A stablecoin is a type of cryptocurrency built to maintain a stable price, most commonly pegged one-to-one with a traditional currency such as the US dollar. This makes it useful as a way to hold value inside the crypto ecosystem without being exposed to the price swings of assets like Bitcoin or Ethereum.
That is the goal. How a stablecoin achieves it varies enormously, and the method determines what can go wrong. A token that holds dollars in a bank and a token that runs an algorithm are both called stablecoins, but they fail in completely different ways — and one of those categories has already failed catastrophically.
The problem a stablecoin solves
Ordinary cryptocurrencies move in price constantly. That makes them awkward for anything that needs a steady number.
If you want to step out of a volatile position without moving money back to a bank, you need somewhere stable to go. If you want to price something in dollars on a platform that does not handle bank transfers, you need a dollar-denominated token. If you want to send value internationally at crypto speed without the recipient receiving an unpredictable amount, you need stability.
A stablecoin is designed for exactly these situations. Its entire purpose is that the number does not move.
The three models
Almost every stablecoin uses one of three designs. Knowing which one you are looking at tells you most of what you need.
1. Fiat-backed
The issuer holds reserves — cash, bank deposits, short-term government debt — and issues tokens against them, in principle one token per dollar held.
This is by far the largest category. USDT and USDC together account for the overwhelming majority of stablecoin supply, with the total stablecoin market sitting above $300 billion in 2026.
What you are trusting: that the reserves exist, that they are liquid enough to meet redemptions, and that the issuer will honour them. This is a claim on a company, verified by whatever disclosure that company chooses to publish.
What can go wrong: the reserves are of poorer quality than stated, or they exist but become temporarily inaccessible. Both have happened.
2. Crypto-collateralised
Instead of a company holding dollars, a smart contract holds cryptocurrency as collateral and issues stablecoins against it.
Because the collateral is itself volatile, these systems are overcollateralised: you must lock more value than you mint. DAI, issued by the protocol now called Sky, typically requires a collateralisation ratio of 150 percent or more depending on the collateral type. Deposit $150 of ETH, mint up to roughly $100 of DAI. Many users hold well above the minimum to avoid liquidation.
If the collateral falls in value past a threshold, the system automatically liquidates the position to keep the system solvent.
What you are trusting: the smart contracts, the price feeds that trigger liquidations, and that liquidations execute fast enough during a sharp drop. No company holds the reserves — but code and governance decisions replace that role rather than eliminating it.
What can go wrong: collateral falls faster than liquidations can process, a price feed fails, or a governance decision changes the risk parameters.
3. Algorithmic
No meaningful reserves at all. The peg is maintained by code that mints and burns a paired token in response to price movements, on the assumption that market incentives will keep the value near a dollar.
What you are trusting: that the incentive loop holds under stress.
What can go wrong: it did. In May 2022, TerraUSD unwound in exactly this way. When confidence broke, the mechanism reversed into a self-reinforcing spiral. UST went from $1.00 to roughly $0.30 in two days and to effectively nothing within a week, erasing tens of billions in value. There were no reserves to fall back on because the design never had any.
The category never recovered. Surviving designs that once called themselves algorithmic have largely moved to hybrid models that hold real collateral, and the pure form is now a small fraction of the market.
A note on labels: DAI is sometimes described as algorithmic because a protocol rather than a company manages it. That is misleading. DAI holds real collateral in excess of what it issues. UST held nothing. Conflating the two obscures the single most important distinction in this whole topic.
How a peg is actually held
Three mechanisms work together, and all three must function.
Reserves or collateral. Something of value stands behind the token.
Redemption. Some party can exchange the token for the underlying asset at face value. This creates a floor — if the token trades below a dollar and can be redeemed for a dollar, doing so is profitable.
Arbitrage. Traders buy below the peg and sell above it, pushing the market price back. This is fast and continuous, but it only works while people believe redemption will function.
That last condition is where things break. A stablecoin can be fully backed and still lose its peg if people stop believing they can get their money out.
What breaking actually looks like
Three documented cases cover the failure modes.
Algorithmic collapse — TerraUSD, May 2022. No reserves. Mechanism reversed. Total loss.
Reserve inaccessibility — USDC, March 2023. Circle disclosed that $3.3 billion of USDC reserves sat at Silicon Valley Bank when the bank failed. The funds were almost entirely recovered within days. But over one weekend, holders had no certainty of that, and USDC fell to roughly $0.87 before recovering. USDC was fully backed the entire time. The assets existed. They were simply not reachable, and that alone was enough.
Confidence pressure — USDT, May 2022. During the turmoil following Terra's collapse, USDT briefly traded to around $0.95 before recovering within hours as redemptions processed.
The USDC case is the most instructive of the three, because it disproves the intuition most people start with. Full backing is necessary. It is not sufficient.
What stablecoins are used for
Moving between platforms. Transferring dollar value between exchanges without touching the banking system.
Sitting out volatility. Converting to a stablecoin without exiting to a bank account.
Trading pairs. Most crypto trading is priced against a stablecoin rather than against a national currency.
Payments and remittances. Sending dollar-denominated value across borders quickly, which has driven significant adoption in countries with unstable local currencies or limited banking access.
What you are actually exposed to
This is the part worth internalising, because it is different from holding a cryptocurrency directly.
When you hold Bitcoin in your own wallet, you are exposed to its price and to your own key management. That is it.
When you hold a stablecoin, you are exposed to: whoever issues it, the quality of what backs it, whether that backing is reachable, whether redemption works, the smart contracts if it is on-chain, and the regulatory environment of the issuer.
The price stability is the output of all those things working. It is not a property of the token.
Regulation is reshaping the category
Two frameworks matter as of 2026.
The GENIUS Act, signed into US law in July 2025, created a federal framework for payment stablecoins. Qualifying issuers must be US-domiciled, hold one-to-one reserves in cash and short-dated Treasuries, publish monthly attestations, and submit to federal supervision.
MiCA, the European Union's crypto regulation, imposes requirements some existing stablecoins do not meet. This led major exchanges to remove or restrict certain stablecoins for EU users through 2025 and 2026.
The practical consequence: which stablecoins you can access depends heavily on where you are, and that is changing. Availability in one country tells you little about another.
Common misconceptions
"Stablecoins are the same as dollars." They are a claim on assets held by someone else. A bank deposit in most developed countries carries government-backed insurance up to a limit. A stablecoin does not.
"Stable means safe." Stable describes the price target, not the risk. A stablecoin can hold its peg perfectly and still carry issuer, custody, and regulatory risk.
"All stablecoins work the same way." Three fundamentally different designs, with different failure modes. The design is the first thing to identify.
"If it's backed one-to-one, it can't depeg." USDC in March 2023 disproves this directly. Backing is necessary but not sufficient — access and confidence matter equally.
How to evaluate any stablecoin
Four questions cover most of it:
Which model is it? Fiat-backed, crypto-collateralised, or algorithmic.
What specifically backs it? "Cash and equivalents" is vague. Published composition is not.
How is that verified, and by whom? There is a real difference between a point-in-time attestation and a full audit, and between quarterly and monthly disclosure.
Who can redeem, and how? If only large institutional clients can redeem directly, your exit depends on market liquidity rather than the redemption mechanism itself.
For the two largest fiat-backed stablecoins specifically, we cover USDT and USDC in their own entries, including reserve composition and verification practices.
This entry explains how stablecoins work. It is not financial advice and not a recommendation to hold any particular token. Figures reflect published data as of August 2026; supply, reserves, and regulatory status all change.