When you think of cryptocurrencies, which word comes to your mind first? This word may be “volatility”. Bitcoin was introduced as a peer-to-peer electronic cash system that allows people to send value without relying on a financial institution to process every transaction.
However, Bitcoin and many other cryptocurrencies can change considerably in price. This makes them difficult to use when the value of a payment needs to remain predictable.
Stablecoins were designed to solve this problem. Instead of allowing their price to move freely with the crypto market, they aim to maintain a stable value, usually relative to a currency such as the US dollar or euro.
Today, stablecoins are used for much more than crypto trading. They are used to transfer funds, make payments, settle transactions, and move value between traditional financial systems and blockchain networks.
In this article, we will look at what stablecoins are, how they work, what types of stablecoins exist, where they are used, and what risks they involve.
Stablecoins are cryptocurrencies designed to maintain a stable value. Most of them are tied to fiat currencies such as the US dollar or euro, although stablecoins can also be linked to other assets.
For example, a stablecoin pegged to the US dollar aims to keep its price close to $1. Depending on the type of stablecoin, this peg can be supported by reserves, crypto collateral, or other mechanisms.
The main difference between stablecoins and cryptocurrencies such as Bitcoin or Ether is price stability. While the value of Bitcoin can change considerably within a short period, a stablecoin is designed to stay close to the value of the asset it follows.
You can keep stablecoins in a digital wallet, send them to another wallet, trade them, or use them in payment and financial applications. Today, stablecoins are also used for cross-border payments, payouts, settlement, and other financial operations.
Why Are Stablecoins So Important?
Bitcoin and many other cryptocurrencies can change considerably in price within a short period of time. This may not be a problem for people who buy cryptocurrencies as an investment, but it makes them less convenient for everyday payments and business transactions.
For a better understanding, imagine that you need to pay a supplier $5,000. If you make the payment in a cryptocurrency whose price changes significantly during the day, the value received by the supplier may be different from the value you intended to send. This makes budgeting, accounting, and pricing more complicated.
A stablecoin pegged to the US dollar is designed to stay close to $1. This makes it easier to calculate the amount of a payment while still allowing funds to move through blockchain networks.
Stablecoins can be used for different purposes, including trading, payments, payouts, cross-border transfers, and settlement. Businesses can also use them inside financial products without necessarily making cryptocurrency the main part of the user experience.
Stablecoins are widely used in crypto trading because they allow traders to move between more volatile cryptocurrencies and an asset designed to maintain a stable value.
For example, a trader may exchange Bitcoin or Ethereum for a stablecoin such as USDT or USDC instead of converting the funds into traditional currency. The stablecoins can remain on a crypto exchange or in a digital wallet and be used again when the trader wants to buy another cryptocurrency.
Stablecoins are also commonly used as trading pairs. Instead of comparing the price of one cryptocurrency directly with another, exchanges can quote its value against a dollar-pegged stablecoin. For example, BTC/USDT shows the price of Bitcoin in USDT.
Another reason is that stablecoins can move between wallets, exchanges, and blockchain applications without first converting the funds to fiat money. The availability, transaction time, and fees depend on the stablecoin, blockchain network, and platform being used.
Stablecoins can also interact with smart contracts and decentralized financial applications. This allows them to be used for trading, lending, borrowing, liquidity provision, and other on-chain financial operations.
Stablecoins use different mechanisms to keep their price close to the asset they follow. Depending on what supports their value, they can be divided into several main types: fiat-backed, crypto-backed, commodity-backed, and algorithmic stablecoins.
Fiat-Backed Stablecoins
Fiat-backed stablecoins are the most common type. They are usually pegged to a traditional currency such as the US dollar or euro and backed by reserves held by the issuer.
For example, USDT and USDC are designed to maintain a value close to one US dollar. Their issuers hold reserve assets to support the stablecoins in circulation and allow eligible holders to redeem them according to the issuer’s terms.
The reserves do not necessarily consist only of cash kept in a bank account. Depending on the stablecoin, they may include cash, bank deposits, government securities, and other short-term financial assets.
Crypto-Backed Stablecoins
Crypto-backed stablecoins use other digital assets as collateral. The collateral is usually managed through smart contracts and may be worth more than the stablecoins issued against it.
DAI is a well-known example of this model. Instead of relying only on traditional reserve assets held by one issuer, its system uses on-chain mechanisms and different types of collateral to help maintain its value.
Since cryptocurrencies used as collateral can change considerably in price, these systems need mechanisms to manage the risk of falling collateral value.
Commodity-Backed Stablecoins
Some stablecoins are linked to commodities rather than fiat currencies. Gold is one of the most common examples.
PAX Gold (PAXG) and Tether Gold (XAUt), for example, are designed to represent ownership of physical gold. Their value therefore follows the price of the underlying commodity rather than the US dollar.
Algorithmic Stablecoins
Algorithmic stablecoins try to maintain their peg using protocols, economic incentives, or changes in token supply instead of relying on traditional reserves in the same way as fiat-backed stablecoins.
This model involves different risks. If the mechanism used to support the peg stops working as expected or market confidence falls, an algorithmic stablecoin may lose its intended value.. Most of the laws put limitations on such projects as they are pretty confusing to understand.
Stablecoins, Bitcoin, and other cryptocurrencies can all be transferred through blockchain networks, but they are designed for different purposes. The main difference is how their value is determined and maintained.
Risks. Bitcoin and stablecoins have different risk profiles. Bitcoin holders are exposed mainly to changes in its market price, along with security and operational risks. Stablecoins have additional risks related to their reserves, issuers, collateral, liquidity, or the mechanism used to maintain the peg.
Price stability. The price of Bitcoin, Ether, and many other cryptocurrencies is determined by the market and can change considerably. Stablecoins are designed to stay close to the value of a particular asset, such as the US dollar. This makes their value more predictable for payments and other transactions.
Backing. Bitcoin does not rely on reserves of dollars or other assets to support its price. Fiat-backed stablecoins work differently. Their issuers hold reserve assets to support the stablecoins in circulation. Other stablecoins may use crypto collateral or different mechanisms to maintain their peg.
Supply. Bitcoin has a maximum supply of 21 million coins, and new bitcoins are issued according to the rules of the Bitcoin protocol. The supply of a stablecoin works differently and depends on its design. For fiat-backed stablecoins, tokens can generally be issued or redeemed as funds enter or leave the system.
Use. Bitcoin is used as a digital asset and can also be used to transfer value. Stablecoins are commonly used when users or businesses want to move value without taking the same level of short-term price exposure. They are used for crypto trading, payments, payouts, settlement, and other financial operations.
Stablecoin regulation has changed considerably in recent years. As stablecoins are increasingly used for payments and other financial operations, regulators are paying more attention to how they are issued, backed, redeemed, and managed.
The rules depend on the country and on the type of stablecoin. Regulators may set requirements for reserve assets, redemption, transparency, risk management, and the companies allowed to issue or provide services involving stablecoins.
In the European Union, stablecoins are covered by the Markets in Crypto-Assets Regulation, known as MiCA. The regulation includes rules for asset-referenced tokens and e-money tokens and sets requirements for their issuers. The stablecoin provisions of MiCA have applied since June 2024.
Other jurisdictions have introduced or continue to develop their own rules for stablecoins. Therefore, a company planning to issue a stablecoin or use stablecoins in a financial product needs to consider the regulations of the markets where the product will operate.
Stablecoins are used for much more than crypto trading. People and businesses can use them to hold value, transfer funds, make payments, and interact with different blockchain-based financial applications.
When stablecoins are used for payments, the asset is only one part of the system. Our guide to stablecoin payment rails explains how wallets, blockchain networks, fiat conversion, payouts, and payment logic work together.
Stablecoins are designed to follow the value of another asset. This relationship is known as a peg. For example, a stablecoin pegged to the US dollar aims to maintain a price close to $1.
How the peg is maintained depends on the stablecoin. Fiat-backed stablecoins rely on reserve assets held by their issuers. When new stablecoins are issued, the corresponding reserves need to support the tokens in circulation. When tokens are redeemed, they can be removed from circulation.
Crypto-backed stablecoins work differently. They use other digital assets as collateral, which can be managed through smart contracts. Since the value of this collateral may change, these systems usually require additional mechanisms to protect the peg.
Algorithmic stablecoins use another approach. Their protocols may adjust token supply or use other economic mechanisms to influence the price. Such systems depend heavily on how well these mechanisms continue to work under changing market conditions.
In practice, maintaining a stablecoin also involves liquidity. If a stablecoin can be bought or redeemed close to its intended value, market participants have an incentive to trade it back toward the peg when its market price moves away from it.
Stablecoins are designed to maintain a stable value, but this doesn’t mean they are free from risks. The risks depend on the type of stablecoin, its issuer, the assets or mechanisms supporting it, and the platforms used to store and transfer it.
If you are planning to use a stablecoin, it is worth checking how it maintains its value and what stands behind it. Stablecoins use different models, so their risks can also be different.
For fiat-backed stablecoins, look at the assets held in reserve and how often information about these reserves is published. Major issuers such as Tether and Circle regularly publish information about the assets supporting USDT and USDC.
You should also check how redemption works. A stablecoin may trade close to its peg on an exchange, but it is important to understand whether it can be redeemed for the underlying currency, who can request redemption, and what conditions apply.
Liquidity is another factor to consider. A stablecoin with active markets across different exchanges and platforms may be easier to buy, sell, or exchange close to its intended value. However, liquidity can change during periods of market stress.
Finally, consider the issuer, the blockchain networks where the stablecoin is available, the platforms used to store or transfer it, and the regulations that apply in your market. Looking at these factors together gives you a better picture of the risks involved.
There are many stablecoins on the market, and they differ in the way they are issued and backed. Here are some well-known examples.
Tether (USDT)
USDT is one of the largest and most widely used stablecoins. It is issued by Tether and is designed to maintain a value of one US dollar. Tether reports that USDT is backed by its reserves and publishes information about these reserves on its website.
USD Coin (USDC)
USDC is a US dollar-backed stablecoin issued by Circle. It is designed to be redeemable 1:1 for US dollars and is supported by reserve assets. Circle publishes information about USDC reserves and regular third-party assurance reports.
DAI
DAI became one of the best-known examples of a decentralized stablecoin. It was created by the Maker ecosystem, which later evolved into Sky. DAI is designed to maintain a value close to one US dollar and is supported through collateral and on-chain mechanisms.
PayPal USD (PYUSD)
PYUSD is a US dollar-denominated stablecoin issued by Paxos for PayPal. It is designed for payments and is backed by US dollar deposits, US Treasuries, and cash equivalents. PYUSD can be redeemed for US dollars and is available on several blockchain networks.
Stablecoins have become an important part of the cryptocurrency market and are increasingly used outside crypto trading. They can be used for payments, payouts, cross-border transfers, settlement, and different financial applications.
However, not all stablecoins work in the same way. They may use different reserve assets, collateral, or other mechanisms to maintain their value, and each model comes with its own risks.
For businesses, using stablecoins also requires more than choosing a token and a blockchain network. Wallets or accounts, payment flows, fiat conversion, compliance, transaction management, and other infrastructure may all be part of the final product.
If you are considering stablecoins for a payment or financial product, ND Labs can help you define the architecture and integrate the required infrastructure. Learn more about our stablecoin payment infrastructure development.
