Stablecoin

A stablecoin is a type of cryptocurrency that aims to maintain a stable value relative to a specified asset, a pool or basket of assets. The specified asset might refer to fiat currency, commodity, or other cryptocurrencies. Despite the name, stablecoins are not necessarily stable. Stablecoins rely on stabilization tools such as reserve assets or algorithms that match supply and demand to try to maintain a stable value.

Historically, multiple stablecoins have failed to maintain their value relative to the underlying assets. With the growing market transactions, stablecoins issuance and usage are increasingly regulated by governments around the world. 

Stablecoins emerged in 2014 as a method for investors in cryptocurrencies to park their money when they invest in other highly volatile cryptocurrencies. Stablecoins are now mainly used for buying or selling cryptoassets, and for making cross-border payments. According to the Bank for International Settlements, the size of the global stablecoin market is approximately $255 billion as of June 2025, with near 99% of stablecoins pegged to the US dollars.

Stablecoins can be distinguished based on their methods of maintaining their relative value with the specified asset. Some major types of stablecoins are as follows:

Fiat-backed stablecoins are stablecoins that claim to be backed by assets denominated in a fiat currency.

The value of a fiat-backed stablecoin is based on the value of the backing currency, which is supposedly held by a third party custodian. The issuer defends the peg of the stablecoin by holding mostly fiat-denominated short-term assets, such as treasury bonds, high-quality commercial paper, repurchase agreements and bank deposits. Therefore, the structure of fiat-backed stablecoins closely resembles that of money market funds (MMFs), and are exposed to similar risk of large-scale redemption requests causing negative fire-sale contagion effects on the financial system.

As of August 2025, nearly 99% of fiat-backed stablecoins are pegged to the US dollars. Major examples of US dollar pegged stablecoins are Tether's USDT, Circle's USDC, and Binance's BUSD.For Euro pegged stablecoins, major examples include Circle's EURC, EUR Tether, and Stasis EUR.

Cryptocurrency-backed stablecoins are stablecoins using other cryptocurrencies as collateral. The reason such stablecoins are created is that by utilizing smart contracts, they allow a decentralized network to track the price of US dollar as closely as possible. Another use case of cryptocurrency-backed stablecoins is to convert a cryptocurrency into ERC20 compatible standard to enable trading on another blockchain.

Major examples of cryptocurrency-backed stablecoins are DAI and Wrapped Bitcoin (WBTC).

Commodity-backed stablecoins are stablecoins that claim to be backed by commodities. Examples are PAX Gold and Tether Gold.

Algorithmic stablecoins, sometimes called seigniorage-style stablecoin, are stablecoins with no reserve assets or only partial reserve assets. They utilize algorithms that match supply and demand to maintain a stable value. The European Central Bank suggests that algorithmic stablecoins should be treated as unbacked crypto-assets.

Some major examples of algorithmic stablecoins are Celo Dollar, Tron's USDD and Kava's USDX

Algorithmic stablecoins are vulnerable to a de-pegging process known as "death spiral", in which an external event, such as the tightening of global liquidity, led to heavy redemption of the stablecoin. This triggered the minting of the linked token to burn the stablecoin, causing the supply of the linked token to increase exponentially, further causing a decrease in price.

A famous case of death spiral is the TerraUSD (UST), which was created by Terraform Labs founded by Do Kwon. TerraUSD was meant to maintain a 1:1 peg with the United States dollar.  Instead of being backed by dollars, UST was designed to keep its peg by linking it with another Terra network token, LUNA. The mechanism worked by providing an economic incentive for arbitrage. If UST lost its peg and traded below $1, an arbitrager could purchase it on the secondary market and redeem it for $1 worth of LUNA. Correspondingly, if UST traded higher than $1, market actors could mint new UST by locking in $1 of LUNA and then sell the new UST on the market for a profit. However, this mechanism assumes there is sufficient market demand for UST and LUNA, making the stablecoin inherently fragile.

In May 2022, UST broke its peg with its price plunging to 10 cents, while LUNA fell to "virtually zero", down from an all-time high of $119.51. The collapse wiped out almost $45 billion of market capitalization over the course of a week.

In the case of TerraUSD, another contributing factor to its failure was its proof-of-stake mechanism. The fall in the price of LUNA caused validators to sell their stakes, allowing malign actors to become dominant validators.