Stablecoins explained: how they hold their value and where they fail

Stablecoins are crypto tokens built to keep a steady price, usually one US dollar, so they can be sent over blockchain networks without the wild swings of bitcoin or ether. Most do it by holding reserves of cash and short-term government debt. Others rely on crypto collateral or on algorithms. The design behind a stablecoin determines how stable it really is, and the history of the market shows that not every design holds up under pressure.

This is general education, not personal financial advice.

What a stablecoin is, and why it exists

A stablecoin is a type of crypto asset whose value is pegged, or tied, to a reference asset. The US dollar is by far the most common anchor, though euro-pegged and gold-backed tokens exist too.

They fill a practical gap. Crypto markets run around the clock on blockchains, but traditional bank transfers don’t. Stablecoins let traders park money between trades, let apps settle payments in minutes, and let people move dollar value across borders without waiting for correspondent banks. Because they live on public blockchains, they can also be built into smart contracts, programs that run automatically when certain conditions are met.

The trade-off is trust. Holding a stablecoin means relying on whoever, or whatever, keeps it at its peg. The Federal Reserve’s research note “The stable in stablecoins” groups them into three families based on how they try to do that.

The three main types of stablecoins

Fiat-backed (off-chain collateralized)

The most common type. A company issues one token for each dollar it receives and holds the money in reserves held off the blockchain, typically bank deposits, short-term Treasury bills and similar cash-like assets. Approved customers, often large institutions, can redeem tokens with the issuer for dollars. The two largest stablecoins, Tether (USDT) and USD Coin (USDC), fall into this group.

Crypto-collateralized (on-chain collateralized)

These coins are backed by other crypto assets locked in smart contracts. Because that collateral is volatile, these systems are usually over-collateralized. Say a user deposits $150 worth of ether to borrow $100 of stablecoins. If the collateral’s value falls too far, the protocol automatically sells it to protect the peg. The design is transparent, since anyone can inspect the collateral on-chain, but a sharp crash in collateral prices can still strain it.

Algorithmic (uncollateralized)

Algorithmic stablecoins hold few or no reserves. Instead, code expands or shrinks supply and uses incentives, often a companion token, to nudge the price back to $1. They work as long as people believe in the system. When belief breaks, there’s little to fall back on.

Type	What backs it	Main strength	Main weakness
Fiat-backed	Cash, bank deposits, Treasury bills	Simple, generally the most stable	Requires trust in the issuer, its banks and its custodians
Crypto-collateralized	Excess crypto locked on-chain	Transparent, no central issuer	Vulnerable to sharp crypto price crashes
Algorithmic	Code and market incentives	Capital-efficient	Prone to death spirals when confidence breaks

Reserves, attestations and audits

For a fiat-backed coin, everything depends on the reserves. Do they exist, are they as large as the tokens outstanding, and can they be turned into cash quickly? A dollar in a bank account and a dollar’s worth of short-term Treasury bills are close to cash. Commercial paper, loans or other crypto assets are not.

Issuers usually publish two kinds of reports:

• Attestations: an accounting firm checks the issuer’s stated reserves at a point in time. It’s narrower than an audit and doesn’t test the issuer’s controls or the full financial statements.
• Audits: a fuller examination of the financial statements under established standards, which says more about the issuer’s overall financial health.

Even good reserves don’t guarantee a smooth ride. In March 2023, USDC briefly fell well below $1 after its issuer disclosed that part of its cash was held at Silicon Valley Bank, which had just failed. It recovered once it became clear the deposits would be accessible. The episode showed that a fully backed coin still inherits the risks of the banks and custodians holding its money.

Reserve income is also why stablecoins are a business. Issuers earn interest on Treasury bills and deposits while usually paying holders nothing, so their profits move with short-term rates, a link explored in our explainer on how interest rates affect markets.

When the peg breaks: TerraUSD and other depegs

The defining stablecoin failure came in May 2022. TerraUSD (UST), then one of the largest stablecoins, was algorithmic. It kept its peg through a companion token called LUNA: users could always swap one UST for $1 worth of newly created LUNA, and vice versa. As long as LUNA held value, arbitrage kept UST near $1.

When large withdrawals pushed UST below its peg, holders rushed to swap out. That created huge amounts of new LUNA, which crashed LUNA’s price, which made UST even less credible, and so on. Within days, UST had collapsed far below $1 and LUNA was nearly worthless, wiping out tens of billions of dollars in market value. The Fed’s note records that the shock spread across the crypto ecosystem, hitting smaller stablecoins hardest, and that the market value of algorithmic stablecoins fell back to 2021 levels.

The lessons have shaped regulation since:

1. A peg is a promise, and a promise is only as good as the assets behind it.
2. Runs can happen in hours on blockchains that never close.
3. Designs that rely on a stablecoin’s own ecosystem for backing are especially fragile.

How stablecoins are used in payments

Stablecoins started as plumbing for crypto trading, and that’s still a major use. But payments are a growing focus:

• Cross-border transfers that settle in minutes, day or night.
• Business settlement, letting companies move funds between partners or their own accounts outside banking hours.
• Access to dollars for people in countries with high inflation or capital controls, though this raises its own regulatory questions.
• On-chain finance, where stablecoins serve as the cash leg of lending and trading apps.

Central banks are watching closely. The Bank for International Settlements argued in its 2025 annual report that stablecoins fall short as the backbone of the monetary system, citing concerns about their singleness (whether every dollar token is always worth the same), elasticity and integrity, including illicit-finance risks. Supporters counter that well-regulated stablecoins can make payments faster and cheaper. Unlike bitcoin, which floats freely, a stablecoin’s success depends on how dull its price stays.

How stablecoins are regulated

Rules are catching up with the market, though details continue to develop and vary by country.

United States. In 2021, the President’s Working Group on Financial Markets issued a report on stablecoins warning about run risk and urging Congress to act. In July 2025, the GENIUS Act was signed into law, creating a federal framework for payment stablecoins. According to the White House fact sheet, it requires issuers to back their tokens fully with highly liquid assets, such as US dollars or short-term Treasuries, to publish the makeup of their reserves monthly, and to follow anti-money-laundering rules. Many details depend on implementing rules from regulators.

European Union. The EU’s Markets in Crypto-Assets Regulation, known as MiCA, brought stablecoins under a single EU-wide rulebook, with its stablecoin provisions applying from mid-2024. MiCA distinguishes e-money tokens, which reference a single official currency, from asset-referenced tokens, which reference a basket or other assets, and sets requirements for authorization, reserves and redemption.

Regulation doesn’t make stablecoins risk-free. Holders still aren’t covered by deposit insurance, and the SEC’s crypto assets resources remind investors that crypto platforms may not offer the protections of traditional finance. Scammers also favor stablecoins because they move quickly, so read our guide on how to spot crypto scams before sending them to anyone you don’t know.

The bottom line

Stablecoins aim to combine the speed of crypto with the stability of a dollar. Fiat-backed coins do this with real-world reserves, crypto-backed coins with excess on-chain collateral, and algorithmic coins with code and incentives, which TerraUSD showed can unravel fast. Before holding any stablecoin, look at what backs it, how reserves are verified, who can redeem and under what rules. New laws in the US and EU are raising the bar, but the peg is still only as strong as the assets and institutions behind it.

For more on digital assets and payments, explore our Crypto & Fintech hub.