Stablecoins

A stablecoin is a cryptocurrency designed to keep its value tied to a stable asset. Most often that asset is the US dollar, so one token is meant to be worth about one dollar. There are also stablecoins linked to the euro, other currencies or gold. The idea is in the name: a coin that aims to stay stable.

Why stablecoins exist

The prices of most cryptocurrencies can swing sharply, sometimes within a single day. That is inconvenient if you simply want to send money, pay for a service, or hold value for a while without moving funds back to a bank. Stablecoins try to combine features of crypto and traditional money:

• transfers run on a blockchain, around the clock, without a bank in the middle
• the value stays close to a chosen currency

In practice, stablecoins are widely used as a unit of account on crypto exchanges, in decentralized finance (DeFi), and for cross-border transfers.

How the peg is maintained

The key question for any stablecoin is what keeps its price stable. The target link to an asset is called the peg. There are several main approaches.

Fiat-backed

A company issues tokens and holds an equivalent amount in reserves, in cash or in low-risk assets such as short-term government bonds. Verified customers can redeem tokens with the issuer for dollars, and that redemption process helps hold the price in place.

This is the most common type. Its main risk is trust in the issuer: do the reserves really exist in the stated amount, where are they held, and how quickly can they be accessed? That is why it matters whether an issuer publishes regular reserve reports and whether independent firms review them.

Crypto-backed

These stablecoins are created by smart contracts against deposits of other cryptocurrencies. Because the collateral itself is volatile, users must lock up more value than the stablecoins they create. This is known as overcollateralization. If the collateral price drops too far, the position is liquidated automatically so the tokens stay backed.

The upside is transparency: collateral sits on the blockchain where anyone can check it. The downsides are complexity and the risk of smart contract bugs.

Algorithmic

Algorithmic stablecoins try to hold their price with code rather than reserves, automatically expanding or shrinking the token supply. History has shown that this model can be very fragile: under stress, confidence disappears and the peg can collapse. The best-known example is the failure of TerraUSD (UST) in May 2022.

Main risks

Being called "stable" does not mean being risk-free:

• Depegging. The price can drift away from its target, briefly or for longer, for example when there are doubts about reserves or a rush of redemptions.
• Issuer risk. The company behind the token may face insolvency, trouble at the banks holding its reserves, or regulatory action.
• Freezing. Many fiat-backed stablecoins let the issuer block tokens at specific addresses, for instance at the request of authorities.
• Technical risk. Vulnerabilities in smart contracts, cross-chain bridges and the platforms where tokens are held.
• Regulation. Rules for stablecoins differ between countries and are still developing.

Practical safety

• Check which network you are sending on. The same stablecoin can exist on several blockchains, and sending to the wrong network can mean losing the funds.
• Verify the token contract address. Scammers create fake tokens with the same name and ticker as well-known stablecoins.
• Be wary of promises of guaranteed returns on stablecoins. The word "stable" is often used in marketing to create a false sense of safety.
• Remember that transfers need a fee paid in the network's native coin. Without it, you cannot send the stablecoin.

Key takeaways

• Stablecoins are cryptocurrencies whose price is tied to a stable asset, most often the US dollar.
• The peg is supported by fiat reserves, crypto collateral or algorithms.
• The main risks are depegging, issuer reliability, freezing and technical flaws.
• Stable does not mean risk-free.