What Are Stablecoins?

A stablecoin is a cryptocurrency designed to keep a steady price, usually one US dollar per token. Stablecoins exist because most cryptoassets swing wildly in value, which makes them awkward to use for payments or as a place to park money between trades. A stablecoin aims to combine the speed of a blockchain transfer with the predictability of a dollar.

The promise “worth one dollar” is only as good as the mechanism behind it. There are three main designs.

1. Reserve-backed (fiat-backed)

A company issues one token for every dollar (or dollar-equivalent asset) it holds in reserve, and lets approved customers swap tokens back for dollars. The largest stablecoins, such as USDT (Tether) and USDC (Circle), work this way.

• What holds the peg: if the token trades below a dollar, traders buy it cheaply and redeem it with the issuer for a full dollar, pushing the price back up.
• What can go wrong: the reserves might not be fully there, might be held in assets that lose value, or might be frozen. In March 2023, USDC briefly fell to about 88 cents after Circle disclosed that part of its reserves was held at Silicon Valley Bank, which had just failed. It recovered once those funds were secured.
• What to check: how often the issuer publishes reserve reports, who audits or attests to them, and what the reserves are invested in.

Issuers of reserve-backed stablecoins can also freeze tokens at specific addresses, for example to comply with law enforcement. That makes them more centralized than coins like bitcoin.

2. Crypto-backed (overcollateralized)

These tokens are backed by other cryptocurrency locked in smart contracts, with more collateral than the stablecoins issued. DAI is the best-known example. To mint 100 dollars of stablecoin you might lock up 150 dollars or more of ether.

• What holds the peg: the excess collateral. If the collateral’s value falls too far, the system automatically sells it to keep the stablecoin backed.
• What can go wrong: a very fast crash can outrun the liquidation process, and the smart contracts themselves can contain bugs.

3. Algorithmic

Algorithmic stablecoins try to hold their peg using code and incentives rather than full reserves, typically by minting and burning a companion token.

The most famous example is a warning. TerraUSD (UST) used this approach and grew to be one of the largest stablecoins before collapsing in May 2022. When confidence slipped, the mechanism minted enormous amounts of its companion token, LUNA, which crashed toward zero. Tens of billions of dollars of value disappeared within days. Designs that depend on confidence tend to fail precisely when confidence is needed.

What stablecoins are used for

• Trading: moving between cryptoassets without converting back to bank money.
• Transfers: sending dollar value across borders quickly, at any hour.
• Savings in unstable economies: in countries with high inflation, dollar stablecoins can be easier to get than actual dollars.
• Decentralized finance: lending and borrowing on blockchain platforms, which carries its own layers of risk.

Stablecoins are not bank deposits

A stablecoin balance is not insured by deposit insurance in Canada or the US. If the issuer fails or the peg breaks, there is no guarantee of getting a dollar back. Regulators in several countries have been writing specific stablecoin rules, which may change who can issue them and how reserves must be held.

The short version

A stablecoin is a promise to be worth one dollar. Reserve-backed coins rely on the issuer’s reserves and honesty, crypto-backed coins rely on excess collateral and code, and algorithmic coins rely on confidence, which has proven the weakest foundation of all.