What Is a Stablecoin and How Does It Work?

A stablecoin is a cryptocurrency designed to hold a steady value, usually exactly $1, by tying its price to an outside asset such as the US dollar. So when someone asks “what is a stablecoin,” the short answer is: a digital dollar that lives on a blockchain, can move anywhere in the world in minutes, and is meant to keep its price instead of swinging like bitcoin.

How well a stablecoin keeps that $1 price depends entirely on what stands behind it. Some are backed by cash and short-term government bonds held by a company. Others are backed by other crypto locked in smart contracts. A third group relied on algorithms and market incentives, and that design produced one of the biggest collapses in crypto history.

This guide explains how each type works, what stablecoins are actually used for, where the risks hide, and how regulators in the EU and US now treat them. If you are new to crypto in general, our crypto guides hub covers the basics first.

What is a stablecoin, in plain terms?

Think of a stablecoin as a token that promises a fixed exchange rate. The most common promise is 1 token = 1 US dollar. Tokens also exist for the euro, the British pound, gold and a few other assets, but dollar tokens make up the overwhelming majority of the market.

The key word is peg. A peg is the target price a stablecoin tries to maintain. When a stablecoin trades at $0.97 or $1.03, it has drifted off its peg. When it trades far below $1 for a sustained period, people say it has depegged.

Stablecoins run on public blockchains such as Ethereum, Solana, Tron and others. That means you can hold them in a regular crypto wallet, send them to anyone with a wallet address, and use them inside decentralized apps, all without a bank opening hours or a wire transfer cutoff.

The best-known examples are Tether (USDT) and USD Coin (USDC), the two largest dollar stablecoins for several years running. Others include Dai and its successor USDS from the Sky (formerly MakerDAO) protocol, PayPal USD (PYUSD) and Ripple USD (RLUSD). For a head-to-head look at the two leaders, see our guide to USDT vs USDC and which is safer.

How does a stablecoin work?

Every stablecoin needs two things to hold its peg: something of value backing each token, and a way for prices that drift from $1 to get pulled back. That second part is called arbitrage, which simply means buying something where it is cheap and selling it where it is expensive.

Minting and redeeming

For a fiat-backed coin like USDC, approved customers (usually businesses and trading firms) can send $1 million to the issuer and receive 1 million new tokens. This is called minting. They can also send 1 million tokens back and receive $1 million, which is called redeeming, and the returned tokens are destroyed (“burned”).

That two-way door is what keeps the price close to $1. If the token trades at $0.99 on exchanges, a trader can buy it cheaply and redeem it with the issuer for $1. If it trades at $1.01, a trader can mint new tokens for $1 and sell them for $1.01. Both trades push the market price back toward the peg.

Most individuals never mint or redeem directly; they trade on exchanges and benefit from the peg that big arbitrage players maintain.

Types of stablecoins

Stablecoins differ mainly in what backs them. Here are the three main types of stablecoins, plus a newer hybrid category.

1. Fiat-backed (fiat-collateralized) stablecoins

These are backed by traditional assets held off-chain: cash in bank accounts, US Treasury bills, money market funds and overnight repurchase agreements (short loans backed by Treasuries). A company issues the tokens and holds the reserves. USDT, USDC, PYUSD and RLUSD all work this way.

The strength of the model is simplicity. The weakness is that you must trust the issuer, its banks, its custodians and its accountants. If reserves are lost, frozen or misreported, the token can wobble.

2. Crypto-collateralized stablecoins

These are backed by other cryptocurrencies locked in smart contracts, which are programs that run automatically on a blockchain. Dai (and now USDS) is the main example. Because crypto collateral is volatile, these systems require overcollateralization: you must lock up more value than you borrow.

For instance, a vault might require at least $150 of ether to mint 100 tokens. If the ether’s value drops close to that minimum, the system automatically sells (liquidates) the collateral to keep the stablecoin fully backed. The benefit is transparency, since anyone can inspect the collateral on-chain. The catch is complexity and exposure to smart contract bugs. Over time Dai also added real-world assets like Treasuries and other stablecoins to its backing, which blurred the line with fiat-backed coins. Our guide to DeFi explains how these lending systems work.

3. Algorithmic stablecoins

Algorithmic stablecoins try to hold the peg with code and incentives rather than full reserves. The usual design pairs the stablecoin with a second, volatile “sister” token. When the stablecoin trades below $1, the system lets you burn it in exchange for $1 worth of the sister token, shrinking supply. When it trades above $1, the reverse happens.

This works only while people believe the sister token has value. If confidence breaks, the design can collapse in hours. TerraUSD proved it.

4. Synthetic or “yield-bearing” dollars

A newer category uses trading strategies to stay near $1. Ethena’s USDe, for example, holds crypto while shorting the same amount through derivatives so that price moves roughly cancel out. These products can pay yield but carry exchange, funding-rate and counterparty risks that traditional stablecoins do not. Many regulators do not treat them as stablecoins at all.

Comparison table: types of stablecoins

Case study: the TerraUSD collapse of May 2022

TerraUSD (UST) was an algorithmic dollar on the Terra blockchain, paired with the LUNA token. Each UST could always be swapped for $1 worth of newly created LUNA. Demand was fueled by the Anchor protocol, which advertised yields of close to 20% a year on UST deposits. By early May 2022, UST had grown into one of the largest stablecoins.

Starting around May 7–9, 2022, large withdrawals from Anchor and big UST sales pushed the price below $1. Holders rushed to swap UST for LUNA, which created huge amounts of new LUNA. LUNA’s price crashed, which made each swap worth less, which caused more panic. This feedback loop is the classic “death spiral.” Within days UST was trading for cents and LUNA had lost more than 99% of its value. Roughly $40 billion of value was wiped out, according to US prosecutors and press reports.

The legal fallout came later. In June 2024, Terraform Labs and co-founder Do Kwon agreed to pay about $4.5 billion to settle the US Securities and Exchange Commission’s fraud case after a jury found them liable. Kwon pleaded guilty to US criminal fraud charges in August 2025 and was sentenced to 15 years in prison in December 2025.

Reserves, attestations and depegs

Attestations vs audits

For fiat-backed coins, the central question is: are the reserves really there, and are they safe? Issuers answer this with published reports, but the type of report matters.

• Attestation: An accounting firm checks that the reserves matched the tokens outstanding at a specific moment. It is a snapshot, narrower than an audit. Circle and Tether both publish regular reserve reports on their transparency pages.
• Audit: A full examination of a company’s financial statements and controls over a period. It is a much stronger form of assurance.
• Proof of reserves: A crypto-native technique that shows wallet balances on-chain. The SEC has warned that such reports are not a substitute for an audit, because they may not show liabilities.

When you read a reserve report, look at three things: what share is cash and short-dated Treasuries (very safe and liquid), what share is riskier assets like loans, precious metals or bitcoin, and which banks and custodians hold the money. Reserve composition differs between issuers and changes over time, so check the issuer’s latest report rather than relying on an old article.

Depegs: what happened to USDC in March 2023

Even a well-run, fully reserved stablecoin can depeg if part of its reserve becomes temporarily unavailable. That is exactly what happened to USDC.

On Friday, March 10, 2023, California regulators closed Silicon Valley Bank (SVB). That evening Circle disclosed that about $3.3 billion of USDC’s roughly $40 billion in reserves sat at SVB. Over the weekend, when banks were closed and redemptions could not settle, USDC fell as low as about $0.87 on some exchanges.

On Sunday, March 12, 2023, the US Treasury, Federal Reserve and FDIC announced that all SVB depositors would be fully protected. USDC climbed back to about $1 within days. Holders who panic-sold near the low locked in losses of more than 10%; those who held were made whole.

What is a stablecoin used for?

Stablecoins are now among the most-used tokens in crypto. Common uses include:

1. Trading: Most crypto trading pairs are priced in stablecoins. Traders park money in USDT or USDC between trades instead of cashing out to a bank.
2. Cross-border payments and remittances: Sending $500 in stablecoins abroad can settle in minutes, often for less than a traditional wire, though cash-out fees on the other end vary.
3. Dollar access: In countries with high inflation or capital controls, people use dollar stablecoins as a savings tool and a way to price goods.
4. DeFi: Stablecoins are the main currency for lending, borrowing and liquidity pools in decentralized finance.
5. Business settlement: Payment companies and some banks use stablecoins to move money between subsidiaries or settle with partners outside banking hours.

One thing stablecoins are not designed for is growth. A stablecoin held in a wallet does not earn anything by itself. Any “yield” you are offered comes from lending it out or depositing it in a platform, which adds new risks.

Stablecoin vs bitcoin: what’s the difference?

People often compare stablecoins with bitcoin because both are crypto, but they solve opposite problems.

In short, you hold bitcoin if you want exposure to a scarce, volatile asset; you hold a stablecoin if you want dollars that move like crypto. Our complete bitcoin guide explains how bitcoin’s fixed supply works.

Stablecoin regulation: EU MiCA and the US GENIUS Act

Stablecoins are among the first areas of crypto to get dedicated laws. Rules differ by country, so always check where you live.

European Union: MiCA

The EU’s Markets in Crypto-Assets Regulation (MiCA) has applied to stablecoins since June 30, 2024, and to the wider crypto industry since December 30, 2024. MiCA splits stablecoins into e-money tokens (EMTs), which track a single official currency like the euro or dollar, and asset-referenced tokens (ARTs), which track a basket or other assets. Issuers need authorization, must hold reserves, must offer redemption at par and face limits on very large non-euro stablecoins used for payments. Around the start of 2025, several major exchanges restricted non-compliant stablecoins, including USDT, for users in the European Economic Area.

United States: the GENIUS Act

In the US, the GENIUS Act (Guiding and Establishing National Innovation for U.S. Stablecoins Act) was signed into law on July 18, 2025. It creates a federal framework for “payment stablecoins.” Key features include reserves backed one-to-one by high-quality liquid assets such as cash, insured deposits and short-term Treasuries, monthly public disclosure of reserve composition, licensing of issuers at the federal or state level, and priority for token holders if an issuer goes bankrupt. The law also states that payment stablecoins are not securities.

The law takes effect on the earlier of 18 months after enactment (January 18, 2027) or 120 days after regulators finalize their rules. Regulators missed the July 2026 deadline for final rules; they had issued proposals, and Treasury opened comment on its own proposal in August 2026, according to law-firm trackers. That makes January 2027 the working effective date. Details can still change, so check the latest guidance from the US Treasury and banking regulators.

Stablecoin taxes are a separate question. In many countries, swapping crypto into a stablecoin is a taxable disposal. Our plain-English crypto tax guide covers the US, UK and EU basics.

Risks of stablecoins

• Reserve risk: The backing may be smaller, riskier or less liquid than claimed.
• Bank and custodian risk: As USDC showed in 2023, reserves can get stuck in a failing bank.
• Run risk: If many holders redeem at once, an issuer may have to sell assets fast, possibly at a loss.
• Freeze and blacklist risk: Major fiat-backed issuers can freeze tokens at specific addresses, for example at law enforcement request. That protects against theft in some cases but means you do not fully control those funds.
• Smart contract and bridge risk: Bugs, hacks or broken cross-chain bridges can make a “wrapped” version of a stablecoin worthless even if the original is fine.
• Platform risk: Stablecoins held on an exchange or yield platform are only as safe as that company. Several lenders that promised stablecoin yields failed in 2022.
• Scams: Fake tokens with real-sounding names and “guaranteed” stablecoin yields are common. Learn the red flags in our guide to common crypto scams.
• Regulatory risk: A coin can be delisted in your region if it does not meet local rules.

A practical habit: before using a stablecoin, check the issuer’s latest reserve report, confirm you are using the official token contract address listed on the issuer’s website, and avoid keeping more on any single platform than you can afford to have frozen for weeks.

Bottom line

A stablecoin is a crypto token built to hold a fixed value, almost always $1. Fiat-backed coins depend on the issuer’s reserves and banks, crypto-backed coins depend on overcollateralized smart contracts, and algorithmic coins depend on confidence, which TerraUSD showed can vanish in days. Stablecoins are useful for trading, payments and moving dollars globally, but they are not risk-free cash and are generally not government insured. Pick coins with clear, frequent reserve reporting, understand who can freeze them, and keep an eye on the MiCA and GENIUS Act rules that now shape the market.

Sources

• Federal Reserve – Joint statement by Treasury, Federal Reserve, and FDIC (March 12, 2023)
• SEC – Terraform and Kwon to pay $4.5 billion following fraud verdict
• ESMA – Markets in Crypto-Assets Regulation (MiCA)
• EUR-Lex – Regulation (EU) 2023/1114 on markets in crypto-assets
• Congress.gov – S.1582, GENIUS Act
• Circle – USDC transparency and reserves
• Tether – Transparency
• Investor.gov (SEC) – Exercise caution with crypto asset securities