Stablecoin

A stablecoin is a type of cryptocurrency where the value of the digital asset is supposed to be pegged to and collateralized by a reference asset, which is either fiat money or another cryptocurrency.^[1] One-to-one backing by a reference asset could make a stablecoin value track the value of the pegged asset and not be subject to extreme changes in value common to many digital assets.^[2] In practice, stablecoin issuers have yet to be proven to maintain adequate reserves to support a stable value, and there have been a number of failures with investors losing the entirety of the (fiat currency) value of their holdings.

Background

Stablecoins have several purported purposes. They can be used for payments and are more likely to retain value than cryptocurrencies, as the latter have high price volatility (finance) and a history of other risks. In practice, many stablecoins have failed to retain their "stable" value. Stablecoins are non-interest bearing and therefore do not provide interest returns to the holder.^{[citation needed]}

Reserve-backed stablecoins

Reserve-backed stablecoins are digital assets that are stabilized by other assets.^[2] Such coins, assuming they are managed in good faith and have a mechanism for redeeming the asset(s) backing them, are unlikely to drop below the value of the underlying physical asset, due to arbitrage. However, in practice, few, if any, stablecoins meet these assumptions.

Reserve-backed stablecoins are subject to the same volatility and risk associated with the backing asset. The reserves must be stored safely, under secure custody to keep it safe from pilfering and robbery.

Fiat-backed

The value of stablecoins of this type is based on the value of the backing currency, which is held by a third party–regulated financial entity. Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer. The stability of the stablecoin is equivalent to the cost of maintaining the backing reserve and the cost of legal compliance, licenses, auditors, and the business infrastructure required by the regulator.

In this setting, the trust in the custodian of the backing asset is crucial for the stability of the stablecoin price. If the issuer of the stablecoin lacks the fiat necessary to make exchanges, the stablecoin can quickly lose value and become worthless.

The most popular stablecoin, Tether, initially claimed to be fully backed by fiat currency; this was proven to be untrue; Tether and Bitfinex were fined $41 million by the Commodity Futures Trading Commission for deceiving consumers.^[3] Instead, Tether only had enough fiat reserves to guarantee their stablecoin for 27.6% of the time during 2016 to 2018. Nevertheless, Tether still remains widely used.

Cryptocurrency stablecoin characteristics are:

• Their value is pegged to one or more currencies (most commonly the US dollar, the euro, or the Swiss franc) in a fixed ratio;
• The value connection is realized off-chain through banks or other types of regulated financial institutions which serve as depositaries of the currency used to back the stablecoin;
• The amount of the currency used to back the stablecoin should reflect the circulating supply of the stablecoin.

Examples: TrueUSD (TUSD),^[4] USD Tether (USDT),^[5] Circle USDC,^[2] Monerium EURe,^[6] Australia and New Zealand Banking Group (ANZ) A$DC.^[7]

In January 2023, National Australia Bank (not Australia's central bank) announced that it would create by mid-2023 an Australian Dollar fiat-backed stablecoin called the AUDN, for streamlining cross-border banking transactions and trading carbon credits.^[8] On 17 January 2024, National Australia Bank announced it was ending its AUDN project.^[9]

Cryptocurrency-backed

Cryptocurrency-backed stablecoins are issued with cryptocurrencies as collateral, conceptually similar to fiat-backed stablecoins. However, the significant difference between the two designs is that while fiat collateralization typically happens off the blockchain, the cryptocurrency or crypto asset used to back this type of stablecoins is done on the blockchain, using smart contracts in a more decentralized fashion. It is possible in some cases for users to take out a margin loan against a smart contract by locking up collateral; a user who takes out a loan may be liquidated by the smart contract should their collateral decrease too much relative to the value of their withdrawal.

Significant features of crypto backed stablecoins are:

• The value of the stablecoin is collateralized by another cryptocurrency or a cryptocurrency portfolio;
• The peg is executed on-chain via smart contracts;
• The supply of the stablecoins is regulated on-chain, using smart contracts;
• price stability is supposedly achieved by introducing supplementary instruments and incentives, not just the collateral.

The problematic aspect of this type of stablecoin is the price instability of the cryptocurrency collateral.

Stablecoin projects of this type are Havven (the pair: nUSD – stablecoin and HAV – the collateral-backed nUSD),^[10] DAI (pair: CDP – Collateralized Debt Position and MKR – governance token used to control the supply).^[11]There is also Wrapped Bitcoin (WBTC), see BitGo.

Seigniorage/algorithmic stablecoins (no reserve backing)

Seigniorage-style coins, also known as algorithmic stablecoins, utilize algorithms.^[12] Seigniorage-based stablecoins are a less successful form of stablecoin.^[13] They are intended to hold a stable value through computer algorithms and game theory rather than a peg to a reserve asset;^[13] however, they have yet to maintain price stability.

TerraUSD (UST), created by Do Kwon, was meant to maintain a 1:1 peg with the United States dollar.^[14] Instead of being backed by dollars, UST was designed to keep its peg through a complex system connected with another Terra network token, Terra (LUNA).^[15] In May 2022, UST broke its peg with its price plunging to 10 cents,^[16] while Luna fell to "virtually zero", down from an all-time high of $119.51.^[17] The collapse wiped out almost $45 billion of market capitalization over the course of a week.^[18] Wired magazine said, "The Ponzinomics were just too obvious: When you pay money for nothing, and stash your nothing in a protocol with the expectation that it will give you a 20 percent yield—all you end up with is 20 percent of nothing."^[13]

On 13 June 2022, Tron's algorithmic stablecoin, USDD, lost its peg to the US Dollar.^[19]

Basis was another example of a seigniorage stablecoin.^[12]

Possible advantages

The Bank for International Settlements lists the possible merits of the subject as enhancement of anti-money laundering efforts, operational resilience, customer data protection, financial inclusion, tax compliance, and cybersecurity.^[20]

Risks and criticisms

Limitations on regulation

In February 2022, Nellie Liang, Under Secretary of the Treasury for Domestic Finance reported to the Senate banking committee that the rapid growth of the stablecoin market capitalization and its potential for financial services innovation require urgent Congressional regulation.^[21]

Although US legislation is progressing in May 2024 to provide increased regulatory clarity for many digital assets, the Financial Innovation and Technology for the 21st Century Act in its current form excludes certain stablecoins from regulation by the SEC, "except for fraud and certain activities by registered firms", and is specifically excluded from regulation by the CFTC.^[22]

Lack of transparency

Tether is currently the world's largest market capitalization stablecoin. In October 2021, it failed to produce audits for reserves used to collateralize the quantity of minted USDT stablecoin.^[23] Tether has since issued assurance reports on USDT backing, although some speculation persists, e.g. using Chinese commercial paper for reserves instead of US dollars as promised.^[24]

Other concerns

Griffin and Shams' research attributed the creation of unbacked USDT to the rise in Bitcoin's price in 2017.^[25] Following that, research indicated little to no evidence that Tether USD minting events influenced Bitcoin values unless they were publicized by Whale Alert.^[26][27][28]

Legislation

In July 2025, the United States passed, the GENIUS Act, a bill aimed at regulating stablecoins; most critically, that they are required to be backed 1:1 in value by a trustworthy fiat or commodity asset.^[29]

Defunct stablecoins

There is a history of depegged and failed stablecoins, i.e. they became worthless.^[30]

• Basis, which had received over $100 million in venture capital funding, shut down in December 2018, citing concerns about US regulation.^[31]
• On 11 May 2022, Terra's stablecoin UST fell from $1 to 26 cents.^[32][33] The subsequent failure of Terraform Labs resulted in the loss of nearly $40B invested in the Terra and Luna coins.^[34][30]Both the United States and Korea are seeking extradition of its founder Do Kwon following his arrest in Montenegro on an Interpol notice.^[35][36]
• Diem (formerly Libra) was abandoned by Facebook/Meta and later purchased by Silvergate Capital.