mechanisms. Stablecoins are designed to absorb volatility and maintain parity with a target asset (typically the U.S. dollar or other fiat currencies).  

Stablecoins are heavily biased toward U.S. dollar denomination—a natural result of their strong alignment with market demand for providing synthetic dollar exposure in dollar-scarce markets. Combining the stability of the U.S. dollar, the cost-effectiveness of blockchain, and 24/7 accessibility, stablecoins have become highly attractive mediums of exchange and reliable stores of value. This dynamic is particularly pronounced in markets long plagued by currency instability and limited access to U.S. bank accounts. In this context, stablecoins effectively act as digital gateways to dollar exposure—a trend reflected in the regions with the fastest-growing on-chain activity in 2025: Asia-Pacific, Latin America, and Sub-Saharan Africa.  

Furthermore, stablecoins have revolutionized the development of cryptocurrencies, particularly decentralized finance (DeFi), by introducing a liquid, low-volatility unit of account. Without stablecoins, on-chain markets would be forced to transact using highly volatile assets such as Bitcoin (BTC), Ethereum (ETH), or Solana (SOL)—exposing users to price risk and reducing the practical utility of DeFi.  

By providing the stability of on-chain assets pegged to the U.S. dollar, stablecoins enhance the price discovery of DeFi protocols and the efficiency of on-chain transaction settlement, thereby improving capital efficiency. This stability and reliability are critical to the core infrastructure on which these new financial markets depend. Therefore, the specific pegging mechanisms and reserve architectures that maintain these characteristics are vital to their resilience—especially during periods of market stress.  

## Asset or Debt Instrument? Substantial Differences Arising from Stablecoin Design  

The underlying mechanisms and reserve architectures of stablecoins directly impact their economic and legal behavior. Different architectures have trade-offs in regulatory compliance, censorship resistance, degree of crypto-native design, control, and stability. They also determine how stablecoins operate, as well as the risks, behaviors, and limitations borne by holders. These nuances raise key questions about how to understand stablecoins—for example, whether a specific type of stablecoin should be considered an asset or a debt instrument.  

In this context, a stablecoin can be considered an "asset" if the holder has direct legal ownership of the stablecoin or its supporting reserves, thereby retaining enforceable rights even in the event of the issuer’s insolvency. In contrast, a stablecoin is more like a "debt instrument" if the issuer retains legal ownership of the reserves, and the holder only has a contractual claim—effectively acting as an unsecured creditor. This distinction depends on the issuer’s legal design and the structure of reserve custody.  

The classification of a token primarily depends on who controls the reserves backing the token and whether that party has a legal obligation to fulfill redemption requests. While most issuers may intend to honor redemption obligations even under stress, without explicit legal obligations or user-controlled reserves, the token functions more like a debt instrument. This distinction determines whether holders retain enforceable rights to the underlying collateral in the worst-case scenario.  

The table below outlines how different types of stablecoins differ in this classification.  

Such structures are typically carefully designed based on the region, target market, or specific use case for which the stablecoin is intended. Even so, differences in legal structures can lead to subtle variations that have significant implications for token holders. Notably, this is just one of many interesting cases where intentional or unintentional architectural differences can have far-reaching impacts on stablecoins and investors.  

## Past Stablecoin Failures Are Closely Linked to Design Flaws  

Several past incidents involved stablecoins depegging from their chosen fiat currencies during crises. These events serve as stark reminders that design differences have tangible consequences—especially during periods of market stress. In fact, every type of stablecoin has experienced failures, reflecting their respective architectural weaknesses and design choices. The following sections discuss some of the most prominent failure cases across the three types of stablecoins. This discussion will lay the groundwork for the in-depth analysis of "fiat-majority-backed," "multi-asset-collateralized," and "synthetic dollar models" in Parts 2, 3, and 4 of this series.  

### The Collapse of SVB, Silvergate, and Signature Bank  

In March 2023, the collapse of three U.S. crypto-focused banks—Silvergate, Silicon Valley Bank (SVB), and Signature Bank—highlighted the long-standing reliance of fiat-backed stablecoins on the traditional banking system. Silvergate’s downfall began when it lost support from the Federal Home Loan Bank (FHLB). Prior to this, Silvergate had been strained by its holdings of large amounts of long-term Treasury bonds and mortgage-backed securities, as the Federal Reserve raised interest rates at an unprecedented pace. To meet growing withdrawal demands, Silvergate was forced to sell assets at massive losses—accelerating its insolvency and eroding market confidence in SVB and Signature Bank, which ultimately led to their collapse.  

When Circle disclosed its $3.3 billion exposure to SVB, its stablecoin USDC plummeted to $0.89, triggering panic in both DeFi and centralized markets—until the Federal Deposit Insurance Corporation (FDIC) stepped in to guarantee all deposits. Within days, USDC restored its peg. However, the shock rippled across all stablecoins, including DAI, which also depegged due to its heavy collateralization with USDC. Later, Circle adjusted its banking partnerships, but the crisis still raised concerns about the fragile link between stablecoins and banks.  

### The Algorithmic Collapse of Terra/Luna  

In early 2022, Terra was a leading Layer 1 ecosystem, centered around its algorithmic stablecoin UST and native token Luna. Anchor, a lending protocol built on Terra, offered depositors a guaranteed 19.5% yield and served as the primary source of capital for the TerraLuna ecosystem. UST maintained its peg through an arbitrage mechanism: 1 UST could be exchanged for $1 worth of Luna; issuing UST would burn Luna, while redeeming UST would mint new Luna. Although Terra’s management later added Bitcoin (BTC) and other cryptocurrency reserves, these reserves never exceeded approximately 20% of UST’s supply—leaving the system largely undercapitalized. At its peak, TerraLuna attracted billions of dollars in capital, despite having limited real-world use cases and high yields supported primarily by Terra subsidies rather than genuine lending demand.  

When market sentiment shifted and Luna’s price fell below the value of UST’s circulation, the redemption mechanism failed. In May 2022, UST’s depegging from Bitcoin triggered massive outflows. Terra restricted redemptions, forcing more capital into secondary markets. When redemptions resumed, Luna was heavily diluted to absorb fleeing capital—its token supply surged from hundreds of millions to trillions, and its price collapsed. Bitcoin reserves failed to stop the price spiral. Within days, the total market capitalization of UST and Luna evaporated by over $50 billion.  

### DAI’s "Black Thursday"  

On March 12, 2020, the MakerDAO (now renamed Sky Protocol) community experienced the "Black Thursday" crisis. A sharp drop in Ethereum’s price and network congestion caused a systemic failure in DAI’s liquidation mechanism. Ethereum’s price fell by over 40%, pushing the collateralization ratio of hundreds of vaults below the threshold. Normally, liquidations are completed through on-chain auctions, where "keepers" bid to purchase collateral with DAI. However, on Black Thursday, exorbitant gas fees and delayed oracle updates caused many bids to fail—allowing speculators and opportunists to win collateral at near-zero cost. Over 36% of liquidations were completed at a 100% discount, creating a 5.67 million DAI shortfall and inflicting heavy losses on many vault owners.  

To make matters worse, DAI反而 depegged at a premium as borrowers rushed to buy DAI to repay their debts. Normally, arbitrageurs would mint new DAI to meet demand, but this time, network congestion, price volatility, and oracle delays posed obstacles. Liquidations and minimal issuance created a supply shock, while demand soared—driving up the pegged price. MakerDAO immediately held debt auctions and issued Maker (MKR), the now-defunct utility token of MakerDAO, to replenish protocol funds. This crisis exposed vulnerabilities in DAI’s liquidation mechanism design and the stability of stablecoins under stress, prompting Maker to implement significant reforms to its liquidation engine and collateral model.  

## Stablecoin Design Is Critical  

The collapse of Silvergate, SVB, and Signature Bank, the algorithmic crash of TerraLuna, and DAI’s "Black Thursday" are powerful reminders of the importance of stablecoin architecture. These crises highlight how architectural design choices influence a system’s resilience and risk profile. TerraLuna’s collapse exposed the structural fragility of fully algorithmic stablecoins, demonstrating that systems lacking sufficient collateral or real economic utility are inherently unstable and prone to collapse under stress.  

In contrast, while the depegging of USDC and DAI was concerning, it was temporary and prompted profound reforms in both ecosystems. After the SVB crisis, Circle increased the transparency of its reserves and strengthened its banking relationships; MakerDAO (Sky Protocol) not only restructured its collateral portfolio to include more real-world assets (RWAs) but also upgraded its liquidation mechanism to prevent cascading defaults.  

What these events have in common is that they exposed flaws in their respective stablecoin types, as well as the specific scenarios most destructive to each type. Understanding how these architectures have evolved in response to failures is critical to evaluating the design choices and differences of today’s stablecoins. Not all stablecoins face the same risks, nor do they have the same optimization goals. Both outcomes stem from their respective underlying architectures. Recognizing this is essential to understanding where stablecoins are vulnerable and how best to use them.  

## Conclusion  

This article has introduced stablecoins and argued for the importance of stablecoin design. In Parts 2 to 4 of this guide, we will explore the three mainstream types of stablecoins: fiat-majority-backed, multi-asset-collateralized, and synthetic dollar models. Each stablecoin differs in terms of resilience and trade-offs—differences that are no less important than their utility or user experience. The unique design, collateral, and governance characteristics of each type of stablecoin (and stablecoins themselves) are key factors that determine their respective risks and the expected behavior of the token for holders.  

### Disclaimer  

The views expressed in this article are solely those of the author and do not constitute investment advice on this platform. This platform makes no guarantees regarding the accuracy, completeness, originality, or timeliness of the information in the article, nor does it assume any liability for losses arising from the use or reliance on the information contained herein.