Stablecoins Explained: What They Are and How They Hold Their Value
Stablecoins aim to stay worth $1. Learn the main types — fiat-backed, crypto-backed and algorithmic — how they keep their peg and the risks to understand.
Most cryptocurrencies swing wildly in price. Stablecoins are designed to do the opposite: hold a steady value, usually one US dollar. They have become one of the most widely used parts of the crypto ecosystem, powering trading, payments and decentralised finance. But "stable" doesn't mean "risk-free".
What is a stablecoin?
A stablecoin is a crypto token whose value is pegged to another asset, most commonly the US dollar. One stablecoin is meant to be redeemable for, or trade very close to, one dollar. Some stablecoins track other currencies such as the euro, or commodities such as gold.
Why people use them
- Moving value on blockchains quickly, any time of day, without converting back to a bank currency.
- A safe harbour for traders who want to step out of volatile assets without leaving crypto.
- Cross-border payments and remittances.
- Holding dollars in countries with high inflation or limited access to foreign currency.
- Decentralised finance — lending, borrowing and providing liquidity.
The main types of stablecoins
1. Fiat-backed stablecoins
These are issued by a company that holds reserves — cash, short-term government bonds and similar assets — to back each token. Users who meet the issuer's requirements can redeem tokens for dollars. The best-known dollar stablecoins work this way.
Key question: Are the reserves real, high quality and independently verified? Look for regular attestations or audits and clarity about where reserves are held.
2. Crypto-backed stablecoins
These are created by locking other cryptocurrencies in smart contracts as collateral. Because crypto is volatile, they're usually over-collateralised — for example, more than $1.50 of crypto might back each $1 of stablecoin. If collateral value falls too far, positions are automatically liquidated to protect the peg.
Key question: How robust is the system during sharp market crashes, and how safe are its smart contracts?
3. Algorithmic stablecoins
Algorithmic designs try to maintain the peg using incentives and supply adjustments rather than full reserves. Some have failed dramatically. The collapse of TerraUSD (UST) in May 2022, which wiped out tens of billions of dollars in value across UST and its sister token, is the most famous example.
Key question: What actually backs each coin if confidence disappears?
| Type | Backed by | Main strength | Main risk |
|---|---|---|---|
| Fiat-backed | Cash and bonds held by an issuer | Simple, widely used | Issuer, reserve and regulatory risk |
| Crypto-backed | Locked crypto collateral | Transparent on-chain | Smart contract and crash risk |
| Algorithmic | Mechanisms and incentives | Capital-efficient on paper | Can collapse in a "death spiral" |
What "losing the peg" means
A stablecoin "de-pegs" when it trades meaningfully away from its target, say at $0.95. Temporary de-pegs can happen during market stress or when there are doubts about reserves. In March 2023, for example, a major dollar stablecoin briefly traded well below $1 after its issuer disclosed exposure to a failed US bank, before recovering once access to the reserves was confirmed. Episodes like this show that even well-established stablecoins carry risk.
Regulation is changing
Governments have been introducing dedicated rules for stablecoin issuers, covering areas such as reserve requirements, audits and redemption rights. The European Union's MiCA regulation includes rules for stablecoins, and other jurisdictions, including the United States, have moved to create their own frameworks. Rules continue to evolve, so check current information for your country.
Practical tips
- Prefer stablecoins with a long track record, transparent reserves and wide availability.
- Be wary of high "yields" offered on stablecoins — higher returns always mean higher risk somewhere.
- Check you are using the correct token contract and network; scammers create fake tokens with the same name.
- Don't assume deposit insurance applies. Stablecoins are generally not bank deposits.
Frequently asked questions
Are stablecoins the same as a bank account?
No. Stablecoins are generally not bank deposits and usually aren't covered by deposit insurance. Your protection depends on the issuer, its reserves and the rules in your country.
Do stablecoins earn interest?
Holding a stablecoin by itself typically earns nothing. Platforms that offer a yield are lending or deploying your funds somewhere, which adds risk. Higher advertised yields mean higher risk.
Can a stablecoin go to zero?
Yes, especially poorly designed algorithmic stablecoins. Well-backed stablecoins have historically held their peg far better, but no stablecoin is risk-free.
Key takeaway
Stablecoins bring price stability to crypto, which makes them genuinely useful. Their safety depends on what backs them and who stands behind them. Understand the type you are holding, and you'll understand its risks. For a broader introduction, read what is cryptocurrency.
Educational content only. This article is for general information and is not financial, investment, tax or legal advice. Crypto assets are highly volatile and you can lose money. Always do your own research and never share your seed phrase or private keys. Read our full disclaimer.
