You've probably heard about a stablecoin "losing its peg."
One day it's $1.00. The next it's $0.87. Then panic. Then collapse.
The usual explanation is technical, bad algorithm, thin reserves, a bank run. But there's a deeper reason these breaks happen. And it has nothing to do with crypto.
It has to do with how money actually works.
In the previous article, we established one idea: money is not a thing you hold. It's a record others agree to honor.
Today we go one level deeper, because that difference, quiet in good times, loud in bad ones, is exactly what determines whether a stablecoin survives a crisis or doesn't.
There Are Actually Several "Dollars"
Here's something most people never think about.
When you get paid, your employer doesn't hand you dollars. They instruct their bank to update a number in your bank's system. Your bank now owes you that amount. That's your "dollar."
When your bank needs to settle with another bank, say, because you sent a wire, they don't use your deposit. They use a completely different kind of dollar: reserves held at the Federal Reserve.
And when you pull cash out of an ATM? That's a third form, a physical note issued by the central bank.
These are three different instruments, all called “dollars”. All treated as equivalent in daily life, even though they are structurally distinct.
The technical term for this fixed one-to-one exchange rate between them is par. And par is the thing that makes the whole system feel seamless.
Par Is Not Natural. It's Maintained.
Here's what most people miss: the reason $1 in your bank account equals $1 in cash isn't physics. It's a social agreement, backed by law, regulation, and political will.
Think about it this way.
Your bank deposit is a promise from your bank. If you trusted your bank less tomorrow, that promise would be worth less. The dollar amount wouldn't change, but your confidence in receiving it would.
So what keeps par intact?
Three things, working together:
- Shared belief. Most people don't audit their bank's balance sheet before swiping their card. They just spend. That collective trust is the engine. Without it, the machine doesn't run.
- Legal structure. Deposit contracts are legally enforceable. Regulation sets minimum standards. Legal tender laws define what must be accepted for payment. These slow down repricing when things get shaky.
- Political backstop. When a bank can't meet withdrawals on its own, central banks step in with liquidity. Governments extend guarantees. Rules get adjusted. Par is defended because authorities choose to defend it.
Strip away those three layers, and one dollar would not always equal one dollar. It never has, on its own.
Picture It Like a Stack
It helps to think of the monetary system as a stack of layers.
At the top: central bank money. Reserves and cash. This is the final settlement asset, the thing everything else ultimately converts into. Nothing is “above” this domestically.
One layer down: commercial bank deposits. Your checking account, your savings account. These are promises from private banks to deliver that top-layer money on demand. In daily life, they work perfectly fine. But structurally, they are claims on the layer above.
Further out: money market funds, commercial paper, repo agreements. These circulate like money in wholesale financial markets. But they are promises to convert into bank deposits, which are themselves promises to convert into reserves.
Every step outward adds one more layer of conversion.
In calm times, all of this looks flat. Everything trades at par. Everything feels equivalent. The stack is invisible.
In stressed times, what matters is not the label “dollar,” but how many layers stand between you and final settlement.
What Happens When Confidence Slips
Imagine investors across the financial system start getting nervous, for whatever reason.
They don't sit down and draw a hierarchy chart. But they instinctively start asking a different question. Not "what yield does this pay?" but "can I actually get my money back?"
And the answer is not the same for every instrument.
So they move. Up the stack. Toward things closer to final settlement. Away from instruments that depend more on confidence and less on guaranteed conversion.
The hierarchy doesn't appear during stress. It reveals itself during stress. It was always there.
And When Things Really Break, Who Gets Protected?
This is the uncomfortable part.
When stress becomes severe, not everything gets saved at par. Authorities have to make choices. And those choices follow the stack.
Protection flows inward, toward the settlement core. Central bank money is preserved. Insured bank deposits, the ones tied to the payment system, used by ordinary households, get strong backing.
Further out? Less certain. Non-bank instruments, wholesale funding, uninsured claims, they may get some support, but they're more exposed. More likely to be repriced. More likely to bear losses.
Two examples make this concrete.
- In 2008, the Reserve Primary Fund, a money market fund widely treated as cash-equivalent, held Lehman Brothers commercial paper. When Lehman collapsed, the fund "broke the buck": its share price fell below $1. Investors who had treated it like a bank deposit discovered it wasn't. It sat too far from the settlement core to be automatically defended, and the confidence holding it at par evaporated overnight.
- In 2023, Silicon Valley Bank collapsed after a classic bank run. But here's what the hierarchy actually looked like in practice: insured depositors (under $250k) were fully protected from day one. Uninsured depositors, businesses with larger balances, sitting one step further out, spent a tense weekend not knowing if they'd get their money back.
They eventually did, because authorities chose to intervene. But that choice was not automatic. It was political. Losses move outward. Equity first. Subordinated debt next. Uninsured claims last.
The hierarchy doesn't just describe how money works normally. It describes who gets protected when the system breaks.
So Where Does That Leave Stablecoins?
A stablecoin makes one promise: this token is worth $1.
Redeem it whenever you want, at face value. That promise puts it directly inside everything we just described.
To keep that promise under pressure, a stablecoin needs to hold assets that can actually convert into settlement money, quickly, at full value. The closer those assets are to the top of the stack, the more credible the promise.
A stablecoin backed by short-term U.S. Treasury bills sits closer to the core. One backed by riskier, longer-duration assets sits further out. One that relies primarily on market confidence, with no clear conversion pathway, is the most exposed when the question shifts from "is this convenient?" to "can I actually redeem this?"
Then there's a third category: synthetic and algorithmic stablecoins. Some, like Ethena, use derivatives rather than holding dollars directly to maintain peg. Others rely on pure algorithmic supply adjustments with no backing at all. What they share is no direct conversion pathway into settlement money, their peg depends almost entirely on confidence and the mechanics holding together. We'll examine how these models work in a later piece.
And stablecoins don't automatically get the same protection as insured bank deposits. Their position in the hierarchy determines how they're treated if stress arrives.
Par is not a design choice. It's a structural commitment. Every stablecoin that promises $1 is implicitly making a claim about where it sits in this stack, and whether it can hold that position when things get hard.
The One Thing to Take Away
"$1 = $1" is true most of the time. But it is conditionally true.
It holds because layers of enforcement, trust, and political support keep different dollar claims trading at par. It holds better for some instruments than others.
Modern money is not flat. It is layered.
Different instruments promise par. Par survives because redemption is enforced and liquidity is supplied when pressure builds. Support flows inward toward the settlement core.
Stablecoins do not sit outside this structure. They inherit it. Their design, their backing, and their legal position determine where they stand in the hierarchy and how they behave when conversion is tested.
Once you see money as a stack of claims rather than a single object, the peg debate becomes clearer. The question is not simply whether something is “a dollar.” The question is what it converts into, and how far it sits from final settlement.
In the next piece, we’ll move one layer deeper and examine how these claims are created in the first place.
This is the second piece in an ongoing series on money and stablecoins; you can read the first article here: Money Is Not What You Think.
Made with Bullet