2.7 What Are Stablecoins? ‘Stable’ Cryptoassets and Their Limitations

What Are Stablecoins? ‘Stable’ Cryptoassets and Their Limitations

What you will understand after this chapter

What stablecoins are and the basic ways they are designed to work.

Why some people use stablecoins within the crypto ecosystem.

Examples of how stablecoins are used in practice, and the main risks involved in those uses.

The types of issuers and designs you may encounter, and key risk considerations for each.

What is a stablecoin?

A stablecoin is a type of cryptoasset that is designed to keep its price close to the value of another asset, most commonly a government currency such as the US dollar, euro or pound.

To try to achieve this, the issuer or protocol uses mechanisms such as backing assets (reserves), collateral, or rules built into software to keep the token’s price near a target (for example, aiming for 1 token ≈ 1 US dollar). Stability is an objective, not a guarantee, and some stablecoins have failed to maintain their target value in the past.

Three broad design approaches are commonly discussed:

Fiat‑backed stablecoins: A company issues tokens and says it holds traditional financial assets (for example, cash and short‑term securities) intended to match or exceed the value of the tokens in circulation.

Crypto backed stablecoins: Tokens are created against other cryptoassets locked in smart contracts, often with more collateral than the face value of the stablecoins to help absorb volatility.

Algorithmic or largely un‑collateralised stablecoins: These rely mainly on software rules and incentives to expand or contract supply, rather than holding large reserves of external assets.

Different designs have different risk profiles. The fact that a stablecoin targets a peg does not mean it will always hold that value.

Why some people use stablecoins

People generally do not seek stablecoins for large price gains, but for specific functions, typically within the wider crypto ecosystem. Common reasons include:

Reducing exposure to volatile coins without fully leaving crypto platforms.

Transferring value across borders using blockchain rails.

Accessing certain lending, borrowing or trading services that are built around stablecoins.

These uses still carry risk. A stablecoin can lose its peg, an issuer can fail, a protocol can be exploited, or regulations can change. Holding stablecoins is not the same as holding insured cash in a bank account.

How stablecoins are used in practice

Stablecoins appear in several contexts:

On trading platforms:

They often act as the “other side” of trading pairs and as a way to move between more volatile cryptoassets and a token that aims to track fiat value. If the stablecoin fails, users can still suffer losses.

Payments and cross border transfers:

Some people and businesses use stablecoins to send funds internationally. While transfers can be relatively fast, they depend on the underlying blockchain, the stablecoin’s design and any intermediaries used, all of which can introduce risk and cost.

Receiving income and making payments:

Some freelancers or remote workers agree to be paid in stablecoins. This exposes them to issuer and peg risk, as well as regulatory and tax considerations, and may not be appropriate for everyone.

Saving and “earning yield”:

Some platforms offer returns on stablecoin balances. These returns are not risk free; they depend on the platform’s activities, counterparties and leverage. High quoted yields can be a sign of higher risk rather than safety.

It is important not to assume that stablecoins are “safe cash” just because they aim to track a fiat currency.

Types and key risk trade offs

Different stablecoin models come with different main risks:

1. Fiat backed stablecoins

Typically issued by a company that holds reserves.

Key risks include the quality and transparency of those reserves, legal and regulatory risk, and the possibility that the issuer or its banks fail or restrict redemptions.

2. Crypto backed stablecoins

Use other cryptoassets as collateral, often visible on‑chain.

Exposed to extreme market moves, smart‑contract vulnerabilities and governance decisions, which can cause under‑collateralisation or loss of funds.

3. Algorithmic or largely un‑collateralised stablecoins

Depend heavily on market confidence in the design and incentives.

Several prominent examples have lost their peg dramatically in the past, causing large losses to holders.

Understanding these trade offs is more important than chasing headline yields or assuming that all “1 dollar” tokens are similar.

Main issuers and projects (as case studies, not recommendations)

A relatively small number of stablecoins account for a large share of market activity. It can be useful to understand them as case studies, while recognising that none is risk‑free and mentioning them here is not an endorsement.

Centralised, fiat backed stablecoins:

These are issued by companies that hold reserves and operate under particular legal frameworks. Questions to consider include: how transparent are the reserves, what assets are held, what jurisdictions apply, and what happens in a stress scenario?

Decentralised, crypto backed stablecoins:

These are issued by protocols based on collateral locked in smart contracts. Points to consider include: collateral quality and volatility, how liquidations work, governance arrangements, and the track record of the protocol.

For any specific stablecoin, you should understand who is behind it, how it is audited or supervised (if at all), and what would happen if many users tried to redeem at once.

Stablecoins in a beginner’s guide

For someone learning about crypto, stablecoins are important because they help explain:

How some people move between fiat and on‑chain assets.

How certain payments and DeFi protocols are structured.

Why design and issuer risk matter, even for tokens that aim to have a “stable” price.

This chapter is intended to build your understanding of how stablecoins work and where the main risks lie. It is not a recommendation to buy, sell or hold any stablecoin or other cryptoasset, and any decision to use them should take into account that you could lose all the money you put in.

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