Minting and redemption in fiat-backed models

Direct at-par minting and redemption is not open to everyone: at Circle (USDC), only KYB-verified institutional Circle Mint accounts can mint or redeem directly, with no spread or per-transaction fee — dollars arrive by wire, USDC settles same- or next-day, and the reverse applies on redemption. Retail users obtain USDC only on secondary markets, i.e. exchanges. At Tether (USDT), the minimum direct redemption or purchase is $100,000, verification requires KYC/AML plus a $150 fee, and the redemption fee is the greater of $1,000 or 0.1% of the amount. Most USDT holders transact through exchanges and OTC desks rather than directly with the issuer.

The role of arbitrage

The market has two tiers: only authorized participants can mint or redeem at par, while everyone else trades on secondary markets where price floats with supply and demand. If the secondary price falls below $1, an arbitrageur buys below market and redeems at $1 with the issuer, pocketing the spread — this pulls demand and price back toward par. If the price rises above $1, an arbitrageur mints at $1 and sells above par, increasing supply and pushing price back down. The mechanism works only as long as redemption is seen as credible and the issuer's reserves are sufficiently liquid.

What backs the reserves

At Circle, the bulk of USDC's reserves sit in the Circle Reserve Fund — an SEC-registered 2a-7 government money-market fund managed by BlackRock — plus deposits at systemically important and other banks and short-dated Treasuries and overnight reverse repo; monthly Big Four attestations confirm reserves are at least equal to USDC in circulation. At Tether, per its Q2 2026 attestation (audited by BDO), reserves were dominated by Treasury bills (about $115 billion) and overnight reverse repo (about $18.6 billion), with gold (about $18.8 billion) and bitcoin (about $5.8 billion) as smaller, more volatile positions; this is published as a quarterly attestation — a point-in-time snapshot, not a continuous audit.

Crypto-collateralized models: over-collateralization and liquidation

A user locks crypto collateral (ETH, staked ETH, wBTC, and other assets) into protocol "vaults"; the protocol mints DAI or USDS against that collateral up to a maximum loan-to-value set by protocol governance — minimum collateralization ratios typically fall in the approximately 130–175% range depending on the asset's riskiness. If collateral value falls and the collateral-to-debt ratio breaches the governance-set liquidation threshold, the protocol automatically triggers an auction of the collateral to cover the debt and restore system solvency. Sky (rebranded from MakerDAO in 2024) now runs DAI (the original 2017 token) alongside USDS (launched 2024, designed for institutional use with an optional-KYC path) in parallel.

Algorithmic and synthetic models

Terra's UST had no direct collateral and relied on a mint-and-burn arbitrage against LUNA. When outflows from the Anchor protocol pushed UST below $1 in May 2022, arbitrageurs' attempt to restore the peg by burning UST for LUNA required minting enormous new LUNA supply, which crashed LUNA's price and set off a "death spiral" — the mechanism meant to defend the peg destroyed itself. A newer design — Ethena's synthetic dollar USDe (since 2024) — works differently: staked crypto collateral is held alongside an equal-and-opposite short position in perpetual futures, so moves in the collateral's price are offset by the short (a delta-neutral design). Yield for sUSDe holders comes from staking rewards plus perpetual funding-rate payments; when funding turns persistently negative, yield can collapse and losses must be absorbed by a reserve fund — a different failure mode from Terra's reflexive collapse.

Where a peg breaks

  • Trouble at the issuer's banking partner: USDC's March 2023 depeg, when part of its reserves were frozen at the failed Silicon Valley Bank.
  • Collateral value falling faster than liquidation can keep up — a structural risk for crypto-collateralized models during sharp market crashes.
  • Loss of confidence and a reflexive collapse in under-collateralized models — the collapse of UST in May 2022.