If you’ve ever asked “what is a stablecoin?” think of it as a digital dollar (or euro) that lives on a blockchain. Unlike Bitcoin or Ether, stablecoins aim to track a stable asset—usually USD—with mechanisms that keep the price near $1. They power crypto trading, cross-border payments, and increasingly mainstream fintech rails. Central banks and watchdogs study them closely because design choices (and reserves) determine how “stable” they really are.
What does a stablecoin actually do?
In practice there are three big families:
- Fiat-reserve (custodial) stablecoins
A company issues tokens and holds cash-like reserves (T-bills, bank deposits). Customers can mint/redeem 1:1, and market-makers trade away tiny price gaps. This is the model used by USDT and USDC, which publish attestations about their reserves. - Crypto-collateralized stablecoins
Users lock volatile crypto (often over-collateralized) in smart contracts to mint a dollar-pegged asset. The system relies on automatic liquidations if collateral value falls. - Algorithmic designs
These tried to maintain the peg with code-driven incentives (no full backing). The most famous—TerraUSD—collapsed in 2022, a cautionary tale regulators still cite.
Why the fuss from policymakers? Because poorly designed coins can break their peg (“depeg”), spark runs, or impact users and markets. Global bodies like the BIS, IMF, FSB, and FATF have all mapped the risks and policy responses.
How stablecoins work
Mint/Redeem: With custodial coins, an issuer mints new tokens when institutions wire dollars in, and burns tokens on redemption. As long as redemptions are reliable and reserves are high-quality, the market price hugs $1.
Arbitrage: If a coin trades at $0.99 and you can redeem for $1, traders buy on exchanges and redeem for profit—pulling price back up. If it trades at $1.01, minters create new tokens and sell—pushing price down.
Collateral & Liquidations: In crypto-collateral systems, smart contracts keep the dollar value of collateral above the value of coins issued. If collateral falls, the protocol sells some to restore the buffer.
Where it can go wrong:
- Reserves trapped or impaired (bank outage, custodian risk). In March 2023, USDC briefly depegged when part of its reserves were stuck at a failing bank—then recovered after authorities stabilized the bank.
- Design risk (algorithmic models). Terra’s 2022 collapse shows incentives alone can’t replace credible backing.
What are stablecoins used for?
- Trading & settlement inside crypto. They’re the default “cash leg” on exchanges and DeFi.
- Payments and merchant settlement. In 2023 Visa began settling some merchant flows in USDC, first on Ethereum and later on Solana, and in 2025 said it would support more stablecoins and blockchains (including EURC), signaling mainstream payments interest.
- Cross-border transfers. Fast, 24/7 value transfer with predictable pricing can beat legacy rails for some corridors, especially when the recipient wants dollars.
- On/off-ramps for Web3 apps. Denominating things in a dollar unit smooths the user experience.
Types of stablecoins
- Fiat-reserve, USD-pegged: USDC (Circle), USDT (Tether), PYUSD (PayPal’s token issued by Paxos). These publish reserve breakdowns and attestations; Tether also releases quarterly assurance reports. Always read the latest disclosures, not just marketing.
- Crypto-collateralized: Onchain, over-collateralized models that rely on liquidations and robust oracle pricing.
- Commodity-backed: Less common (e.g., gold-linked tokens) and come with custody/transport considerations.
- Public-sector stablecoins: In 2025, Wyoming launched FRNT, a state-issued, fully reserved stablecoin with a statutory 102% reserve target and attestation regime—an interesting twist on governance and transparency.
What can I trust? A quick risk checklist
When evaluating a stablecoin, focus on how it stays at $1:
- Reserves & quality. Short-term treasuries and cash at highly rated institutions are better than riskier assets. Look for regular, independent attestations (and, ideally, audited financials for the issuer). Circle and Tether publish reserve information—check the dates and scope.
- Redemption terms. Who can redeem (retail or only institutions)? Minimums? Fees? Speed?
- Concentration risk. One bank or one custodian? Multiple chains or a single chain?
- Governance & controls. Can the issuer freeze tokens? What’s the policy? Is there a clear, enforceable legal claim on reserves?
- Regulatory posture. Is the coin covered by a clear regime in your jurisdiction (e.g., EU MiCA categories like EMT/ART), or operating in a gray area?
The rules in 2025
- European Union (MiCA): The EU’s Markets in Crypto-Assets Regulation went live for stablecoins in June 2024, creating categories (e-money tokens/asset-referenced tokens), issuer licensing, governance, reserve, and disclosure rules—with tougher oversight for “significant” tokens. This is the most comprehensive stablecoin regime at scale today.
- Global principles (FSB): The Financial Stability Board published high-level recommendations in 2023 for regulating global stablecoin arrangements—covering governance, risk management, redemption rights, and data/reporting—used by many jurisdictions as a policy blueprint.
- AML/CFT (FATF): The FATF requires VASPs and intermediaries to implement Travel Rule compliance and risk controls that explicitly consider stablecoin risks; its 2024–2025 updates note patchy international adoption and push countries to tighten enforcement.
- United States: Agencies (Fed, Treasury/FinCEN) apply existing AML/BSA rules to crypto businesses, and bank supervisors have issued risk guidance. A comprehensive federal stablecoin statute remains a policy debate; state-level experiments (like Wyoming’s FRNT) are moving faster.
How “stable” are stablecoins, really?
- Depegs happen. USDC’s March 2023 dip below $1 (after part of its reserves were at a failed bank) recovered once backstops were in place—but it proved reserves and redemptions matter more than branding.
- Algorithmic designs are fragile. TerraUSD’s failure was a stark reminder that incentives alone can’t hold a peg in stress. Full or over-collateralization and clean redemption are sturdier.
- Policy view: Central banks (BIS/IMF) warn that stablecoins import bank-like run risk unless reserves, disclosures, and redemption are truly robust—and that their use in payments links them to the broader financial system. Translation: design details and supervision make the difference.
Stablecoins vs CBDCs
- Stablecoins are private money, usually holding short-term government assets and bank deposits, settling on public blockchains.
- CBDCs are central-bank liabilities (public money), issued and run by the state.
- Bank deposits are private money too, but inside the banked system with deposit insurance and lender-of-last-resort backstops.
Each has pros/cons; in 2025 we’re seeing hybrid rails, like Visa plugging USDC settlement into card-network flows.
How to pick a stablecoin
- Match the job: Trading on exchanges? Use the coin with deepest liquidity there. Paying vendors? Confirm they’ll accept (or auto-convert) your coin and which chain they support.
- Stick to reputable issuers: Read the latest attestation and terms. If disclosures are stale or vague, that’s a yellow flag.
- Mind the chain: Fees and speed vary (Ethereum vs Solana vs others). If a merchant or PSP supports Solana USDC settlement, it may be faster/cheaper than legacy rails.
- Watch counterparty & freeze controls: Custodial coins often have blacklist/freeze functions (for court orders and AML). Know that before you park big balances.
- Diversify operationally: Hold working capital across more than one coin/custodian and keep a fiat runway for emergencies.
- Compliance isn’t optional: If you’re a business, confirm Travel Rule/AML obligations with your provider and your jurisdiction.
Conclusion
Stablecoins aren’t one thing—they’re a design space. The good ones pair credible backing, clean redemption, and frequent disclosures with sensible guardrails. That’s why regulators (EU MiCA, FSB, FATF) focus on reserves, governance, AML and user protections. If you remember only two tips: read the latest attestation/terms, and use the coin that fits your job and jurisdiction. That’s how to get the “stable” out of stablecoins—without surprises.