Stablecoins are digital assets designed to maintain a fixed value, most commonly pegged to fiat currencies like the US dollar or euro. This article explains how they work, the different types available, and the role they play in global payments and decentralised finance (DeFi).
A stablecoin is a type of cryptasset that is designed to minimise price volatility by being backed by a reserve asset. Typically, this asset is a national currency such as the US dollar or euro, but it can also be commodities like gold.
The aim is to offer the benefits of crypto – such as speed and accessibility – without the sharp price swings seen in coins like Bitcoin or Ethereum.
Stablecoins are commonly used to move money quickly across borders, provide a stable medium of exchange on crypto platforms, and support payment innovation, especially in emerging markets where access to traditional banking is limited.
Types of stablecoins in the market
There are three main types of stablecoins:
- Fiat-backed stablecoins
These are the most common and are backed 1:1 by a national currency. Tether (USDT) and USD Coin (USDC) are the leading examples. Issuers hold reserves in bank accounts to support each token in circulation. Circle, the issuer of USDC, publishes monthly attestations to confirm reserves.
- Crypto-backed stablecoins
These use cryptocurrencies as collateral. A well-known example is DAI, issued by MakerDAO, which is backed by Ethereum and other digital assets. To account for crypto’s volatility, these stablecoins are often overcollateralised.
- Algorithmic stablecoins
These rely on software algorithms to control supply and demand, aiming to keep the price stable without holding reserves. However, many have failed to maintain their peg. The collapse of TerraUSD (UST) in 2022 highlighted the risks of this model.
How stablecoins are used in payments and DeFi
Stablecoins have become essential in decentralised finance (DeFi), where they are used for trading, lending, and liquidity provision. They also play a growing role in international payments, particularly for businesses that want faster settlement or access to dollar-denominated value in countries with unstable currencies.
According to a 2024 report by The Block Research, stablecoins settled over $9 trillion in transactions during the year, signalling their increasing role in the broader financial system.
Companies such as Visa and PayPal have also moved into the space. In 2023, PayPal launched its own stablecoin, PYUSD, issued by Paxos, while Visa began experimenting with USDC on Solana for cross-border settlements.
Are stablecoins regulated?
Stablecoins are in a regulatory grey area in many countries. In the US, new frameworks are being shaped under the proposed GENIUS Act, which aims to require issuers to maintain full reserves and undergo regular audits.
In the UK, the Financial Services and Markets Act 2023 gave the Bank of England new powers to supervise systemically important stablecoin issuers. The FCA also plans to publish rules for digital settlement assets in 2025.
What are the risks associated with stablecoins?
Despite their promise, stablecoins come with risks. These include:
- Lack of transparency: Not all issuers publish real-time proof of reserves.
- Regulatory uncertainty: Frameworks are evolving, but remain inconsistent.
- Counterparty risk: If the issuer fails or mismanages reserves, users may not be able to redeem tokens.
The collapse of TerraUSD showed how quickly confidence in a stablecoin can evaporate, leading to significant financial losses and wider market disruption.
Stablecoins are emerging as a key component of modern digital finance. They provide a practical solution for both consumers and businesses looking to harness the benefits of blockchain technology without being exposed to extreme price volatility.
As regulation matures and adoption grows, their role in the payments ecosystem is likely to deepen – but transparency and accountability will remain essential.
