Educational only. Not financial advice.
Stablecoins in one sentence
Stablecoins are digital tokens designed to track the price of a reference asset—most commonly the U.S. dollar—so you can move value on crypto rails without constant price swings.
Why stablecoins exist
Crypto is great at fast, global settlement, but volatile prices make everyday use hard. Stablecoins solve that by holding (or simulating) dollar value while keeping the speed and programmability of blockchains. Traders use them as a “cash” leg, businesses use them for cross-border payments, and individuals use them to store value in a familiar unit without a bank account in the middle.
How the “peg” works
- Fiat-backed redemption: An issuer takes dollars (or short-term Treasuries), mints $1 stablecoins, and promises to redeem 1:1 back to dollars. If the market price drifts, arbitrage restores the peg.
- Over-collateralized crypto: A protocol locks more than $1 of crypto to mint $1 of stablecoin; if collateral falls, positions are liquidated to protect the peg.
- Algorithmic mechanisms: The protocol tries to hold price via supply adjustments or incentive tokens—these are the riskiest and have failed in the past.
Main types of stablecoins (with pros & cons)
| Type | Peg Mechanism | Typical Examples | Pros | Key Risks |
|---|---|---|---|---|
| Fiat-backed | 1:1 reserves in cash, bank deposits, and short-term Treasuries; issuer redeems on demand | USDC, USDT, PYUSD | Most liquid; simple to understand; usually tight peg | Issuer/custodian risk; bank exposure; blacklisting controls |
| Crypto-collateralized | Over-collateralized vaults; on-chain liquidations | DAI, sUSD, LUSD | Transparent on-chain collateral; non-custodial | Collateral volatility; smart-contract risk; market stress can widen peg |
| Algorithmic / Seigniorage | Supply expands/contracts; relies on market incentives and companion tokens | (Various historical projects) | Capital-efficient in theory | High failure rate; “death spiral” risk; avoid for savings |
| Asset-backed (non-USD) | Backed by commodities or non-USD assets | PAXG (gold-linked), EUR-pegged coins | Exposure to other assets; niche use cases | May not be dollar-stable; liquidity varies |
How minting and redeeming works (practical view)
Custodial issuers (e.g., USDC, USDT)
- On-ramp: A customer completes KYC with the issuer or exchange, wires dollars, and receives the same amount of stablecoins minus fees.
- Redemption: Return the tokens to the issuer to receive dollars back. Large redemptions are common during market stress and are part of how the peg stays tight.
- Reserves: The issuer holds cash/T-bills and publishes attestations or audits about the backing.
On-chain protocols (e.g., DAI)
- Lock collateral (ETH, liquid staking tokens, or tokenized T-bill exposure) in a smart contract.
- Mint stablecoins up to a conservative loan-to-value ratio (e.g., 66%).
- If collateral value drops, automated liquidations repay the debt and protect the system.
Popular uses for stablecoins
- Payments & remittances: Send value globally in minutes with low fees. Recipients can hold the coin or cash out locally.
- Trading & hedging: A “cash” leg on exchanges; move between venues quickly; park gains without leaving the crypto ecosystem.
- Cash management: Some issuers/protocols offer yield via short-term T-bill exposure or on-chain money markets (mind the risks).
- DeFi building block: Liquidity pools, lending markets, and derivatives often settle in a stable unit.
- Cross-border commerce: Settle invoices, pay contractors, or manage multi-currency exposure more easily than with wires.
Key risks you should understand
- Depegging: Market price can drop below $1 during stress. Check historical peg performance on several exchanges.
- Reserve quality & transparency: For fiat-backed coins, scrutinize attestations/audits, asset mix (cash vs. T-bills), and issuer disclosures.
- Counterparty & custody: Issuer, banks, and custodians can fail or face freezes. Token contracts may allow blacklisting of addresses.
- Smart-contract risk: Bugs, governance attacks, and oracle failures can break on-chain stablecoins.
- Regulatory & sanctions: Policy changes or enforcement actions can affect redemption, listing, or address blocking.
- On/Off-ramp friction: KYC, withdrawal limits, banking partner outages, or regional restrictions can slow redemptions.
- Concentration & chain risk: Liquidity often concentrates on a few chains. Network outages or fee spikes can impede transfers.
- Algorithmic fragility: Purely algorithmic models can unravel fast; avoid using them as savings.
How to choose a stablecoin (practical checklist)
- Purpose: Payments, trading, long-term holding, or DeFi? Your use case determines the best design.
- Issuer profile: Who runs it, where are they based, and what is their track record?
- Reserves & reports: Cash/T-bills vs. riskier assets; frequency and depth of attestations or audits.
- Redemption terms: Minimums, fees, and eligibility for individuals or only institutions.
- Blacklist policy: Can the issuer freeze or claw back tokens? What are the criteria?
- Chain support: Which networks are supported (Ethereum, Solana, etc.) and where is liquidity deepest for your needs?
- Smart-contract reviews: For on-chain coins, look for audits, bug bounties, and simple, battle-tested designs.
- Ecosystem fit: Does your exchange, wallet, or payment partner support the coin natively?
- Market depth: Check volumes and spreads on your preferred venues.
Safety best practices
- Diversify: Don’t keep all funds in one issuer or protocol. Mix fiat-backed and on-chain options if appropriate.
- Use hardware wallets for large balances: Keep long-term holdings off exchanges whenever possible.
- Test small first: When moving to a new chain or platform, start with a tiny amount, then scale.
- Monitor the peg: Spot-check prices on several exchanges and aggregators, not just one.
- Stay current: Follow issuer announcements, reserve reports, and chain status dashboards.
Examples at a glance
- USDC: Fiat-backed, widely used by businesses and exchanges, generally tight peg, strong compliance posture.
- USDT: Largest by market cap with deep liquidity across many chains; issuer transparency has improved over time; still evaluate reserves.
- DAI: Crypto-collateralized; over time has incorporated tokenized T-bill exposure via backing assets; on-chain governance.
Frequently asked questions
Are stablecoins safe?
No asset is risk-free. Fiat-backed coins depend on the issuer and its banking partners; on-chain coins depend on collateral quality and smart-contract design. Diversify and understand redemption terms.
Do stablecoins pay interest?
The tokens themselves typically do not. Yield comes from platforms (exchanges, on-chain lending) that take your tokens and deploy them—introducing additional risk. Always evaluate counterparty risk and terms.
What’s the difference between USDC and USDT?
Both aim for a $1 peg and huge liquidity. Differences include issuer entities, disclosures, banking relationships, and chain distribution. Choose based on your venue support, transparency preferences, and use case.
Are stablecoins legal in the U.S.?
They are widely used by U.S. users and companies, and regulation is evolving. Issuers operate under money-transmission and trust structures; always follow your local laws and tax rules.
The bottom line
Stablecoins bring the speed of crypto to the familiarity of dollars. Pick the design that fits your goal, read the fine print on reserves and redemption, and diversify your exposure. Used thoughtfully, they’re a powerful tool for payments, trading, and cash management.
Next up: explore our Guides & Checklists for step-by-step walkthroughs on wallets, transfers, and avoiding common mistakes.