What is a stablecoin? A simple explanation

Stablecoins are designed to provide a more stable digital unit of value in the crypto market than many other cryptocurrencies. Their value usually tracks a traditional currency such as the US dollar. This guide explains what a stablecoin is, how stablecoins work, the different types of stablecoins, and what to consider regarding their benefits, risks, and regulation.

Key takeaways

• Definition: Stablecoins are digital tokens whose value is tied to fiat currencies or other assets to avoid sharp price fluctuations.

• Types: There are fiat-backed, crypto-backed, and algorithmic stablecoins without real-asset backing.

• Examples: Well-known stablecoins include USD Coin (USDC), Tether (USDT), and DAI.

• Use cases: They are used for payments, as trading instruments, or as a digital complement to traditional currencies.

• Benefits and risks: Stablecoins bring greater stability to the crypto market but carry risks such as limited transparency or losing their peg, known as a depeg.

What is a stablecoin?

A stablecoin is a cryptocurrency whose value is tied to a stable asset, such as the US dollar, the euro, or gold. This link is known as a peg and is intended to keep the price as steady as possible. As a result, a stablecoin’s price usually fluctuates far less than that of cryptocurrencies such as Bitcoin or Ethereum.

Stablecoins are issued on a blockchain and used for purposes such as payments, transfers, or as an intermediate asset when trading. How their value is maintained depends on the model: an issuer may hold reserves, while other stablecoins use decentralized mechanisms.

How do stablecoins work?

From a technical perspective, stablecoins are issued as digital tokens on a blockchain. Depending on the model, their value is stabilized through reserves, crypto collateral, or algorithmic mechanisms. With a 1:1 peg, one stablecoin is intended to equal one unit of the underlying asset.

In collateralized models, reserves are managed by an issuer or controlled through smart contracts. They usually consist of bank deposits and short-term government bonds; crypto-backed stablecoins instead use deposited crypto assets as collateral.

In practice, stablecoins often only approximate their target value. In addition to fluctuations in the value of deposited assets, there is a risk that reserves may not exist in full or may not be sufficiently transparent. An exact, permanent match with the target value is therefore not guaranteed.

Types of stablecoins

There are three types of stablecoins. They differ primarily in how their value is backed and kept as stable as possible, the mechanism known as pegging.

Fiat-backed stablecoins

• Definition: Fiat-backed stablecoins are tied to a traditional currency such as the US dollar or euro.

• Mechanism: Reserves support the intended 1:1 value. These reserves often consist of cash or short-term bonds and are managed by an issuer through banks. Deviations may occur if reserve values fluctuate or the reserves are not fully disclosed.

• Example: USD Coin (USDC), issued by Circle.

Crypto-backed stablecoins

• Definition: Crypto-backed stablecoins are backed by deposited cryptocurrencies rather than fiat currencies.

• Mechanism: Because cryptocurrencies themselves fluctuate in value, collateral worth more than the stablecoins is usually deposited. This is known as overcollateralization. Smart contracts manage the collateral automatically.

• Example: DAI, managed by MakerDAO.

Algorithmic stablecoins without collateral

• Definition: Algorithmic stablecoins do not use physical reserves.

• Mechanism: Instead, smart contracts adjust the supply in response to demand in an effort to keep the value stable.

• Example: TerraUSD (UST), which lost its peg to the US dollar and collapsed in May 2022. This model is considered experimental and has shown particular weaknesses under extreme market conditions.

Why do stablecoins exist?

Stablecoins emerged in response to the high volatility of many cryptocurrencies. By tracking traditional currencies, they aim to minimize price fluctuations. At the same time, they combine fast, cross-border transactions with a digital unit tied to a reference value. This makes blockchain payments more predictable, whether for trading or everyday use.

Despite being supported by assets or algorithms, stablecoins are not risk-free. However, they demonstrate how cryptocurrencies can be used in practice, particularly in regions with limited access to banking services.

Stablecoin use cases

Stablecoins offer many uses both within and outside the crypto ecosystem:

• Payments: Fast, low-cost, global transactions

• Trading: An intermediate currency for moving out of volatile tokens during periods of high volatility

• Money transfers: Cross-border payments with lower fees and faster settlement

• Preserving value: A store of value during volatile market periods or in countries with unstable currencies

• Smart contracts: A reliable reference value for automated processes on a blockchain

• Decentralized finance (DeFi): Lending and liquidity pools on blockchain platforms

Stablecoins play a key role in DeFi. They enable more stable transactions and serve as collateral on lending platforms. Without them, many DeFi protocols would be significantly more vulnerable to price fluctuations.

What is USDC?

USD Coin (USDC) is a fiat-backed stablecoin pegged to the US dollar that launched in 2018. It is issued by Circle, a publicly traded US company. Circle has accounting firms provide monthly confirmation that USDC is backed by cash reserves and short-term US Treasury securities. With a market capitalization of approximately $73 billion, USDC is the world’s second-largest stablecoin. In practice, it is commonly used for payments, trading, and blockchain-based financial applications.

You can trade USD Coin (USDC), among other assets, on Bitpanda. Bitpanda is not the issuer of the stablecoins shown here.

What is DAI?

DAI is a decentralized stablecoin managed by MakerDAO, a decentralized autonomous organization, or DAO. DAI maintains its peg to the US dollar through a mechanism controlled by smart contracts and deposited crypto collateral. It therefore combines stability and decentralization without overarching central control.

How are stablecoins regulated?

Stablecoins are receiving increasing attention from financial regulators worldwide. Stablecoin regulation aims to ensure transparency, consumer protection, and financial system stability.

In the EU, the Markets in Crypto-Assets Regulation (MiCAR) applies. It entered into force on June 29, 2023. The rules for stablecoins have applied since June 30, 2024, while the remaining provisions have applied since December 30, 2024. Following the end of all transitional periods, MiCAR has applied in full since July 1, 2026. MiCAR distinguishes between two categories of stablecoins:

• Electronic money tokens (EMTs): Their value is tied to a single currency such as the euro or US dollar.

• Asset-referenced tokens (ARTs): Their value refers to multiple assets, a basket of currencies, or other reference values.

Among other requirements, issuers must demonstrate that sufficient reserves exist and are audited regularly. BaFin, Germany’s financial regulator, also monitors compliance with these requirements.

In the United States, President Trump signed the GENIUS Act on July 18, 2025. It is the country’s first comprehensive federal framework for payment stablecoins. In general, only approved entities known as “permitted payment stablecoin issuers” will be allowed to issue payment stablecoins. They must maintain 1:1 backing through high-quality, liquid reserves, disclose those reserves monthly, and have them reviewed by an independent auditing firm. The GENIUS Act will take effect on the earlier of two dates: 18 months after enactment - January 18, 2027 - or 120 days after the relevant US regulators publish their final rules.

Benefits and drawbacks of stablecoins

Stablecoins combine the relative stability of traditional currencies with the technological capabilities of cryptocurrencies. However, they can carry different risks depending on the type.

Benefits

• Lower price volatility than other cryptocurrencies

• Fast and often inexpensive transactions, including across borders

• Available around the clock without depending on bank opening hours

• Suitable for payments, trading, and DeFi applications

Drawbacks

• A stablecoin can lose its peg, as TerraUSD did in 2022

• Reserves may not be complete or transparently documented

• Centralized issuers create dependency and default risks

• Regulatory requirements may change and restrict use

• Algorithmic models are considered particularly vulnerable

How to buy stablecoins on Bitpanda

You can trade USD Coin (USDC), EURC, and EURCV on Bitpanda. The usual process is as follows:

1. Create an account: Register with Bitpanda and complete identity verification.

2. Deposit funds: Add money using one of the available payment methods.

3. Select a stablecoin: Search for the stablecoin you want, such as USD Coin (USDC).

4. Choose an amount: Enter the amount you want to invest and review the details before buying.

5. Confirm the purchase: Complete the transaction. The stablecoin will then appear in your portfolio.

Bitpanda is not the issuer of the stablecoins shown here. Buying cryptocurrencies involves risk and may result in losses. Only invest amounts you can afford to lose.

Conclusion: Stablecoins and their role in the crypto world

Stablecoins are a bridge between the volatile crypto world and the stability of traditional currencies. Because they are tied to assets such as the US dollar, the euro, or gold, they make everyday transactions, trading, and storing value more predictable than other cryptocurrencies.

Stablecoins are not risk-free. Whether a peg holds depends on the quality of the reserves, the issuer’s transparency, and the mechanism used. TerraUSD demonstrated in 2022 how quickly a model without real collateral can fail. Anyone using stablecoins should therefore carefully check how a stablecoin is backed and who is behind it.

More topics about cryptocurrency

If you'd like to delve deeper into the world of cryptocurrencies, you'll find more articles in the Bitpanda Academy:

• Crypto taxes

• How to store cryptocurrencies securely

• The difference between cryptocurrencies and fiat currencies