What are stablecoins? How “digital dollars” work and where they can fail

What is a stablecoin, in one paragraph?#

Most crypto-assets, such as bitcoin or ether, have prices that rise and fall freely. A stablecoin is a token built to do the opposite: to keep a steady value relative to something outside crypto, called the reference asset — typically the US dollar ^[2]. US regulators describe stablecoins as digital assets “designed to maintain a stable value relative to a national currency or other reference assets” ^[1]. ethereum.org puts it simply: stablecoins are tokens “designed to stay at a fixed value, even when the price of ETH changes” ^[5].

The important word is designed. The design — what backs the token and who promises to swap it back for dollars — decides how well the target holds. That design is called the stabilization mechanism, and it differs a lot from one stablecoin to the next ^[2].

Why do people use stablecoins?#

Inside crypto markets, stablecoins act as the cash leg of trades. A Federal Reserve note reported that more than 80% of trade volume on major centralized crypto exchanges involved a stablecoin as one side of the trading pair ^[2]. The US Treasury’s 2021 interagency report found that stablecoins were then used in the United States mainly to trade, lend and borrow other digital assets ^[1].

• Parking value between trades without converting back to a bank account.
• Moving dollars between platforms quickly, wallet to wallet, regardless of banking hours or public holidays ^[6].
• Collateral and borrowing in DeFi lending and as one side of many pools on decentralized exchanges.
• Cross-border payments, especially in countries where access to dollars is limited — a use the Bank for International Settlements (BIS) notes alongside serious concerns ^[6].

What types of stablecoins exist?#

Regulators and researchers group stablecoins by what stands behind them. The Federal Reserve uses three categories: off-chain collateralized, on-chain collateralized and uncollateralized, also called algorithmic ^[2]. A later Fed note uses the friendlier names fiat-backed, crypto-collateralized and algorithmic ^[7].

Categories and examples from the Federal Reserve’s 2022 note. Some coins mix designs; the Fed calls these hybrids.

Fiat-backed coins dominate. The BIS says the fiat-backed variant “accounts for the lion’s share of the market” ^[6]. Algorithmic coins have proved the most fragile group: the collapse of TerraUSD in May 2022 sent the market value of uncollateralized stablecoins back to 2021 levels ^[2]. Our guide to how stablecoins keep their peg walks through each mechanism step by step.

How is a stablecoin created and redeemed?#

New stablecoins are minted when someone hands the issuer an asset — dollars for a fiat-backed coin, crypto for a crypto-backed one. When coins are returned for redemption, they are burned (removed from circulation) and the underlying asset is paid back ^[2].

Life cycle of a fiat-backed stablecoin

Here is the catch for beginners: the mint-and-redeem window is usually not open to you. Circle says its Mint service lets exchanges, institutional traders and banks redeem USDC 1:1 for dollars, and that it “is not available to individuals or small businesses” ^[8]. Fed researchers note that fiat-backed issuers tend to mint and burn only with institutional customers, so retail users rely on secondary markets such as exchanges ^[7].

Arbitrage by approved customers is what normally pulls the price back toward $1. If they cannot or will not redeem, a dip can last.

Is a stablecoin the same as a dollar in the bank?#

No. A bank deposit is a claim on an insured bank. A stablecoin is a claim — if it is a claim at all — on a private issuer. The Treasury report points out that redemption rights vary widely: some issuers may postpone redemptions for seven days or suspend them at any time, and some coins give users no direct redemption right at all ^[1].

The BIS adds a further difference. Bank money always trades at par, but stablecoins carry the name of their issuer — like “red dollars” and “blue dollars” — and trade at exchange rates that can drift from $1. It argues this means stablecoins fail what it calls the test of singleness of money ^[6].

How big is the stablecoin market?#

Large, and concentrated in a few US-dollar coins. DefiLlama’s stablecoin data, retrieved on 3 October 2026 at 04:56 UTC, counted 340 US-dollar-pegged stablecoins with a combined circulating supply of about $312.8 billion ^[9]. In that snapshot, Tether (USDT) accounted for about 58.8% of the total and USD Coin (USDC) for about 23.7% — our calculation from the same data ^[9]. For comparison over time, the Treasury report cited stablecoin supply rising from $21.5 billion on 19 October 2020 to $127.9 billion on 18 October 2021, an increase of about 495% ^[1]. A market-cap table on ethereum.org, retrieved on 3 October 2026, listed USDT at about $184 billion and USDC at about $74 billion ^[5]; Circle reported $75.2 billion of USDC in circulation as of 24 September 2026 ^[8]. Figures differ between sources, partly because they are taken at different moments and count different coins.

How are stablecoins regulated?#

It depends on where you are. Both the European Union and the United States now have laws with specific rules for stablecoins. In the European Union, the Markets in Crypto-Assets Regulation (MiCA) splits stable-value tokens into e-money tokens, which reference a single official currency, and asset-referenced tokens, which reference other values or rights, or a combination such as several currencies ^[3]. Issuers of e-money tokens must be authorised as credit institutions (banks) or electronic money institutions, and holders must be able to redeem “at any time and at par value” ^[3].

What does the US GENIUS Act require?#

In the United States, stablecoins now have their own federal law. The GENIUS Act (Guiding and Establishing National Innovation for U.S. Stablecoins Act), Public Law 119-27, was approved on 18 July 2025 ^[4], and the White House announced the signing that day ^[10]. Before it, a 2021 interagency report had urged Congress to require payment-stablecoin issuers to be insured depository institutions ^[1]; the Act instead allows three kinds of issuer, listed below ^[4].

The law covers payment stablecoins: digital assets used, or designed to be used, for payment or settlement, whose issuer is obligated to redeem them for a fixed amount of money and says it will keep a stable value (Section 2) ^[4]. National currencies, bank deposits and securities are excluded from that definition (Section 2) ^[4].

A selection of sections, summarised by us. The full Act also covers foreign issuers, anti-money-laundering duties, custody and more.

When does it apply? Section 20 says the Act takes effect on the earlier of two dates: 18 months after enactment, or 120 days after the main federal regulators issue final rules to implement it ^[4]. Counting from 18 July 2025, 18 months is 18 January 2027 (our arithmetic). Section 13 told regulators to issue those rules within 1 year of enactment ^[4]; our sources do not show whether final rules have been issued, so we cannot confirm whether the Act is already in force. Separately, from 3 years after enactment — 18 July 2028 by our count — digital asset service providers may not offer or sell a payment stablecoin to people in the United States unless a permitted issuer issued it, with some exceptions (Section 3(b)) ^[4].

Elsewhere, the BIS notes that the EU, Japan and Singapore require issuers to obtain authorisation and set up local entities ^[6]. Rules differ by country, so check what applies where you live before relying on any protection.

What can go wrong with a stablecoin?#

• Losing the peg. In March 2023, Circle said $3.3 billion of USDC reserves (out of around $40 billion) was stuck at Silicon Valley Bank; USDC and DAI fell to under 90 cents on secondary markets before recovering over about three days ^[7].
• Runs. If holders doubt the issuer can pay, they rush to redeem first — the same dynamic as a run on an uninsured bank ^[2].
• Frozen balances. The BIS notes that, working with blockchain analytics firms, stablecoin issuers can block or freeze funds in cases of known infractions ^[6] — so a balance you hold is not beyond the issuer’s reach.
• No undo button. A payment sent to the wrong address or a lost private key means the funds are, in the BIS’s word, “irretrievable” ^[6].
• General crypto risks. EU supervisors warn of scams, fraud and cyber attacks, and that you are unlikely to have any rights to protection or compensation if things go wrong ^[11].

What mistakes do beginners make here?#

• Treating a stablecoin as an insured bank balance

  It is a claim on a private issuer. Deposit insurance generally covers the issuer’s bank account, not you.

• Assuming you can always redeem for $1

  Direct redemption is usually limited to approved business customers. Ordinary users sell on exchanges at whatever the market price is.

• Lumping all stablecoins together

  A fiat-backed coin, a crypto-backed coin and an algorithmic coin fail in very different ways. Check the design before you hold one.

• Reading size as safety

  USDC and DAI were among the four largest stablecoins when both fell below 90 cents in March 2023 ^[7]. Size and reputation did not prevent the de-peg.

• Chasing the highest stablecoin interest rate

  Interest on a stablecoin comes from lending or other strategies, each with its own risks. EU supervisors tell consumers to be particularly wary of promised high returns ^[11].

Frequently asked questions#

The bottom line#

A stablecoin is a promise, not a property of the token. How strong that promise is depends on what backs it, who can redeem it, and how much people trust the issuer when markets are stressed. Most of the time the big dollar coins trade close to $1; history shows that “most of the time” is not “always”.

Next, see the mechanics in detail in how stablecoins keep their peg, or learn how stablecoins power decentralized exchanges.

Sources#