What Are Stablecoins? A Beginner’s Guide

Stablecoins are digital assets designed to minimize the price volatility associated with cryptocurrencies. By pegging their values to stable assets like fiat currencies, stablecoins aim to redefine global finance. In this article, we’ll dive deeper into what stablecoins mean and how they work. We’ll also highlight their types, benefits, drawbacks, and future outlook. 

What Are Stablecoins?

Stablecoins are a special class of cryptocurrencies whose market values are pegged to an external reference, often a real asset. Most stablecoin issuers peg their tokens to reference assets such as fiat currencies, precious metals, commodities, or financial instruments. Examples of stablecoins include Tether (USDT) and USD Coin (USDC).

Stablecoins Vs Central Bank Digital Currencies (CBDCs)

How Do Stablecoins Work?

Stablecoins are crypto assets issued by private companies on a blockchain network. Most stablecoins are pegged to fiat currencies. In fact, U.S Dollar-denominated stablecoins constitute 99% of the stablecoin market. They’re backed 1:1 by cash reserves, government treasury bills, financial instruments, and liquid assets. These reserves ensure that investors can redeem stablecoins for the reference assets anytime. 

While the composition of reserves varies across stablecoins, these digital assets are primarily designed to maintain a stable store of value. They don’t experience significant price fluctuations, which is a contributing factor to their widespread adoption as a medium of exchange. 

The core mechanism that helps stablecoins maintain their peg is collateralization.

Under-collateralized stablecoins are more susceptible to depegging. Investors lose confidence in such stablecoins, triggering mass redemptions that further widen the gap between a stablecoin’s value and its peg. Thus, stablecoins should either be fully reserved or over-collateralized.

Types of Stablecoins Explained

1. Fiat-backed Stablecoins

Fiat-backed stablecoins are backed 1:1 by fiat currencies such as the U.S Dollar. They may also hold reserves of cash equivalent assets, like short-term treasury bills, to secure their value. Usually, independent custodians maintain and audit the reserves for these stablecoins. Examples of fiat-collateralized stablecoins include USDT, USDC, and EURC.

2. Commodity-backed Stablecoins

Commodity-backed stablecoins are blockchain-based currencies tied to commodities like oil or gold. Tether Gold (XAUt) is the most popular digital token backed by physical gold reserves. It is pegged 1:1 to one fine troy ounce of gold. These tokens are also divisible, enabling you to buy as little as 0.000001 troy fine ounce. 

Another token that is redeemable into LBMA-certified Good Delivery gold bullion bars is Pax Gold (PAXG). You can purchase small fractions of the token, starting from 0.01 PAXG.

3. Crypto-backed Stablecoins

A crypto-backed stablecoin is a digital currency whose value is linked to the market price of another cryptocurrency. As the reserve cryptocurrency may be prone to intense market volatility, these stablecoins are usually overcollateralized.  

For instance, Sky Protocol’s DAI is soft-pegged 1:1 to the U.S Dollar. 100.5% of the DAI in circulation is backed by Ethereum and other cryptocurrencies. The minimum collateralization ratio varies based on the deposited crypto asset. 

4. Algorithmic Stablecoins

Algorithmic stablecoins are cryptocurrencies that maintain a stable value by adjusting their demand and supply through pre-programmed algorithms or smart contracts. They mint/burn tokens to correct demand/supply imbalances. If the market value of an algorithmic stablecoin exceeds its peg, the protocol mints new coins to reduce its price. Conversely, if the stablecoin’s value falls below the peg, the protocol burns existing coins to increase its price. 

A unique feature of algorithmic stablecoins is that they may or may not hold reserves. However, these stablecoins carry high risks. 

In 2022, massive sell-offs depegged TerraUSD (UST) from its $1 value. As UST prices continued to plummet, the algorithm kept on minting LUNA tokens to maintain the peg. The oversupply of LUNA caused its price to drop by over 80%, triggering a massive 60% fall in the UST price. Eventually, both coins collapsed, resulting in a crypto crash of over $40 billion.

Popular Stablecoins

1. Tether (USDT)

As of December 2025, Tether (USDT) is the third-largest cryptocurrency and the largest stablecoin by trading volumes and market capitalization. Touted as a trailblazer in the digital usage of conventional currencies, USDT tokens dominate the stablecoin market. Pegged 1:1 to the U.S Dollar, USDT is designed to maintain a steady value of $1. It is backed 100% by Tether reserves, offering comprehensive liquidity on reputable exchanges and democratising cross-border payments across blockchains.

2. United States Dollar Coin (USDC)

USDC is a digital dollar stablecoin backed 100% by cash and cash-equivalent assets. Most USDC reserve assets are held in the Circle Reserve Fund, an SEC-approved money market fund. Issued by Circle, USDC is the world’s largest regulated stablecoin redeemable 1:1 for USD. It is also the second-largest stablecoin by trade volumes and market cap. Currently, USDC is natively supported on 28+ blockchains, fostering cross-chain interoperability and global accessibility.

3. EURC

EURC is another fully-reserved fiat-collateralized stablecoin issued by Circle, and the largest Euro-backed cryptocurrency by market capitalization. It is MiCA-compliant and is widely used for forex borrowing, lending, and trading. Reputable financial systems within the EEA hold the Euro reserves. Using Circle Mint, businesses can swap EURC for Euros and vice versa, and transfer EURC tokens across multiple blockchains seamlessly. It also helps customers access on-chain dollar liquidity by facilitating instant EURC to USDC conversions. 

Why Are Stablecoins Important? 

Stablecoins facilitate speedy cross-border transactions via decentralized blockchains. Therefore, they’re particularly valuable for organizations with a global workforce or clientele. They’re also highly beneficial for migrant workers who need to remit money to their homelands. 

Most importantly, stablecoins help manage the price volatility associated with traditional cryptocurrencies like Bitcoin and Ethereum. Their value is pegged to real-world assets, like fiat currencies or precious metals, which tend to have relatively steady prices. Hence, stablecoins act as a reliable store of value and medium of exchange for merchant payments.

Moreover, stablecoins serve as digital money or tokenized cash, enabling instant, on-chain settlements. Businesses can hold stablecoin reserves on blockchains to prevent operational bottlenecks and optimize liquidity management.

Furthermore, stablecoins are expected to play a crucial role in moulding a global financial system where public and private money co-exists. They can complement central bank digital currencies (CBDCs), strengthening the digital payments ecosystem.

Many financial institutions are also participating in the stablecoin ecosystem by introducing their own stablecoins or deposit tokens. For example, JP Morgan’s JPM Coin facilitates 24/7 cross-border transfers and intra-day settlements. It seamlessly integrates with traditional banking infrastructure, helping streamline operations and boost liquidity.

Overall, both individuals and institutions can leverage stablecoins for everyday payments, faster accounting reconciliations, treasury management, and DeFi operations. 

Benefits and Risks of Stablecoins

Benefits

• Instant settlements and 24/7 operations: Conventional payment systems take 2-4 days to process a transaction. They also function from Monday to Friday for a fixed number of hours each day. Contrarily, stablecoins are available 24/7 and process cross-border payments instantly. 
• Enhanced transparency: As international transfers involve multiple time zones, intermediaries, and different regulatory frameworks across countries, it is harder to track their status. Conversely, transactions involving stablecoins are recorded on immutable blockchain ledgers and can be monitored in real-time. Additionally, most centralized exchanges evaluate each transaction for AML/KYC issues, ensuring regulatory compliance.
• Cost-efficiency: Legacy financial systems often route transactions, especially global remittances, through multiple correspondent banks and intermediaries. Consequently, transaction costs and settlement times can be higher. In contrast, stablecoins operate on decentralized blockchain networks, eliminating the need for middlemen and fostering low-cost transfers.
• Global accessibility and inclusion: Stablecoins are accessible even in regions with less developed financial infrastructure. Moreover, crypto exchanges, especially DEXs, don’t require users to complete elaborate identity verification processes to trade stablecoins. Thus, anybody with a compatible device and an internet connection can transact stablecoins regardless of their location.
• Broader stablecoin use cases: Apart from swifter cross-border payments, lower fees, and faster checkouts, stablecoins support multiple use cases. You can trade them for other currencies, including fiat and cryptocurrencies, in the spot market. You can also buy/sell stablecoin-settled derivative contracts. Additionally, you can use stablecoins as collateral to borrow cryptocurrency loans. Users can even deposit them in staking or liquidity mining pools to earn rewards.

Risks

• Threat to traditional banking systems: If individuals and businesses choose to hold stablecoins instead of keeping funds in bank accounts, banks can face major challenges. Banks depend on customer deposits to sanction loans. A decrease in deposits would reduce their ability to lend loans, reducing their interest income. As the reserves backing stablecoins are held by issuers, widespread stablecoin adoption can disrupt conventional banking systems.
• Operational hurdles: Financial institutions need to embrace new technologies, conduct staff training, deploy blockchain infrastructure, and ensure crypto wallet integrations to use stablecoins. They also need to monitor transactions in real time, while complying with anti-money laundering and cryptocurrency laws. Without the necessary resources and capabilities, banks may face increased risks of regulatory non-compliance and security breaches.
• Issuer risks: The companies that issue stablecoins can cease operations or go bankrupt due to various factors. These include business failures, regulatory pressures, loss of customer confidence, inadequate reserves, and depegging. 
• False claims: Issuers may often make untrue statements about the reserves backing their stablecoins. In 2021, the Commodity Futures Trading Commission (CFTC) slapped a $41 million fine on Tether. The company had allegedly made misleading statements and concealed crucial facts regarding the reserve funds backing USDT.

Stablecoin Regulations

• Genius Act: In July 2025, the US government passed the Genius Act (Guiding and Establishing National Innovation for US Stablecoins). It is a comprehensive legislation for regulating stablecoins.

The Act requires stablecoin issuers to adhere to the Bank Secrecy Act and AML/CFT norms. It has mandated issuers to hold 1:1 reserves for issued stablecoins. These can be in the form of repurchase agreements, cash reserves, U.S. Treasury bills, or any other high-quality asset. Moreover, issuers must regularly report and audit the reserve composition.

To prohibit stablecoin issuers from functioning like unregulated banks, the Genius Act has imposed a key restriction. They can’t pay interest/yield, making stablecoins a less attractive investment avenue compared to money market funds and bank deposits.

• MiCA: In the European Union, MiCA has banned the issuance of algorithmic stablecoins. The regulation mandates that MiCA-recognized fiat-collateralized stablecoins be backed 1:1 by liquid reserves. Overall, MiCA has laid down stringent rules for stablecoin issuers to safeguard the EU’s financial stability and monetary sovereignty.

Stablecoins vs Other Cryptocurrencies

Stablecoins vs Bitcoin

Bitcoin is the world’s pioneer digital currency powered by blockchain technology. Though it is the largest crypto asset by market cap, it is highly volatile. Its price tends to rise or fall rapidly, making it a risky investment. However, due to Bitcoin’s deep liquidity, scarcity, and widespread adoption, it is being increasingly accepted as a digital payment method. Also, it is created through a process of mining on a decentralized, permissionless blockchain network.

Conversely, the market value of a stablecoin is tied to a stable asset with a relatively steady price. Additionally, stablecoins are issued by companies and predominantly used for cross-border payments.

Stablecoins vs Altcoins

All cryptocurrencies, apart from Bitcoin, are collectively known as alternative coins or altcoins. They address the limitations of Bitcoin, solve certain problems, or introduce specific use cases. For example, Ethereum is the first digital currency to support intelligent contracts and decentralized finance (DeFi) protocols. Solana is a high-performance blockchain that is more scalable, affordable, and energy-efficient than Ethereum. 

Many altcoins tend to be more volatile and riskier than Bitcoin due to smaller market capitalization, lower liquidity, or speculative demand. Their prices are primarily influenced by demand-supply dynamics, alongside other factors like real-world utility, global adoption, and market sentiment.

Conversely, stablecoins ensure price stability as they’re designed to maintain a stable value relative to the reference asset. While they exhibit lower price volatility, they’re not 100% risk-free. They’re subject to depegging, issuer, and regulatory risks.

The Role of Stablecoins in the Cryptocurrency Ecosystem

Stablecoins are crypto assets that bridge the gap between traditional and digital money. Since they’re pegged to external references like fiat currencies with a relatively stable value, they minimize price volatility.

Additionally, stablecoins are minted and recorded on immutable blockchains. Hence, nobody can alter stablecoin transaction data or balances, making them a transparent and reliable medium of exchange.

Fiat-collateralized stablecoins play a pivotal role in asset tokenization by providing a stable pricing reference for real-world asset (RWA) tokens. This enables a fair valuation for tokenized assets. Moreover, tokenization facilitates fractional ownership of RWAs. For example, a property worth $100,000 can be tokenized into 10,000 blockchain-based coins, each worth $100. 

Stablecoins also power secondary markets for tokenized assets by enabling price discovery and 24/7 trading. Without stablecoins, investors often need to convert fiat into crypto to conduct trades. This process entails higher costs and may involve third-party payment processors. By denominating tokenized assets in stablecoins, trades can be executed entirely on-chain at lower costs.

With advancements in blockchain technology, crypto wallet security, and on-chain analytics, more high-speed networks with faster consensus mechanisms are evolving. Additionally, stablecoins can automate cash flows from tokenized assets using intelligent contracts, while fostering greater blockchain interoperability. 

Conclusion

Stablecoins can boost crypto trading by acting as a bridge between traditional currencies and cryptocurrencies. They also maintain a stable price relative to the reference asset, protecting investors from extreme market volatilities. Stablecoins are also a boon for users based in locations with no or limited access to foreign currencies like the US Dollar. By offering greater stability, transparency, and accessibility, stablecoins can revolutionize the digital asset market and the broader financial system.

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