Stablecoins peg their value to other currencies, collateral or algorithms to offer more stability than other cryptocurrencies and behave more predictably, like fiat currency.
Stablecoin Definition
A stablecoin is a cryptocurrency with a value that’s tied to that of another currency or asset like the U.S. dollar. This allows a stablecoin to maintain a consistent value, making it a reliable alternative to more volatile cryptocurrencies like Bitcoin and Ethereum.
Fiat currencies are currencies issued and backed by a government, instead of being backed by a physical commodity like gold. Examples include the U.S. dollar, the British pound and the Euro. Fiat currencies offer a stable and largely predictable amount of value, making them suitable for both short- and long-term financial transactions.
Stablecoins attempt to bridge the gap between these stable options and cryptocurrencies. While cryptocurrencies offer utility benefits like faster financial transfers, cheaper international transfers and broader access to financial services, their value can be very volatile.
What Is a Stablecoin?
A stablecoin is a cryptocurrency that has a value pegged to that of another asset, such as a fiat currency like the U.S. dollar or a physical commodity like gold or silver. The value of a stablecoin is often tied 1:1 to another asset, meaning the value of a stablecoin pegged to the U.S. dollar would be $1. This approach makes stablecoins a more reliable option compared to cryptocurrencies like Bitcoin whose value can be more unpredictable.
Stablecoins are available on popular blockchain platforms like Ethereum, Solana and Ripple. As a result, investors can access the transparency and security of blockchain technology without some of the risks associated with crypto investing.
How Do Stablecoins Work?
There are several factors to keep in mind when understanding how stablecoins keep their value relatively consistent and what could cause their value to change:
Market Incentives
While the value of a stablecoin is meant to be pegged 1:1 to another asset, it isn’t always an exact match. In the case of a stablecoin tied to the U.S. dollar, sometimes its value may be a few cents higher or lower than $1. These slight shifts encourage investors to follow the basic principle of buying low and selling high.
If a stablecoin is trading at a few cents below $1, investors are incentivized to buy more stablecoins at a lower price. This reduces the number of stablecoins in circulation. If a stablecoin is trading at a few cents above $1, then investors will be incentivized to add more stablecoins to the blockchain and sell them at the higher price to make a profit. Together, these incentives help regulate the number of available stablecoins and their value.
Collateralization and Reserves
Collateralization applies to stablecoins backed by cryptocurrencies, fiat currencies or physical commodities. In crypto, collateral refers to digital assets that users pledge as part of participating in projects or platforms. Users may provide collateral to secure a loan or complete a transaction, ensuring repayment in the event that something goes wrong and a borrower or platform needs to recoup the losses.
In the case of stablecoins, users must provide collateral when minting, or creating, coins. Collateral is then held in reserve, meaning it’s kept in storage for safekeeping. Stablecoins may also have a liquidation ratio, which refers to the minimum value the collateral must meet. If the collateral falls below this value, all users surrender their collateral to the blockchain network or issuer to sustain the stablecoin’s value and address any debt. These practices maintain the value of a stablecoin while protecting a network’s long-term health.
Algorithmic Approaches
Algorithmic stablecoins (more on these to come) are more experimental and use unique methods to manage their value. For example, a system may use two tokens, where one token can be altered to regulate the value of the other. An issuer may then increase or decrease the supply of one token to regulate the value of the second token as needed.
Another technique involves letting users own a percentage of a blockchain network. In this system, the number of tokens in a user’s wallet automatically rises or falls according to a stablecoin’s daily average price. This helps the value of the stablecoin adjust to changes in supply and demand.
Types of Stablecoins
There are four main types of stablecoins in circulation: fiat-backed, commodity-backed, crypto-backed and algorithmic.
1. Fiat-Backed Stablecoins
Fiat-backed stablecoins are the cryptocurrencies most closely related to fiat (or traditional) currencies because they are backed by real-world currencies. Each fiat-backed stablecoin is tied to a specific fiat currency in a 1:1 ratio. The most common fiat currency is the U.S. dollar.
The stablecoin issuer ensures cryptocurrency remains stable by keeping fiat currency as collateral with a financial institution. The stablecoin always has a set amount of fiat currency in reserve that’s proportionate to the stablecoins it has issued. For example, if a stablecoin issuer has one million U.S. dollars in reserve, it might only offer one million stablecoins, each worth one U.S. dollar.
Examples of fiat-backed stablecoins include Tether (USDT) and USD Coin (USDC).
2. Commodity-Backed Stablecoins
Commodity-backed stablecoins are cryptocurrencies that use commodities such as gold, real estate or metals as collateral to provide stability. Gold is generally the most popular commodity used as collateral for commodity-backed stablecoins.
Examples here include Paxos Gold (PAXG) or Tether Gold (xAUT). These specific Stablecoins allow holders to participate in the gold market and have the utility benefits of a cryptocurrency without the challenges of physically owning gold bars.
3. Crypto-Backed Stablecoins
Crypto-backed stablecoins are cryptocurrencies that use one or more cryptocurrencies as collateral to provide their stability. These stablecoins use a mix of smart contracts on the blockchain to lock in cryptocurrency reserves instead of relying on a central financial institution to hold reserves like fiat-backed cryptocurrencies.
The process works like this: The buyer locks up their original cryptocurrency in a smart contract in return for an equivalent amount in stablecoins. One of the more popular stablecoins to use this approach is the Dai stablecoin.
4. Algorithmic Stablecoins
Algorithmic stablecoins are the outlier in that they do not use any form of collateral to achieve their stability. Instead, they achieve price stability by using algorithms to control the supply and circulation of their tokens on the marketplace. These stablecoins issue new tokens when the price of stablecoins goes above the target price or above the fiat currency it is tracking. This reduces its price by increasing supply. Conversely, these stablecoins stop issuing tokens if the price goes below the target, which raises the price by limiting supply.
Why Are Stablecoins Important to Cryptocurrency?
Stablecoins have become an important part of the cryptocurrency ecosystem because they provide a cryptocurrency option wherein stability is a key requirement of the financial transaction.
Stablecoins offer a way for consumers to use cryptocurrencies to buy financial products that require more stability such as mortgages and some insurances, opening up new markets and financial options for cryptocurrencies that were traditionally restricted to fiat currencies.
Cryptocurrencies are typically much more volatile than traditional assets such as stocks, commodities or currencies. For example, in May 2017, Bitcoin reached a price of $2,000 but then skyrocketed to an eye-popping $19,000 by December 2017. In 2020, as the world entered Covid lockdowns, Bitcoin’s price was around $7,000 but then skyrocketed again to over $19,000 by November 2020.
This volatility means it’s hard to predict and rely on the value of a cryptocurrency over the medium or long term. Without the ability to rely on the value of these coins, cryptocurrencies are less suitable for financial transactions that require a stable value over a longer period of time, such as real estate transactions.
Stablecoins were invented to fill this need, providing stability, long-term purchasing power and the predictability of a fiat currency alongside the utility benefits of cryptocurrencies. These utility benefits may include fast and straightforward international money transfers without the expensive fees charged by banks.
Use Cases of Stablecoins
Stablecoins can be applied in several key areas, including decentralized finance and cross-border transactions.
Digitized Real-World Assets
Because stablecoins are tied to other assets, they make it easier to trade real-world assets that have been digitized. These include real estate, digital art and physical commodities. As a result, broader groups of users can participate in the trading landscape.
Decentralized Finance (DeFi)
Stablecoins support various functions in decentralized finance, including lending, borrowing, investing and yield farming. Their consistent value brings peace of mind and efficiency to decentralized exchanges, and they can reach communities that have been overlooked by traditional financial institutions.
Cross-Border Transactions
Stablecoins facilitate faster and cheaper global transactions compared to traditional services. While this supports international business, it also enables migrants working abroad to send remittances back home to their families at an affordable rate.
Peer-to-Peer (P2P) Transactions
The lower fees and quicker transactions associated with stablecoins make them a top option for completing everyday transactions. Users in peer-to-peer networks can easily execute simple payments, even when different currencies or assets are involved.
Risk Management
In the face of major market shifts, stablecoins provide a reliable option investors can turn to when seeking a more conservative approach. Investing in stablecoins can protect users from changes in local currencies as well, especially in less-developed markets where investors are looking for more established assets.
Benefits of Stablecoins
Stablecoins come with a range of upsides that promise to make them a part of the financial landscape for years to come.
Reduced Volatility
Cryptocurrencies like Bitcoin can constantly fluctuate in value, creating a level of unpredictability that could pose a risk to investors. Because stablecoins are tied to more reliable assets like gold or the U.S. dollar, investors can trust that the value of a stablecoin will remain relatively consistent over an extended period.
Faster Transactions
Traditional financial institutions often involve intermediaries when processing transactions, leading to extended wait times. In addition, popular cryptocurrencies like Ethereum and Bitcoin can be slowed down by high network traffic. Stablecoins avoid intermediaries and high-traffic networks, completing transactions in a few minutes or even seconds.
Greater Affordability
Stablecoins stand out as a cheaper alternative to traditional institutions, especially in the case of cross-border transactions. Completing cross-border transactions may involve multiple intermediaries if a bank is involved. But stablecoins remove these middle layers, making international payments simpler and less costly.
Global Reach
Because of their ability to facilitate cheaper cross-border payments, stablecoins are more accessible to global audiences. Areas that may not have traditional finance options can then participate in payment and investing networks via stablecoins.
Enhanced Security
Stablecoins leverage blockchain technology, which provides an immutable record of all transactions conducted on the network. This contributes to transparency and security with any kind of transaction involving stablecoins. And stablecoins are pegged to more dependable currencies to protect investors against rapid price fluctuations.
Challenges of Stablecoins
Although stablecoins have generated plenty of excitement, they still have some issues that users need to account for before investing in these coins.
Suspicious Activity
While stablecoins have made life easier for everyday users, bad actors can also take advantage of this technology. Stablecoins can be used to avoid financial sanctions, commit fraud and carry out money laundering schemes.
Centralized Control
Centralization in itself isn’t a bad thing, but it places a lot more control in the hands of the issuer. Users need to make sure they trust the issuer first — an issuer with ill intentions may lie about how many stablecoins they have in reserve or abuse powers like the ability to freeze or delete tokens in a user’s crypto wallet.
De-Pegging
Changes in prices and other events may lead to a phenomenon known as de-pegging, where a stablecoin falls below a target value. In other words, it is no longer tied 1:1 to its asset. This may affect an individual investment or the entire network, so users need to be aware of this risk when investing in stablecoins.
Evolving Regulations
Stablecoins may be subject to varying rules in different regions, and governments are continuing to develop new blockchain regulations. The problem lies in keeping track of various rules to ensure stablecoin transactions remain compliant.
Technological Access
Global audiences can participate in networks that use stablecoins, but only if they have the necessary technology. Companies that lack certain infrastructure may be unable to support stablecoin transactions, and individuals without technologies like mobile devices or reliable internet may be left out of the digital investing scene.
The Future of Stablecoins
Stablecoins have soared in popularity, with 208 billion stablecoins entering circulation in 2025. As of writing this article, the stablecoin market is worth more than $233 billion. The stablecoin with the highest market capitalization value is Tether, which is pegged to the U.S. dollar as its fiat-backed currency. Tether has a total market value of just over $144 billion.
That said, some have called for more regulation around stablecoins given the Trump administration’s attempts to deregulate cryptocurrencies and spur stablecoin growth. Stablecoins promise to disrupt traditional payment systems and financial infrastructure while competing against fiat currencies, which are carefully regulated by governmental bodies and central banks. This may bring stablecoin providers under scrutiny as their cryptocurrencies displace traditional fiat currencies while providing new forms of financial products and platforms.
Frequently Asked Questions
What are the top stablecoins?
According to Forbes, the top stablecoins based on market capitalization are Tether, USDC, Ethena USDe, Dai and First Digital USD.
What is the strongest stablecoin?
According to market capitalization, Tether is considered the strongest stablecoin. However, USDC is also a close second since it is backed by the U.S. dollar and U.S. Treasury instruments.
Are stablecoins protected from loss?
Stablecoins are not completely protected from loss. They are designed to be tied in value 1:1 to an established asset, and investors are often required to provide collateral to participate in stablecoin projects and platforms. While these measures offer additional security, they do not guarantee zero losses when investing in stablecoins.
What are the disadvantages of stablecoins?
Due to a phenomenon known as de-pegging, the value of a stablecoin may fall slightly below the value of the asset it’s pegged to. In addition, stablecoin users can still become victims of bad actors and untrustworthy issuers.
How do stablecoins make money?
Actions like minting, transferring or redeeming stablecoins often come with fees, allowing stablecoin issuers to turn a profit. Users usually pay collateral when investing in stablecoins as well, so issuers are protected against losses and malicious behavior.
