Stablecoin Risks Explained: How Synthetic Dollars Compare

Stablecoins are among the most widely used crypto assets, trailing only Bitcoin and Ethereum in market capitalization. While they help mitigate the extreme price volatility typical of cryptocurrencies, they still come with their own set of risks. Synthetic dollars, as a newer category of stable assets, seeks to offer more attractive incentives than traditional stablecoins such as USDT and USDC. However, synthetic dollars introduce new design and risk considerations of their own.

In this article, we explore the key risks associated with both fiat-backed stablecoins and synthetic dollars, and how Falcon Finance is addressing the challenges specific to synthetic dollar models.

Risks of Fiat-Backed Stablecoins

Traditional stablecoins, typically backed by off-chain fiat reserves, carry risks tied to their centralized structure and dependence on the legacy financial system. These include:

• Custodial risk: Assets held by third parties may be mismanaged or become inaccessible.
• Counterparty risk: Trust is placed in issuers and intermediaries to honor redemptions.
• Regulatory uncertainty: Changing laws can disrupt operations or freeze funds.
• Centralization risk: A single point of failure can jeopardize the entire system.

One of the primary concerns is custodial risk. Since the reserves (cash, bonds, treasuries) are held by centralized custodians like banks, fiat-backed stablecoins are exposed to counterparty risk. There’s the danger that a custodian could mismanage funds, suffer a failure (as seen with traditional banks), or have assets frozen due to external pressures, leading to a depeg, as occurred with USDC after the collapse of Silicon Valley Bank. While audits offer some assurance, the day-to-day management of these vast, off-chain reserves remains somewhat opaque compared to on-chain operations.

This leads directly to another concern of regulatory uncertainty. As stablecoin issuers operate at the intersection of crypto and traditional finance, they are prime targets for government oversight. Future regulations concerning reserve composition, operational requirements, or even outright bans could significantly impact their functionality and accessibility. One example is Tether’s USDT, which, despite being the largest-cap stablecoin, was delisted from some crypto exchanges after the new law on stablecoins came into force in the European Union in 2025.

Finally, the inherent centralization risk means these stablecoins are operated by single companies. This makes them susceptible to actions like censorship or the freezing of funds, where the issuer can block transactions or blacklist addresses at will or upon legal request. It also establishes a single point of failure: any significant legal, financial, or operational challenge faced by the issuing company could directly threaten the stability and usability of the stablecoin itself.

Risks of Synthetic Dollars

Synthetic dollars offer greater transparency and yield potential through on-chain mechanisms compared to traditional stablecoins, but they also introduce a distinct set of risks driven by technology and market dynamics. These include:

Smart contract risk
Synthetic dollar protocols depend on multiple smart contracts deployed on-chain to manage minting, redemption, collateral, and strategy execution. Any bug, vulnerability, or exploit in these contracts can compromise the system. Because many contracts are interconnected across protocols, a flaw in one can trigger cascading failures in others.

Strategy risk
Synthetic dollars often rely on complex trading or hedging strategies to generate yield and maintain their peg. These might include funding rate arbitrage, market-neutral positions, or staking-based returns. Such strategies are not guaranteed to succeed and can underperform or fail entirely, especially during black swan events, rapid market shifts, or oracle failures. If arbitrage dries up or funding flips against the strategy, peg stability and yield can both suffer.

Market volatility risk
Even with hedging strategies in place, sharp price swings in underlying crypto assets can trigger forced liquidations and put pressure on the protocol’s safeguards. If many users rush to redeem their synthetic dollars at the same time in what’s known as a bank run scenario, it can overwhelm available liquidity and jeopardize the peg.

How Falcon Finance Mitigates Risks

Falcon Finance recognizes the unique risks that come with synthetic dollars and has built a risk management framework focused on transparency, diversification, and active oversight.

To manage strategy risk, Falcon uses a multi-layered approach. The protocol combines automated systems with manual oversight to monitor and adjust positions in real time. During volatile market conditions, its trading infrastructure allows the team to actively reduce risk and protect user assets. An Insurance Fund, supported by a portion of protocol profits, serves as a buffer during periods of low or negative yields and can step in to buy USDf on the open market when needed, supporting price stability.

To guard against market volatility, Falcon requires overcollateralization when users mint USDf using non-stablecoin assets. This means users must deposit more collateral than the amount of USDf received. The overcollateralization ratio (OCR) is not fixed. Instead, it is dynamically adjusted based on the asset’s volatility, liquidity, and market conditions to maintain both safety and efficiency.

A 7-day cooldown period is enforced when users redeem USDf back into collateral assets. This helps defend against potential exploits such as vampire attacks or sudden liquidity drains during times of stress.

To reduce smart contract risk, Falcon adopts the ERC-4626 standard for its tokenized yield vaults. This widely accepted standard improves composability and includes protections against known vulnerabilities, such as share inflation attacks. Falcon’s contracts have also been audited and verified through an ongoing attestation process led by HT Digital, a professional audit firm. These include quarterly Proof-of-Reserve reports and ISAE 3000 assurance reviews, providing transparency around asset backing and operational soundness.

Conclusion

Stablecoins are a key part of the crypto ecosystem, but they come with different types of risk. Traditional stablecoins, backed by off-chain reserves like fiat in bank accounts, face risks from centralization, regulation, and custody. On the other hand, synthetic dollars like USDf are fully onchain and more transparent, but they carry risks tied to smart contracts, market volatility, and strategy performance.

Falcon Finance is built to manage these risks through overcollateralization, active risk monitoring, and strong security standards. The protocol uses onchain tools, third-party audits, and dynamic risk controls to protect users and keep USDf stable.

As with any financial tool, it’s important for users to understand how each stablecoin works, assess the risks, and make informed decisions before getting involved.