What is a stablecoin?

Why stablecoins matter

As a critical bridge between traditional finance and the blockchain economy, stablecoins provide several key benefits:

• Lower volatility than conventional cryptocurrencies.
• Instant global transactions with minimal fees.
• Use in smart contracts and decentralized applications.
• Accessibility for individuals in countries with unstable currencies.
• Integration into Web3, non-fungible token (NFT) marketplaces and metaverse economies.

Types of stablecoins

To understand stablecoins more clearly, it helps to explore the three major types currently in use.

1. Traditional asset-backed stablecoins

Also known as fiat-collateralized stablecoins, these are backed 1-to-1 by real-world assets, such as government-issued currencies or commodities. Each token is redeemable for an equivalent value of the underlying asset, typically stored in a reserve account.

So, if a stablecoin is pegged to USD, then $1 is held in a bank account for each stablecoin issued.

If a stablecoin is pegged to the price of gold, then a specific amount of gold is held in a vault for each stablecoin issued.

Examples

• USDT (Tether).
• USDC (USD Coin).
• USDP (PAX Dollar).
• XAUt (Tether Gold).

Pros

• Price stability and high liquidity.
• Easy integration into crypto exchanges and apps.
• Popular with institutional investors and payment providers.

Cons

• Requirement of trust in a single issuing entity.
• Subject to know your customer and anti-money laundering laws and fiat regulations.
• Reliance on third-party audits for reserve verification.

In 2025, regulators in the U.S., European Union and Asia-Pacific regions implemented stricter disclosure requirements and reserve audits for fiat-backed stablecoin issuers, improving transparency but increasing operational burdens.

2. Cryptocurrency asset-backed stablecoins

These are backed by other cryptocurrencies, usually overcollateralized to account for the volatility of the underlying assets. Instead of being managed by a centralized issuer, most use smart contracts to lock and release collateral.

Since the amount of cryptocurrency that backs up these stablecoins is more than the value of the stablecoin itself, any price fluctuations of the underlying cryptocurrency don't affect the value of the stablecoin.

Examples

• DAI (pegged to USD, backed by Ethereum and other cryptocurrency).
• sUSD (backed by Synthetix network assets).

Pros

• More decentralized than fiat-backed stablecoins.
• Transparent and controlled by smart contracts.
• Used heavily in DeFi protocols.

Cons

• Still exposed to crypto volatility.
• Requirement of user participation to manage collateral ratios.
• Less liquid than fiat-backed alternatives.

While asset-backed stablecoins dominate in volume, a newer class uses no collateral at all, relying instead on algorithms for stability.

3. Noncollateralized (algorithmic) stablecoins

These stablecoins maintain their peg through automated monetary policies, typically using algorithms to expand or contract supply based on market demand. They rely on smart contracts to supply tokens to the market if the value increases and to sell tokens if the price falls below the peg. This ensures the stability of the token and enables it to hold its peg.

The asset to which the stablecoin is pegged could be a fiat currency, such as USD, or another asset, such as gold.

Examples

• AMPL (Ampleforth).
• FRAX (Fraxlend, partially algorithmic).
• kUSD (Kowala, discontinued).

Pros

• No need to hold reserve assets.
• Designed for scalability and decentralization.

Cons

• High risk of depegging during market shocks.
• Prone to death spirals if trust erodes, as seen in TerraUSD's 2022 collapse.
• Difficult to regulate and predict.

Since the collapse of TerraUSD in 2022, investor caution around algorithmic stablecoins has increased significantly. New models now focus on hybrid collateral-algorithm systems to mitigate risks.

Use cases for stablecoins

As stablecoins mature, their practical applications continue to expand across both traditional finance and emerging blockchain ecosystems:

• Cross-border payments. Used to avoid delays and fees in international transactions.
• DeFi. Used as collateral, liquidity pairs and yield farming tools in DeFi.
• Crypto exchanges. Used as a safe trading pair and value store during periods of volatility.
• Remittances. Used for sending money across borders with near-zero fees.
• Payroll and merchant payments. Increasingly used by businesses paying remote workers or accepting cryptocurrency.

Stablecoins are also being explored for use in government-backed digital currency pilots and are integrated into Web3 wallets, blockchain-based gaming and metaverse marketplaces.

Challenges and criticisms of stablecoins

Despite their advantages, stablecoins are not without risk:

• Governments still defining how to regulate them.
• Centralization concerns for fiat-backed models.
• Technical vulnerabilities in smart contract-based stablecoins.
• Risk of insolvency or mismanagement if reserves aren't fully backed.
• Loss of peg in algorithmic models.

In response, stablecoin issuers have been pushed to adopt regular audits, proof-of-reserve mechanisms and transparency dashboards.

Stablecoins vs. CBDCs

As stablecoins become more integrated into global finance, they're often compared to another form of digital currency gaining traction: central bank digital currencies (CBDCs). While stablecoins are private sector innovations, CBDCs are government-issued digital assets.

CBDCs, like the digital yuan and pilot versions of the U.S. digital dollar, are centrally controlled, offering more stability and legal clarity. Stablecoins offer faster innovation, more privacy and use in DeFi but are subject to market and legal risks.

Many financial experts expect coexistence, with stablecoins dominating DeFi and international payments, while CBDCs dominate retail public use.

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