Stablecoins explained: how crypto dollars work

Most cryptocurrencies are volatile. Stablecoins are designed not to be. They are tokens that aim to keep a stable value, most commonly one US dollar, so people can move money around crypto markets without riding every price swing.

What stablecoins are used for

• Trading — most crypto trading pairs are quoted against dollar stablecoins.
• Payments and transfers — sending dollars across borders in minutes, at any hour.
• DeFi — lending, borrowing and providing liquidity in protocols.
• A parking place — traders move into stablecoins to step out of the market without cashing out to a bank.

Type 1: fiat-backed

The largest stablecoins, such as USDT (Tether) and USDC, are issued by companies that say each token is backed by reserves — cash, short-term government bonds and similar assets. You trust the issuer to hold those reserves and to redeem tokens for dollars.

The key questions are about the reserves: what exactly they hold, who audits or attests to them, and whether the issuer can freeze tokens (most can, and do so when required by law enforcement).

Type 2: crypto-collateralised

Some stablecoins are created by locking up more crypto than the stablecoins issued. For example, you might deposit $150 of ETH to mint $100 of stablecoins. If the collateral’s value falls too far, the system automatically sells it to protect the peg. DAI is the best-known example. These designs are more transparent — the collateral is on-chain — but depend on smart contracts and on volatile collateral.

Type 3: algorithmic

Algorithmic stablecoins try to hold their peg with code and incentives rather than full reserves. The most famous example, TerraUSD (UST), collapsed in May 2022, wiping out tens of billions of dollars of value within days. Its failure is now the textbook case of why “stable” is a goal, not a guarantee.

What can go wrong

• De-pegging — even well-backed stablecoins can briefly trade below $1 in a panic. In March 2023, USDC dipped well below its peg for a weekend after its issuer disclosed exposure to a failed US bank.
• Issuer risk — the company behind a fiat-backed stablecoin could mismanage reserves or face legal action.
• Freezing — issuers can blacklist addresses.
• Smart contract risk — bugs or exploits in the token or the protocols using it.

Stablecoins are increasingly regulated, with new rules in the EU and other jurisdictions. Before holding significant amounts, understand who issues the coin, what backs it and how redemptions work.