What is a stablecoin?
The value of stablecoins is pegged to traditional currencies like the US dollar, offering more stability as digital currencies. As a result, their prices generally remain more constant compared to other cryptocurrencies.
Stablecoins combine blockchain technology with the reliability of traditional currencies and are used for example in payments, transactions or as an interim solution in trading. Depending on the stablecoin, either an issuer secures it with real assets or decentralised mechanisms are used. Stablecoins are seen as an example of how digital and traditional financial systems can complement each other.
How do stablecoins work?
Stablecoins are digital tokens on a blockchain whose value is pegged to fiat currencies or other assets. The aim is to keep the price as constant as possible. For this purpose, the stablecoin should be mathematically backed 1:1 by the underlying base value. This peg is ensured through reserves managed by an issuer or controlled by smart contracts, for example in the form of foreign currencies, bonds or crypto assets.
In practice, however, this target value is often only approximately achieved. In addition to price fluctuations in the underlying assets, there's also the risk that the reserves are not fully available or lack sufficient transparency. A permanently exact value representation is therefore not guaranteed.
Types of stablecoins
There are generally three types of stablecoins. They mainly differ in their so-called pegging mechanisms, which defines how their value is secured and kept as stable as possible.
Crypto-collateralised stablecoins: The value of a stablecoin is backed by deposited cryptocurrencies. They are not based on fiat currencies but on digital collateral.
Fiat-collateralised stablecoins: The targeted 1:1 value to the respective fiat currency is secured through reserves. These often consist of cash or bonds and are managed by an issuer at banks. The peg should mathematically match the amount of stablecoins in circulation. In practice, however, deviations can occur, for example when reserves fluctuate or are not fully disclosed.
Non-collateralised stablecoins: Algorithmic stablecoins, also called non-collateralised stablecoins, do not use physical reserves. Instead, smart contracts control the supply based on demand to keep the value constant.
The last model is considered experimental – especially in extreme situations, weaknesses become apparent. Regulatory pressure is also increasing: the Genius Act in the US demands more transparency and in some cases real backing. In Europe, as part of the planned EU regulation "Markets in Crypto-Assets" (MiCAR), the inclusion of algorithmic stablecoins is being discussed.
Why do stablecoins exist?
Stablecoins are a response to the high volatility of many cryptocurrencies. By pegging to traditional currencies like the US dollar, they aim to minimise price fluctuations. At the same time, they offer an alternative to traditional currencies by enabling fast and cross-border transactions with a value-pegged digital unit. This makes it easier and more predictable to process payments on the blockchain – whether in trading or everyday life.
Despite being backed by assets or algorithms, stablecoins are not without risk. However, they demonstrate how cryptocurrencies can be used in practice, especially in regions with limited access to banking services.
Use cases for stablecoins
Stablecoins offer a wide range of applications both within and outside the crypto ecosystem.
Some key use cases include:
Payments: for fast, low-cost and global transactions without traditional banks
Trading: as an intermediate currency to secure profits or exit volatile tokens during high volatility
Remittances: for cross-border transfers with lower fees and faster processing
Hedging: as a store of value during volatile market phases or in countries with unstable currencies
Smart contracts: as a reliable reference value for automated processes on the blockchain
Decentralised finance (DeFi): for lending, staking or liquidity pools on blockchain-based platforms
Stablecoins play a key role in DeFi: They enable stable transactions, serve as collateral on lending platforms and form the basis for many decentralised applications. Without them, many DeFi protocols would be much more susceptible to price fluctuations and harder to use.
The most well-known stablecoins at a glance
Stablecoins have gained recognition due to their stability and potential for fast transactions. The largest and most well-known stablecoins include Binance USD, USD Coin and DAI.
Tether (USDT)
Tether is the largest and most well-known stablecoin, pegged 1:1 to the US dollar. USDT exists on several blockchains, including Ethereum, Tron and Solana. The stablecoin is centrally issued by the company Tether Limited, which claims that the value of every USDT is fully backed by reserves, though this has been critically questioned in the past. Its centralised management has raised concerns about the transparency and verifiability of the stated fiat reserves.
Binance USD (BUSD)
BUSD is a stablecoin issued by Binance in partnership with Paxos (a US financial institution and technology company). BUSD is pegged 1:1 to the US dollar and aims to offer users a safer way to trade with cryptocurrencies.
USD Coin (USDC)
USD Coin is a stablecoin supported by Circle and Coinbase. It is known for being fully backed by US dollars and offers an alternative to USDT with similar features. USDC is often praised for its transparent reserve reports and compliance with regulatory standards.
DAI (DAI)
DAI differs from other stablecoins in that it is a decentralised stablecoin managed by MakerDAO (a decentralised autonomous organisation, or DAO). MakerDAO serves as the backbone of the system and enables transparent and efficient management of the stablecoin. DAI maintains its peg to the US dollar through a mechanism controlled by smart contracts, making this stablecoin an interesting example of combining stability and decentralisation.
