What Is a Stablecoin?
A stablecoin is a token that aims to be worth exactly one unit of a regular currency, usually one US dollar. It’s what makes payments and settlement on a blockchain practical: you can send value in minutes, at any hour, without the price changing on the way. That’s also why it matters to payments teams, not just crypto traders.
Two of their biggest uses: sending money between countries (compare How International Money Transfers Work) and trading on decentralised exchanges, where most tokens are priced against a stablecoin.
Keeping that price at exactly 1 is the hard part. There are three main designs, and they hold the price in very different ways.
1. Backed by Cash and Bonds
The issuer holds real dollars, or short-term government bonds, for every coin it issues. USDC (Circle) and USDT (Tether) work this way. The price holds because of redemption: eligible holders can hand a coin back and get a dollar.
- If the coin trades at 0.99, traders buy it cheaply and redeem it for 1.00, which pushes the price back up.
- If it trades at 1.01, they deposit a dollar, receive a new coin and sell it for 1.01, which pushes the price down.
The weak point is the reserves. In March 2023, Circle said about 3.3 billion dollars of USDC’s reserves were held at Silicon Valley Bank when the bank failed. USDC lost its peg (a “depeg”) and fell below 90 cents for a short time, and returned to 1 once it was clear the deposits were safe. The design worked; the question was whether the dollars behind it were really there.
2. Backed by Other Crypto
Here the coin is backed by crypto deposited in smart contracts. DAI started this way. Because that collateral can fall in value, it’s over-collateralised: more than a dollar of crypto locked for every dollar of stablecoin, with automatic liquidations if it falls too far. It works much like on-chain lending, and it inherits the same risks: oracle prices and fast crashes.
3. Backed by an Algorithm
An algorithmic stablecoin has little or nothing behind it. It tries to hold the price by minting and burning a second token. TerraUSD (UST) worked this way: one UST could always be swapped for one dollar’s worth of a token called LUNA.
In May 2022, large withdrawals pushed UST below a dollar. Holders swapped UST for newly minted LUNA and sold it, which crashed LUNA’s price, which meant more LUNA had to be minted for every UST, which crashed it further. Within days both were worth almost nothing, and tens of billions of dollars of value were wiped out. The lesson: a promise of a dollar needs something worth a dollar behind it.
Are Stablecoins Safe? Three Questions to Ask
- What backs it, and is that published and checked by someone independent?
- Who can redeem it for a dollar, and how quickly?
- What happens if everyone tries to leave at once?
For Engineers: Stablecoins in a Payment System
Treat a stablecoin like any other payment rail on your ledger: record each payment once, wait for enough block confirmations before you treat it as final, and reconcile what the chain says against your own books every day. And don’t assume the price is exactly 1: store the amount in the coin itself, and convert at the rate when you need to.
This article explains how the systems work. It is not financial or investment advice, and the rules for crypto assets change and differ from country to country: check the current ones where you live.