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Stablecoin

Type of cryptocurrency that is reserve backed From Wikipedia, the free encyclopedia

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A stablecoin is a type of cryptocurrency that aims to maintain a stable value relative to a specified asset, a pool or basket of assets. The specified asset might refer to fiat currency, commodity, or other cryptocurrencies.[1][2]

Despite its name, stablecoins are not necessarily stable. Stablecoins rely on stabilization tools such as reserve assets or algorithms that match supply and demand to try to maintain a stable value. However, multiple stablecoins have failed to maintain their value relative to the underlying assets.[3]

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Background

Stablecoins emerged in 2014 as a method for investors in cryptocurrencies to park their money when they invest in other highly volatile cryptocurrencies.[4][5] Stablecoins are now mainly used for buying or selling cryptoassets, and for making cross-border payments.[1] As of July 2024, over 90% of stablecoins are pegged to the US dollars.[6]

While most stablecoins are non-interest bearing and therefore do not provide returns to the holder, some issuers and service providers began offering yield-bearing stablecoins in an attempt to gain market share.[7][8][9][10]

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Comparison with CBDC

A stablecoin should not be confused with a central bank digital currency (CBDC). While both are electronic digital payment utilizing the blockchain. CBDC is issued by central banks, meaning that they are a direct claim on the central bank, while stablecoin is issued by private entity.[1][11]

Types of stablecoin

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Stablecoins can be distinguished based on their methods of maintaining their relative value with the specified asset. Some major types of stablecoins are as follows:[12][13]

Fiat-backed stablecoins

Fiat-backed stablecoins are stablecoins that claim to be backed by assets denominated in a fiat currency.

The value of stablecoins of this type is based on the value of the backing currency, which is supposedly held by a third party custodian. 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.

Cryptocurrency stablecoin characteristics are:

  • Their value is pegged to one or more currencies (most commonly the US dollar or the Euro);
  • 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.

Major examples of fiat-backed stablecoins are Tether's USDT, Circle's USDC, and Binance's BUSD.[5][14]

Cryptocurrency-backed

Cryptocurrency-backed stablecoins are stablecoins using other cryptocurrencies as collateral. The reason such stablecoins are created is that by utilizing smart contracts, they allow a decentralized network to track the price of US dollar as closely as possible. Another use case of cryptocurrency-backed stablecoins is to convert a cryptocurrency into ERC20 compatible standard to enable trading on another blockchain.[15]

Major examples of cryptocurrency-backed stablecoins are DAI and Wrapped Bitcoin (WBTC).

Commodity-backed stablecoins

Commodity-backed stablecoins are stablecoins that claim to be backed by commodities. Examples are PAX Gold and Tether Gold.[13]

Algorithmic stablecoin

Algorithmic stablecoins, sometimes called seigniorage-style stablecoin, are stablecoins with no reserve assets or only partial reserve assets. They utilize algorithms that match supply and demand to maintain a stable value. The European Central Bank suggests that algorithmic stablecoins should be treated as unbacked crypto-assets.[3]

Some major examples of algorithmic stablecoins are TerraClassicUSD (not to be confused with the defunct TerraUSD, see below), Celo Dollar, Tron's USDD and Kava's USDX.[12]

"Death spiral" of algorithmic stablecoin

Algorithmic stablecoins are vulnerable to a de-pegging process knows as "death spiral" [16][17], in which an external event, such as the tightening of global liquidity, led to heavy redemption of the stablecoin. This triggered the minting of the linked token to burn the stablecoin, causing the supply of the linked token to increase exponentially, further causing a decrease in price.[18][19]

A famous case of death spiral is the TerraUSD (UST), created by Do Kwon. TerraUSD was meant to maintain a 1:1 peg with the United States dollar.[20] 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).[21] In May 2022, UST broke its peg with its price plunging to 10 cents,[22] while Luna fell to "virtually zero", down from an all-time high of $119.51.[23] The collapse wiped out almost $45 billion of market capitalization over the course of a week.[24][25]

In the case of TerraUSD, another contributing factor to its failure is the proof of stack (POS) mechanism. The fall in the price of LUNA caused validators to sell their stacks, allowing malign actors to became dominant validators.[26]

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Use cases and potential advantages of stablecoin

Convenience for crypto investors

The main advantage of stablecoins is they provide convenience for investors in cryptocurrencies, allowing investors to park their money while buying and selling other more volatile cryptocurrencies.[3][4]

Cross-border payments

Stablecoins are used for cross-border payments, especially for cross-border remittance to less developed countries. Cross-border payments are traditionally associated with high transaction costs, prolonged processing times, and limited access for unbanked populations. Since stablecoins can be sent using a smartphone, it can facilitate faster cross-border transactions for individuals with limited access to financial institutions.[27][28][29]

Hedge against hyperinflation

Stablecoins are being used in countries where hyperinflation is occurring, such as Argentina and Venezuela. Due to monetary policies of these countries, citizens are often unable obtain foreign currencies through formal financial services. Since some stablecoins could maintain a relatively steady value against specific assets such as the US dollar, they are used as a hedge against hyperinflation.[30][31][32][33]

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Financial and regulatory risks of stablecoin

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Anti-Money Laundering / Counter-Financing of Terrorism compliance concern

Stablecoins enable person-to-person transfers without the need for a regulated intermediary, which raised concern from international financial institutions on Anti-Money Laundering (AML) and Counter-Financing of Terrorism (CFT) compliance.[34][35] Blockchain maintains pseudonymity for individual users, which can preserve privacy but also facilitates illegal use in the absence of Know Your Customer (KYC) requirments.[36]

Erosion of monetary sovereignty

After the passing of the GENIUS Act by the Trump administration in the United States, Jürgen Schaaf, adviser to the European Central Bank (ECB) wrote that widespread adoption of US dollar stablecoins could erode European monetary sovereignty and financial stability.[37]

Volatility risk

Central banking authorities such as the European Central Bank have cautioned that even fully reserve-backed stablecoins might be vulnerable to "noise traders" (i.e. traders seeking arbitrage opportunities due to tiny pricing fluctuations).[38]

Lack of reserve transparency

Tether's USDT is currently the world's largest market capitalization stablecoin. Tether initially claimed their stablecoin is fully backed by fiat currency. However, in October 2021, it failed to produce audits for reserves used to collateralize the quantity of minted USDT stablecoin.[39] Tether and Bitfinex were fined $41 million by the Commodity Futures Trading Commission for deceiving consumers.[40] The CFTC found that Tether only had enough fiat reserves to guarantee their stablecoin for 27.6% of the time during 2016 to 2018. Since then, Tether began issuing assurance reports on USDT backing, although some speculation persists, e.g. using Chinese commercial paper for reserves instead of US dollars as promised.[41]

Role in speculative crypto investment

Griffin and Shams' research attributed the creation of unbacked USDT to the rise in Bitcoin's price in 2017.[42] Following that, research indicated little to no evidence that Tether USD minting events influenced Bitcoin values unless they were publicized by Whale Alert.[43][44][45]

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Legislation and regulation

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United States

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.[46]

European Union

The European Union introduced the Markets in Crypto-Assets Regulation (MiCAR) in June 2023. The regulation became applicable to asset-referenced tokens and e-money tokens on 30 June 2024.[47] MiCAR has no clear regulation on global firms issuing the same stablecoin both from an EU-regulated entity and from a third-country entity, causing concern that in that event of large scale redemption of a multi-country stablecoin, the reserves located in the EU might be quickly depleted.[48]

Hong Kong

In December 2024, Hong Kong gazetted its Stablecoins Bill.[49] The bill was passed in May 2025 with the first stablecoin issuance licenses expected in early 2026.[50] The Hong Kong Monetary Authority, the regulatory body of stablecoins in Hong Kong, warned the public to "rein in the euphoria".[51][50] In particular, guidelines require stablecoin issuers to have strict rules on anti-money laundering, risk management, and corporate governance.[52]

Singapore

In November 2023, the Monetary Authority of Singapore finalized its Stablecoin Regulatory Framework after conducting public consultation since October 2022.[53] Issuers of stablecoins are required to maintain a portfolio of reserve assets denominated in the currency of the stablecoin peg.[54] On 16 November 2023, the regulator approved Paxos Digital and StraitsX as stablecoin issuers.[55]

UAE

In June 2024, the Central Bank of the UAE established the Payment Token Services Regulations to regulate the use of stablecoins in the UAE. The regulations prohibit persons within the UAE from accepting stablecoins for the sale of goods and services except licensed payment token.[56][57]

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Defunct stablecoin projects

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There is a history of de-pegged stablecoins and stablecoin projects that have been abandoned by the issuer.[58]

De-pegged stablecoins

  • In June 2021, IRON stablecoin, which is an algorithmic stable coin partially collateralized by USDC, de-pegged after large selling orders to its linked TITAN token.[59]
  • In May 2022, Terra's stablecoin UST lost its peg with the US dollar. The subsequent failure of Terraform Labs resulted in the loss of nearly $40 billion invested in the Terra and Luna coins.[60][58] Terraform Labs filed for bankruptcy in January 2024. Both the United States and Korea seek extradition of its founder Do Kwon following his arrest in Montenegro on an Interpol notice.[61][62] In December 2024, Do Kwon was extradited to the United States.[63]

Abandoned stablecoin projects

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References

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