How do stable coins like Tether and USD stay “stable” through the massive ups and downs of the rest of the crypto market?

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Why aren’t they subject to supply and demand curves changing their price?

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Imagine if you could freely buy and sell Amazon gift cards, and that the price of Amazon gift cards was tracked on the stock exchange.

Because an Amazon gift card buys you whatever amount is on its face, the price of Amazon gift cards would always track pretty close to US dollars. No one is paying $200 for a $100 Amazon gift card. On the flip side, if you had a $100 Amazon gift card and someone offered you $50 for it, you’d say no, because you can buy $100 worth of stuff on the gift card.

So Amazon gift cards in my example are essentially a stable coin. Because they’re very close to cash, their value is very close to cash. In the case of stable coins, whoever makes the coin guarantees that you can trade in your coins for their equivalent value in $USD.

There are two big categories of stablecoins, one of which is far more stable than the other.

The first category is coins that have a reserve of some other asset, held in a trusted location. This is how Tether is managed. The issuing authority guarantees that you can exchange 1 of the stable coin for $1 (or some other fixed asset) and holds sufficient reserves to make that exchange. The result is that you get a cryptocurrency that compromises somewhat on avoiding a need to trust any central authority, but still allows anonymous exchanges. This style of stable coin is only as good as the trust in the backing authority, but with audits that trust can be reasonably high.

The other category is algorithmic stablecoins. They’re what have been in the tech news cycle most recently since a large one (Terra) just completely imploded. These coins introduce automatic mechanisms whereby coins are added or removed from the supply to target a specific valuation. In the case of Terra this is done by use of a secondary cryptocurrency that is *not* stable, called Luna. The idea here is that if Terra starts trading at $0.97 you could buy 100 Terra for $97 and destroy them, receiving in exchange $100 worth of Luna. In the process you push Terra’s price back towards $1.00. That process breaks down when people have a crisis of confidence in Luna. The algorithm only promises larger and larger quantities of Luna, but gives you no mechanism of converting that currency into something else.

They are subject to price and demand. Tether even depegged slightly while USDC went above peg. Massive market makers can buy up the depegged tether for cheaper than $1 and exchange them 1:1 for USD from Tether’s parent company.
Alameda Research is estimated to have made around a billion dollars this week arbitraging the depegged tether to dollars.