What is a Stablecoin?

A stablecoin is a type of cryptocurrency whose value is tied to another asset that acts as collateral. The asset could be a fiat currency like the U.S. dollar, a commodity like gold or silver, a different cryptocurrency or an algorithm that continuously matches the coin’s supply with real-time demand.


Stablecoins are typically issued as tokens on a blockchain platform and are traded on decentralized exchanges (DEXs) or used within decentralized applications (dApps). Beginner traders often purchase this type of digital currency because it provides a reliable, low-risk way for newbies to enter the decentralized finance (DeFi) market.

Stablecoins are typically used to facilitate trades on crypto exchanges. Their relatively consistent value makes them an attractive option for low-stake remittances. Instead of buying bitcoin directly with fiat currency (like the US dollar, for example) a trader might exchange fiat for a stablecoin — and then execute a trade with the coin for another cryptocurrency like Bitcoin or ether (ETH).

Other popular uses for this type of digital currency include:

Lending and borrowing: DeFi platforms like Aave and MakerDAO offer stablecoin lending and borrowing services. Users can lend their coins to earn interest or use them as collateral to borrow other assets. Similarly, borrowers can take out stablecoin loans to access liquidity without needing to sell other crypto assets.

Yield farming: Stablecoins are used in yield farming, a situation in which users stake or provide pools with liquidity to earn governance tokens or other rewards.

Insurance: Some DeFi insurance platforms use stablecoins to provide users with a reliable and transparent medium for purchasing insurance coverage or paying out claims.

Techopedia Explains

Unlike traditional cryptocurrencies, stablecoins are distributed and governed by a central authority called the issuer. The buyer has to trust that the coin’s issuer has a sufficient amount of the asset the coin is pegged to. If the issuer doesn’t have enough reserve assets to back the coins in circulation, the stablecoin will lose its peg and its value will become unstable.

How They Work

Users need a crypto wallet to buy, sell, trade and store stablecoins, just as they do for other cryptocurrencies.

Although different coins use different approaches to achieve stability, there are four primary types of stablecoins: fiat-backed, commodity-backed, algorithmic-backed and crypto-backed.

What Are Fiat Stablecoins?

This type of stablecoin is backed by a reserve of a fiat currency and maintains its value by being redeemable at a fixed exchange rate (typically 1:1). Well-known examples of fiat-collateralized coins include Tether (USDT), USD Coin (USDC) and TrueUSD (TUSD).

Here is how a fiat-collateralized stablecoin works:

  1. The issuer of the coin creates a reserve of the fiat currency the stablecoin is pegged to. The reserve is held by the issuer or a trusted third-party custodian, such as a bank or another financial institution.
  2. The issuer mints a fixed number of coins that corresponds to the amount of fiat currency held in reserve.
  3. The stablecoins are released into circulation through direct purchases or through exchanges and dApps.

Fiat-collateralized stablecoins are popular because their values are easy to understand. To provide an additional layer of security, some fiat-collateralized coins maintain a reserve that exceeds the total value of the issued coins. This ensures the digital currency is always fully backed, even when the value of the reserve assets decreases.

What Are Commodity Stablecoins?

This type of stablecoin is tied to a physical commodity like gold or a financial instrument that represents the commodity, such as gold-backed Exchange Traded Funds (ETFs).

Gold is not the only commodity that can be used as collateral, but it is arguably the most popular because throughout history, it has been used as a store of value during times of economic uncertainty. Well-known examples of gold-collateralized coins include PAX Gold (PAXG) and Tether Gold (XAUT).

Here is how a gold-collateralized stablecoin works:

  1. The coin’s issuer creates a reserve in the form of physical gold bars stored in secure vaults or shares of gold-backed ETFs or similar financial products.
  2. The issuer mints a fixed number of coins corresponding to the amount of gold held in reserve.
  3. The stablecoins are released into circulation through direct purchases or through exchanges and dApps.

Commodity-collateralized coins are popular because they can provide investors with a hedge against inflation and other types of economic instability. To accommodate potential fluctuations in market conditions, most commodity-collateralized stablecoins maintain a reserve that exceeds the total value of the issued coins.

What Are Algorithmic Stablecoins?

Algorithmic stablecoins use algorithms and smart contracts to regulate the coin’s supply in response to changing market demands. This type of stablecoin, which is typically backed by a reserve of another cryptocurrency, will automatically mint or burn coins to maintain a stable value.

Popular algorithmic stablecoins include DAI, Frax (FRAX) and Magic Internet Money (MIM). Here is how an algorithmic stablecoin works:

  1. The coin’s issuer selects a stable value relative to a specific asset as a peg.
  2. The issuer builds their coin on a blockchain platform that supports smart contracts. The smart contracts contain the rules and algorithms that govern the coin’s supply in response to demand.
  3. If the market price deviates from the peg, the smart contract algorithms automatically adjust the supply of stablecoins to restore the coin’s value to the target peg.

While algorithmic stablecoins offer a more scalable solution when compared to asset-backed or crypto-collateralized coins, they require a high degree of technical expertise and understanding to properly design and implement. Experts recommend that investors carefully assess the risks and benefits of using algorithmic stablecoins before relying on them for financial transactions or investments.


Although stablecoins are often used as a safe-haven asset during times of high volatility in the decentralized finance ecosystem, they have been controversial because there is no way to know whether the issuers actually hold the necessary assets to back up their coins in circulation.

To ensure the stability of the market and protect the interests of investors, regulators are looking at ways to provide clear guidance and oversight for the market in regards to the following concerns:

Anti-Money Laundering (AML) and Know Your Customer (KYC) — AML and KYC regulations require stablecoin issuers and exchanges to verify the identity of their customers and monitor transactions for potential money laundering or terrorist financing activities.

Securities Laws — In some cases, stablecoins can be considered securities and may be subject to securities laws and regulations. The determination of whether a stablecoin is a security depends on several factors, including its underlying structure.

Consumer Protection Laws — Stablecoins can also be subject to consumer protection laws, which require issuers and exchanges to disclose information about their products and services to consumers, and protect them from fraud and other deceptive practices.

Tax Regulations — Stablecoin transactions can be subject to tax regulations — including capital gains tax, sales tax and value-added tax, depending on the jurisdiction and the type of transaction involved.

Payment Services Regulations — Stablecoins that are used for payment services can be subject to payment services regulations, which require issuers and exchanges to obtain licenses and comply with regulations related to payment processing.


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