Stablecoins are in the news on a daily basis. Major banks are considering releasing their own stablecoins. Governments have started regulating them. On 18 July 2025, the US government, e.g., signed a law to create a regulatory regime for dollar-pegged stablecoins. So, this is the first of two articles on stablecoins. In this article, we answer the following questions: What are stablecoins? Why do they matter? What are the different types of stablecoins? And how do they relate to other cryptocurrencies? In the next article, we will then focus on the legal aspects of stablecoins.
What are stablecoins?
Wikipedia describes a stablecoin as “… a type of cryptocurrency where the value of the digital asset is supposed to be pegged to a reference asset, which is either fiat money, exchange-traded commodities (such as precious metals or industrial metals), or another cryptocurrency.”
So, what are we talking about? Stablecoins are a category of digital assets that are specifically designed to maintain a stable value. They achieve this by being pegged to a reference asset, typically a fiat currency like the US dollar or euro. Traditional cryptocurrencies such as Bitcoin or Ethereum are known for their price volatility. Stablecoins on the other hand aim to offer the benefits of blockchain technology, such as fast, borderless, and programmable transactions, but without the associated price fluctuations.
Why do they matter?
Stablecoins have become the backbone of many digital asset transactions. They offer the benefits of cryptocurrency, like speed, low cost, and global reach, while avoiding its biggest flaw: volatility. With stable value, they make it possible to trade, lend, borrow, and transfer money on blockchain platforms without worrying about large price swings. This makes them attractive not just to crypto users, but also to businesses, fintech companies, and even central banks.
Stablecoins are already widely used on cryptocurrency exchanges as quote currencies (e.g., USDT or USDC pairs). They enable traders to move in and out of volatile assets without relying on fiat bank transfers. In cross-border payments, stablecoins enable near-instant remittances with lower fees compared to traditional money transfer services. This is especially the case in regions with unstable banking systems. Additionally, stablecoins are used for borrowing, lending, and staking. They allow users to earn interest or participate in decentralized governance while maintaining exposure to a relatively stable asset. They have also become critical tools for avoiding capital controls and hyperinflation in countries with unstable currencies.
Let’s put things in perspective: in 2024, over 70% of trading volume on major cryptocurrency exchanges was settled using stablecoins. Beyond trading, stablecoins are now used for cross-border payments, employee payroll, and remittances. Some stablecoins are accepted by merchants and payment processors, integrating them into the real economy. Stablecoins have even seen growing use in countries with unstable currencies, where they serve as a hedge against inflation. This trend is expected to grow, especially in emerging markets.
Notably, the total supply of stablecoins has grown significantly: as of mid-2025, the combined market capitalization of major stablecoins exceeds 150 billion USD.
What are the different types of stablecoins?
Wikipedia mentions 3 different types, but the literature mentioned in the sources below also discuss a fourth one. They can be grouped into distinct types based on how they maintain their price stability. Each of these approaches reflects a different mechanism for achieving price parity with a target asset.
Fiat backed
Fiat-collateralized stablecoins are backed 1:1 by reserves held in traditional financial institutions. These reserves can include bank deposits, short-term government securities, or other low-risk instruments. When a user purchases a stablecoin, the issuer stores an equivalent amount of fiat currency in reserve. Examples of this type include USD Coin (USDC), Tether US (USDT) and Tether EU (EURT). These coins are generally considered the most stable, though they rely heavily on the trustworthiness and transparency of the issuer. Concerns over reserve backing have occasionally led to regulatory scrutiny, particularly in Tether US’ case. For example, in 2021, the US Commodity Futures Trading Commission (CFTC) fined Tether $41 million for misleading statements about its reserves.
Cryptocurrency backed
Crypto-collateralized stablecoins are backed by other cryptocurrencies rather than fiat. These stablecoins are typically overcollateralized to account for the volatility of their underlying assets. A prominent example is DAI, which is issued by the MakerDAO protocol and backed by Ethereum and other assets deposited in smart contracts. Users lock up collateral that exceeds the value of the DAI issued, helping to maintain its dollar peg. This model removes the need for centralized custodians but introduces complexity and vulnerability during market downturns, as seen in March 2020 when rapid price drops led to liquidations within the Maker system.
Algorithmic stablecoins
Algorithmic stablecoins use smart contracts and market incentives to maintain a peg without relying on collateral. Instead of being backed by assets, these coins regulate supply algorithmically. When the price drops below the peg, the protocol may reduce supply by incentivizing users to burn coins. If the price rises above the peg, new coins are minted. This model is theoretically elegant but has proved highly unstable in practice. The most notorious failure in this category was TerraUSD (UST), which lost its peg in May 2022 and collapsed entirely, wiping out over $40 billion in market value. This event highlighted the systemic risks algorithmic stablecoins pose when trust and liquidity disappear.
Commodity backed
In addition to these main types, a niche category exists for commodity-backed stablecoins. These are pegged to physical goods such as gold or oil. Paxos Gold (PAXG), for example, is backed by physical gold stored in London vaults, allowing users to own fractionalized gold on the blockchain. These stablecoins combine the technological advantages of digital tokens with the perceived safety of tangible assets.
How they relate to other cryptocurrencies
In the broader ecosystem of cryptocurrencies, stablecoins play an essential role. Traditional cryptocurrencies like Bitcoin are often used as speculative assets or long-term stores of value (sometimes called “digital gold”). Stablecoins on the other hand serve as more practical tools for day-to-day transactions, on-chain liquidity, and as units of account within decentralized finance (DeFi) platforms. Their price stability makes them an ideal medium for settling trades, providing collateral, and earning yield in lending protocols. So, they function as a much needed bridge between volatile cryptocurrencies and traditional financial systems, as they allow users to store and transfer value on blockchain networks with a degree of price predictability.
Sources:
- https://en.wikipedia.org/wiki/Stablecoin
- https://en.wikipedia.org/wiki/Cryptocurrency
- https://nl.wikipedia.org/wiki/Cryptogeld
- https://www.coindesk.com/learn/what-are-stablecoins/
- https://www.imf.org/en/Publications/fintech-notes/Issues/2021/07/29/The-Rise-of-Stablecoins-460268
- https://www.circle.com/en/resources/what-is-a-stablecoin
- https://www.theblock.co/data/crypto-markets/stablecoins
- https://www.chainalysis.com/blog/stablecoins-cross-border-payments/
- https://www.chainalysis.com/reports/2024-crypto-geography-report/
- https://finance.ec.europa.eu/publications/proposal-regulation-markets-crypto-assets-mica_en
- https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf
- https://www.bis.org/publ/arpdf/ar2023e.htm
- https://www.circle.com/en/transparency
- https://docs.makerdao.com/
- https://www.technologyreview.com/2022/05/18/1052267/what-the-collapse-of-the-luna-cryptocurrency-means/ (MIT)
- https://www.paxos.com/paxgold/
- https://www.reuters.com/legal/government/trump-signs-stablecoin-law-crypto-industry-aims-mainstream-adoption-2025-07-18/