What is a Stablecoin?

A stablecoin is a cryptocurrency designed to hold a constant price, almost always $1.00. They are the bridge between volatile crypto assets and the rest of the economy: traders use them to take profits without leaving the chain, DeFi protocols price loans and liquidity in them, and cross-border users use them to move dollars where dollars are hard to get.

The three main designs

Fiat-backed. Each token is (claimed to be) backed 1:1 by dollars or short-dated US Treasuries held by the issuer. Redeem a token, get a dollar. USDT (Tether) and USDC (Circle) are the giants here. Transparency varies: Circle publishes detailed monthly attestations, while Tether has historically been less forthcoming but has improved.

Crypto-collateralized. Users lock up crypto (ETH, staked ETH, or other assets) as collateral and mint the stablecoin against it, typically at over-collateralization ratios of 150 percent or more. If the collateral value falls, the position is liquidated. MakerDAO's DAI is the canonical example. USDS and sUSDS are its successors.

Algorithmic. Uses code — not external collateral — to maintain the peg, usually by expanding or contracting supply through incentives. This design has an awful track record. TerraUSD (UST) is the infamous case: it lost its peg in May 2022 and wiped out roughly $40 billion of value in a week. Pure algorithmic stablecoins are largely discredited; most "algorithmic" tokens today are partially collateralized hybrids.

Why they dominate volume

On most days, stablecoin transfer volume is larger than Bitcoin and Ethereum transfer volume combined. Why? They are the unit of account for crypto markets. A trader buying bitcoin on Binance is almost always paying USDT, not dollars. A DeFi user borrowing against ETH usually borrows USDC. A freelancer in Argentina getting paid from the US often prefers a USDT transfer on Tron over a five-day wire.

The risks

Peg breaks, briefly or permanently, are the main risk. USDC traded as low as 87 cents for a weekend in March 2023 when Circle disclosed exposure to the collapsing Silicon Valley Bank. The peg returned once regulators guaranteed the deposits, but it was a reminder that even the most "trusted" fiat-backed stablecoin is a claim on a private company holding dollars at a commercial bank.

Regulatory risk is the other axis. The United States has debated stablecoin legislation for years; the EU's MiCA is already in force and restricts the use of non-euro stablecoins for payments. Expect the map of which stablecoins are usable to keep changing.

Using them sensibly

For most users, two rules: diversify across issuers, and be specific about which chain you are using. USDC on Ethereum, USDC on Solana, and USDC on Tron are all different tokens from a technical standpoint — do not send one to the other.