A stablecoin is a cryptocurrency designed to hold a steady value, most often one US dollar. Traders use stablecoins to park money between trades without leaving the crypto market, and people use them to send money across borders on a blockchain. They are among the largest categories in crypto, yet they are also among the most misunderstood, because a stable price is a promise that has to be kept.
This guide explains how the main types of stablecoin try to hold their value, the ways they can lose it, and the questions to ask before you hold one. Stablecoins are not risk-free, and "stable" describes the target, not a guarantee.
What "stable" means
A stablecoin aims to trade at a fixed reference, such as one dollar. In practice, it trades within a small band around that price, and the band can widen under stress. The reference is called the peg. When a stablecoin trades below its peg, it is said to be depegged, and the gap is a measure of how much trust the market has lost.
The peg is maintained by a mechanism. The type of mechanism decides where the risk sits, and that is the first thing to understand.
Fiat-backed stablecoins
Fiat-backed stablecoins hold reserves equal to the coins in circulation. For each token issued, the issuer holds an amount of cash or cash-like assets, such as short-term government debt, in a bank or custodian. Holders can usually redeem tokens for dollars through the issuer, which keeps the price close to one dollar.
The risks sit in the reserves and the redemption process. Questions to ask include what the reserves are made of, who holds them, how often they are reported, whether the report has been independently checked, and whether redemption is quick and available to ordinary holders. A reserve held in assets that cannot be sold quickly can fail to support the peg in a rush of redemptions.
Crypto-collateralised stablecoins
Crypto-collateralised stablecoins are backed by other cryptocurrencies, usually held in a smart contract. Because the collateral itself is volatile, these coins are normally overcollateralised: the value of the deposits is worth more than the tokens issued. If the collateral falls too far, the system liquidates it to protect the peg.
The risks come from the collateral and from the smart contract. A sharp fall in the collateral can force liquidations at poor prices, and bugs or governance decisions in the contract can cause losses. These systems are more complex than fiat-backed coins, and the complexity is part of the risk.
Algorithmic stablecoins
Algorithmic stablecoins try to hold their peg through supply changes and incentives, rather than through reserves. In the most common designs, a companion token absorbs the price swings. These designs have a poor record. A well-known algorithmic stablecoin lost its peg in May 2022, and its companion token collapsed with it, wiping out large sums for holders. Treat algorithmic designs with the greatest caution.
A worked example: a depeg
Suppose you hold 1,000 tokens of a stablecoin that trades at 1.00 dollar, so your holding is worth 1,000 dollars. Then confidence wavers and the price falls to 0.95. Your holding is worth 950, a loss of 50 on paper, even though you did nothing.
If the issuer redeems at one dollar, the loss disappears. If redemption is slow, restricted or unavailable, the price may stay below one dollar until confidence returns, and some holders may never recover the full amount. The gap between the market price and the redemption value is the real risk.
| Scenario | Market price | Value of 1,000 tokens | Outcome |
|---|---|---|---|
| Peg holds | 1.00 | 1,000 | No change |
| Temporary depeg, redemption works | 0.95 | 950 | Redeem at 1.00 restores 1,000 |
| Depeg, redemption blocked | 0.95 or lower | 950 or less | Loss until confidence returns |
Stablecoins are not bank deposits
A stablecoin is not a bank account. In most countries, holding a stablecoin does not come with deposit insurance, and the issuer is a private company. Some stablecoins are regulated under specific rules, and others are not. The rules differ by country and change over time, so check the status of any coin you use.
Stablecoins also carry the risks of the blockchain they run on. A coin on a network with outages or fee spikes can be slow or expensive to move, and a token that is hacked or frozen can be lost to you even when the reserves are sound.
Why people use them
Stablecoins are used for three main jobs. Traders use them to hold value between positions without converting to a bank currency. People in places with weak local currencies use them to protect savings, though this carries the same issuer and regulatory risks. Businesses and individuals use them to move money across borders, often faster and cheaper than some bank transfers, when the system works as intended.
Each job depends on the peg holding and on being able to redeem or sell the token at its reference value. That is why the risks above matter.
Who is responsible when a stablecoin fails
When a stablecoin loses its peg, the question of responsibility follows. For a fiat-backed coin, holders have a claim against the issuer and the reserves, and the outcome depends on what the reserves contain and how quickly they can be sold. For a crypto-collateralised coin, the contract and the liquidators decide much of what happens. For an algorithmic coin, there may be no one to claim against, because the design has no reserves at all.
Before you hold a stablecoin, find out who the issuer is, where it is based, which rules apply to it, and what you could do if you could not redeem. An answer like "the protocol" is not enough. Find a named party with a legal obligation, or accept that you are relying on code and market confidence alone.
What to check before you hold one
- The type: fiat-backed, crypto-collateralised or algorithmic.
- The reserves: what they are, who holds them, and how often they are reported and checked.
- Redemption: how you turn tokens back into dollars, how long it takes, and any minimum amounts.
- The track record: how the coin behaved in past stress, including any time it lost its peg.
- The network: the fees and the reliability of the blockchain it runs on.
- The rules: whether the issuer is regulated where you live.
Common mistakes
Assuming stable means safe. A stable price is a target, and it can fail.
Holding a large amount in one coin. Spreading across issuers reduces the risk of a single failure, though it adds complexity.
Ignoring redemption. A coin that trades at one dollar in calm markets may not be redeemable in a crisis.
Chasing yield. Some platforms pay high interest on stablecoin deposits. Higher returns usually mean higher risk, and the deposits can be lost if the platform fails. The guide on interest on crypto deposits covers custody, which is where that risk sits.
Key takeaways
A stablecoin is a token designed to hold a steady value, usually one dollar. Fiat-backed coins rely on reserves and redemption, crypto-collateralised coins rely on overcollateralisation and contracts, and algorithmic coins have a poor record. A depeg turns a stable holding into a loss, especially if redemption is blocked. Check the type, the reserves, the redemption process, the track record, the network and the rules before you hold any stablecoin.
This guide is for general information, not financial advice. See the disclaimer.