5.1 Understanding the Risks
What you'll learn: The four main risk categories that affect stablecoins, real examples of what can go wrong, and practical strategies to protect yourself while using digital dollars.
Before you start using stablecoins, it's essential to understand the risks involved. While stablecoins promise stability and efficiency, 'stable' refers only to price targets, not to the absence of risk. Understanding these risks helps you make informed decisions and protect yourself as you begin your stablecoin journey.
Let's first break down the four primary risk categories into plain language with practical examples. While most risks become manageable once understood, they affect different regions differently: what's a minor inconvenience in the US might be a major barrier in countries with less developed banking infrastructure.
1. Counterparty & Custodial Risk
What it means: When you hold stablecoins, you trust the issuing company to keep real dollars backing your tokens. If that company or their bank fails, your stablecoins could lose value.
Real example: In March 2023, Silicon Valley Bank collapsed. Circle (USDC's issuer) had $3.3 billion of its $40 billion reserves stuck in that bank. USDC temporarily dropped to $0.87 before recovering to $1.00 when the government guaranteed the deposits [1][2]. Most holders who waited recovered as the peg normalized following deposit guarantees, but the scare showed how digital dollars depend on traditional banks.
How to protect yourself:
Don't put all your money in one stablecoin
Check if issuers publish regular reports about their reserves
Use stablecoins for transactions, not long-term savings
Only risk what you can afford to lose
2. Smart Contract Risk
What it means: Stablecoins run on computer code. Like any software, this code can have bugs. Unlike your banking app crashing, a stablecoin bug could mean permanent loss of funds.
Real example: Think of a broken ATM that gives wrong change, except this ATM handles millions and can't be easily fixed. In 2016, The DAO hack resulted in $60 million in losses due to a code vulnerability [3]. While major stablecoins like USDC use simple, well-tested code, newer or experimental stablecoins carry higher risk.
How to protect yourself:
Stick to established stablecoins with long track records
Avoid brand-new or experimental projects
Test with small amounts first
Keep funds in simple wallets rather than complex DeFi applications
3. Market & Liquidity Risk
What it means: Sometimes you might not be able to convert your stablecoins back to dollars immediately, or you might get slightly less than $1.00 per token during market stress.
Real example: During the March 2023 banking crisis, USDC depegged over a weekend when banks were closed. People panicked because they couldn't redeem tokens until Monday. Once banks opened, everything normalized quickly [4].
For comparison, Terra's UST stablecoin completely collapsed in May 2022 when too many people tried to sell at once, wiping out $60 billion [5]. This shows the difference between temporary liquidity issues (USDC) and fundamental design failures (UST).
DAI, another stablecoin, successfully handled the March 2020 "Black Thursday" crash despite extreme market volatility, proving that well-designed systems can survive stress [6].
How to protect yourself:
Avoid large transactions during market stress
Understand that redemptions might take 1–2 business days
Keep some regular currency for emergencies
Don't panic during temporary price wobbles
4. Regulatory & Compliance Risk
What it means: Governments are still figuring out how to regulate stablecoins. Rules can change suddenly, affecting your ability to buy, sell, or use them.
Real example: The European Union implemented comprehensive stablecoin rules (MiCA) in 2024, establishing strict requirements for issuers including reserve requirements and banning algorithmic stablecoins [7]. Some issuers had to leave the European market entirely. In the US, different states have different rules, creating confusion. What's legal in Wyoming might face restrictions in New York.
How to protect yourself:
Stay informed about rules in your country
Use services that follow know-your-customer (KYC) requirements
Keep records for tax purposes
Have backup plans if regulations change
Putting Risks in Perspective
These risks are real but manageable. Consider that traditional banking has its own risks: banks fail, accounts get frozen, and currencies lose value to inflation. The key is understanding which risks you're comfortable with for your specific needs.
Risk Quick Reference
User mistakes (wrong address, lost password)
Very Common
Usually total loss
No warning — happens instantly
Regulatory changes
Common
May restrict access
New laws announced, KYC requests
fluctuations (temporary depeg)
Sometimes
Temporary, usually recovers
Price drops below $0.99
Bank problems (like SVB)
Rare
Could lose value temporarily
News about bank troubles
Smart contract bugs
Very Rare
Could lose everything
Affects new/untested stablecoins
When Stablecoins Make Sense (Lower Risk)
Quick transactions:
Sending money internationally (minutes vs days)
Trading between cryptocurrencies
Online purchases
Short-term holding (days or weeks)
Why lower risk: You're exposed to risks for less time, and the benefits clearly outweigh traditional alternatives.
When to Be More Careful (Higher Risk)
Long-term storage:
Life savings
Emergency funds you can't afford to lose
Business operating capital
Retirement funds
Why higher risk: Longer exposure means more chance something could go wrong, and you need guaranteed access to these funds.
Learning from History
2022 Terra/UST collapse: Algorithmic design without proper backing failed completely ($60B loss) [5]
2023 USDC/SVB incident: Traditional banking risk affected stablecoins but recovered fully [1][2][4]
2024 EU MiCA regulation: Clear rules provided certainty but forced some changes [7]
The pattern is clear: well-backed stablecoins (USDC, USDT) recover from crises, while experimental designs (UST) can fail completely. Stick with established options and you reduce your risk significantly.
The Bottom Line
Stablecoins aren't risk-free, but neither is traditional banking. The difference is that stablecoin risks are newer and less familiar. Once you understand them, you can use stablecoins for their benefits (speed, low cost, accessibility) while protecting yourself from their downsides.
Now that you understand these risks, you're ready to take the next steps safely. The following sections will guide you through choosing a wallet, setting it up securely, and making your first transactions, all while keeping these risk considerations in mind.
Remember: start small, use established stablecoins, and never risk money you can't afford to lose.
Key Takeaways:
Counterparty risk means trusting issuers and banks; USDC's 2023 SVB incident showed recovery is possible with proper reserves
Smart contract bugs are rare in major stablecoins but can cause permanent losses in experimental projects
Temporary price fluctuations during crises differ from total collapses; most liquidity issues resolve within days
Start with small amounts, use established stablecoins, and never risk more than you can afford to lose
References
[1] USDC Stablecoin Regains Dollar Peg After Silicon Valley Bank ... - https://www.coindesk.com/business/2023/03/13/usdc-stablecoin-regains-dollar-peg-after-silicon-valley-bank-induced-chaos
[2] Circle assures market after stablecoin USDC breaks dollar peg - https://www.reuters.com/business/crypto-firm-circle-reveals-33-bln-exposure-silicon-valley-bank-2023-03-11/
[3] Reentrancy Attacks and The DAO Hack Explained - https://blog.chain.link/reentrancy-attacks-and-the-dao-hack/
[4] USDC nearly regains $1 peg after Circle says SVB deposit is available - https://www.cnbc.com/2023/03/13/usdc-nearly-regains-1-peg-after-circle-says-svb-deposit-is-available.html
[5] The Rise and Fall of Terra: How a $60 Billion Crypto Ecosystem Crumbled - https://www.okx.com/learn/terra-collapse-ust-luna-stablecoin
[6] DeFi proved resilient during the March 2020 and May 2021 - https://cointelegraph.com/news/defi-proved-resilient-during-the-march-2020-and-may-2021-market-crises
[7] MiCA Regulation: How the EU is Shaping the Future of Crypto Asset Compliance? - https://amlwatcher.com/blog/mica-regulation-how-the-eu-is-shaping-the-future-of-crypto-asset-compliance/
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