What Are Stablecoins? A Complete Guide to Stable Cryptocurrency

What Are Stablecoins and Why Do They Exist?

Stablecoins are cryptocurrencies engineered to maintain a constant value relative to a reference asset, usually the US dollar. They solve cryptocurrency's volatility problem—Bitcoin can swing 10% in a day, but USDC stays at $1. This stability enables practical use cases like payments, savings, and trading without constant price risk.

Volatility makes regular cryptocurrencies impractical for many uses. You can't price goods in Bitcoin if its value changes hourly. You can't hold savings in ETH if it might drop 50% during a market crash. Stablecoins provide a stable unit of account within the crypto ecosystem.

Before stablecoins, traders had to convert to fiat currency to exit positions—a slow, expensive process involving banks. Stablecoins let you move to safety instantly, 24/7, while staying on-chain. This liquidity is why they've become essential market infrastructure.

Stablecoins also bridge traditional finance and crypto. Businesses can accept stable cryptocurrency payments and convert to dollars seamlessly. International transfers that take days and cost fees through banks happen in minutes with stablecoins. To understand the underlying technology, see how blockchain technology works.

How Do Stablecoins Maintain Their Peg?

Stablecoins maintain their peg through different mechanisms depending on their type. Fiat-backed stablecoins hold dollar reserves—for every token issued, a dollar (or equivalent) sits in a bank. Crypto-backed stablecoins use overcollateralization with volatile assets. Algorithmic stablecoins use supply/demand mechanisms, though these have proven fragile.

Fiat-backed stablecoins work simply: the issuer holds reserves equal to or greater than circulating supply. When you buy USDC, Circle (the issuer) holds that dollar. When you redeem, they return it. Regular audits verify reserves exist. This creates a straightforward 1:1 backing.

Crypto-backed stablecoins like DAI use overcollateralization. To mint $100 of DAI, you must lock up $150+ of ETH as collateral. If ETH's price drops, your position is liquidated before the stablecoin becomes undercollateralized. This requires no trusted custodian but is less capital-efficient.

Algorithmic stablecoins attempted to maintain pegs through supply manipulation alone—minting and burning tokens based on price. The collapse of TerraUSD (UST) in 2022, which lost $40 billion, demonstrated these designs' fundamental fragility. Pure algorithmic stablecoins are now largely discredited.

What Are the Different Types of Stablecoins?

The three main stablecoin types are fiat-backed (held in traditional banking), crypto-backed (overcollateralized with cryptocurrency), and algorithmic (using supply mechanisms). A fourth category, commodity-backed stablecoins pegged to gold or other assets, remains niche. Each type offers different trade-offs between decentralization, capital efficiency, and risk.

Fiat-backed stablecoins dominate the market. USDT and USDC together hold over $130 billion. They're centralized—issuers can freeze accounts and must comply with regulations—but offer the most reliable pegs. Their reserves increasingly include US Treasury bills, earning yield that issuers keep.

Crypto-backed stablecoins like DAI prioritize decentralization. No company can freeze your DAI. But overcollateralization means locking $150 to get $100, capital-inefficient compared to fiat-backed alternatives. They also inherit the volatility risk of their collateral assets.

Commodity-backed stablecoins like Paxos Gold (PAXG) represent ownership of physical gold stored in vaults. Each token corresponds to one troy ounce. These appeal to investors wanting gold exposure with crypto's portability but add complexity around physical asset custody. For DeFi applications of stablecoins, see our DeFi guide.

What Are the Major Stablecoins?

The largest stablecoins by market cap are Tether (USDT) at ~$140 billion, USD Coin (USDC) at ~$40 billion, and DAI at ~$5 billion. USDT dominates trading volume but faces transparency concerns. USDC offers better regulatory compliance. DAI provides decentralization. Other notable stablecoins include FRAX, TUSD, and USDP.

USDT (Tether) launched in 2014 as the first major stablecoin. It's ubiquitous in crypto trading, especially on offshore exchanges. However, Tether's reserve transparency has been questioned—they've faced fines and only provide periodic attestations rather than full audits. Despite concerns, USDT has maintained its peg through multiple crises.

USDC (USD Coin), issued by Circle, prioritizes regulatory compliance and transparency. Monthly attestations from major accounting firms verify reserves. Circle is pursuing a public listing and banking licenses. USDC is preferred by institutions and US-regulated platforms, though it's smaller than USDT globally.

DAI is issued by MakerDAO, a decentralized protocol. Users generate DAI by depositing collateral (primarily ETH and USDC) into 'Vaults.' No company controls DAI—governance token holders vote on parameters. This decentralization appeals to DeFi users but means no customer support if things go wrong.

How Are Stablecoins Used?

Stablecoins serve as trading pairs on exchanges, collateral and medium of exchange in DeFi, payment rails for international transfers, savings vehicles earning yield, and on/off ramps between crypto and traditional finance. Their stability and 24/7 availability make them uniquely useful across cryptocurrency and increasingly in traditional commerce.

Trading is the primary use case. Most crypto pairs are quoted against USDT or USDC. When Bitcoin drops, traders sell to stablecoins rather than cashing out to banks. This preserves capital on-chain, ready to buy back in when markets recover.

DeFi protocols depend on stablecoins. You borrow stablecoins against crypto collateral, earn yield by lending them, or provide liquidity in trading pairs. Stablecoins are the stable leg that makes complex financial operations possible. Learn more about tokenomics to understand these mechanisms.

Payments and remittances are growing use cases. Sending $1000 internationally costs cents and takes minutes with stablecoins versus $50+ and days through banks. Businesses in emerging markets increasingly use stablecoins to avoid local currency volatility and banking limitations.

What Are the Risks of Stablecoins?

Stablecoin risks include depegging (losing the $1 value), counterparty risk (issuer insolvency or fraud), regulatory action (accounts frozen, operations shut down), smart contract vulnerabilities (for decentralized stablecoins), and bank run scenarios. The 2023 USDC depeg during the Silicon Valley Bank crisis illustrated how traditional banking risks can affect crypto.

Depegging can be temporary or permanent. USDC briefly dropped to $0.87 when Silicon Valley Bank—holding $3.3B of Circle's reserves—failed in March 2023. It recovered within days after the bank was made whole. UST's depeg in 2022 was permanent, destroying $40 billion as the algorithmic mechanism failed.

Centralized stablecoins carry counterparty risk. If Tether were found to lack sufficient reserves, USDT could collapse. Freezing risks are real too—both USDT and USDC have blacklisted addresses, making those tokens worthless. This centralization contradicts crypto's permissionless ethos but is required for regulatory compliance.

Regulation is intensifying. The EU's MiCA requires stablecoin issuers to hold reserves in European banks. US regulators are developing stablecoin frameworks. Uncertainty creates risk—issuers might be forced to halt operations in certain jurisdictions. For broader crypto risks, see our blockchain risks guide.

Last Updated: December 2025