Topic: Crypto · Type: Evergreen · Reading time: ~8 min

In May 2022, around $40–50 billion disappeared from the crypto market in the span of a week. Not because Bitcoin crashed. Because something that called itself a stablecoin stopped being stable.

That event — the collapse of TerraUSD — is the reason you should understand stablecoins before you touch them, hold them, or earn yield on them. It's also the reason that despite the chaos, the rest of the stablecoin market didn't implode. Most stablecoins behaved exactly as advertised. Understanding why requires knowing how they actually work.

What a stablecoin actually is (and what it isn't)

A stablecoin is a cryptocurrency designed to hold a fixed value — almost always pegged 1:1 to the US dollar. Unlike Bitcoin or Ethereum, whose prices are set entirely by market sentiment, a stablecoin's issuer actively works to keep the price at $1.00. That's the whole point.

Think of it like a poker chip at a casino. You convert dollars into chips to play the game (the crypto ecosystem), and when you're done, you convert back. The chip itself isn't meant to go up or down — it's a unit of exchange, not a speculative asset.

As of late 2025, stablecoins have a combined market cap of over $316 billion, with daily trading volume hitting $156 billion. Around 90% of that is split between just two tokens: Tether (USDT) and USD Coin (USDC). Nearly 97% of all fiat-backed stablecoins are denominated in US dollars, which tells you something about where demand actually comes from — and who controls this market.

Worth knowing: In 2024, stablecoin transfer volume reached $27.6 trillion — more than Visa and Mastercard combined. They aren't a niche instrument anymore.

The three types — and why the distinction matters

Not all stablecoins work the same way, and the mechanism underneath determines how risky they are. Most articles gloss over this. They shouldn't.

Fiat-backed stablecoins are the simplest and most common. For every USDC or USDT in circulation, the issuer (Circle and Tether, respectively) holds roughly one dollar's worth of cash or short-term US Treasury bills in reserve. You give them $100, they issue you 100 tokens, and in theory you can always redeem them. Their structure closely resembles a money market fund — which is useful, because it tells you the risk profile: normally very low, but vulnerable to bank-run dynamics under extreme stress.

Crypto-backed stablecoins work differently. DAI, for example, is backed not by dollars but by other crypto assets like Ethereum. To issue $100 of DAI, you might need to lock up $150 worth of ETH as collateral — the overcollateralization is a buffer against volatility. If ETH's price drops sharply, the smart contract automatically liquidates the collateral. Clever in design, but dependent on the underlying crypto not crashing too fast.

Algorithmic stablecoins use code rather than reserves to maintain the peg. If the token trades above $1, the protocol creates more supply to push the price down. If it trades below $1, it burns supply to push the price up. No real assets required — just maths and market confidence. This sounds elegant. It is, until it isn't.

TerraUSD (UST) was the defining example. At its peak in early 2022 it had an $18 billion market cap. By mid-May 2022, it was worth less than a cent. The algorithm's design assumed that market confidence and a sister token called LUNA would always create enough buying pressure to restore the peg. When large holders began selling, confidence cracked, a death spiral began, and there was nothing physical to stop it. Investors lost an estimated $40–50 billion. Do Kwon, Terraform Labs' founder, was eventually convicted of fraud and sentenced to 15 years in a US federal prison in late 2025.

That case isn't a reason to dismiss all stablecoins. It's a reason to ask, every time: what actually backs this?

Where stablecoins are actually being used

The use cases break down more clearly than most people expect.

Within crypto trading, stablecoins act as the default "safe harbour." When a trader wants to sell Bitcoin but stay in the ecosystem, they convert to USDC rather than exit to a bank account. This is where most of the daily volume comes from.

Cross-border payments are the fast-growing use case. Traditional international wire transfers can take 2–5 days and carry fees of 3–5%. A stablecoin transfer settles in seconds for a fraction of the cost. Stripe now lets US merchants accept stablecoin payments, converting them to dollars and charging roughly half of its standard card fee. PayPal announced in April 2025 that it would offer 3.7% interest on its stablecoin (PayPal USD) held in wallets.

The most underreported use is dollar access in economies with weak local currencies. In countries like Argentina, Nigeria, and Turkey — all facing serious inflation — stablecoins let ordinary people hold dollar-equivalent value without needing a US bank account. A 2024 survey of crypto users across five emerging-market countries found that 47% used stablecoins specifically to access dollars. This isn't speculation. It's financial survival.

For DeFi (decentralised finance) applications, stablecoins provide the liquidity layer. You can lend DAI on a DeFi protocol and earn interest without worrying about price drops eroding your principal. They're also used as collateral to borrow other cryptocurrencies. If you're curious about how this ecosystem connects, understanding what a blockchain actually is helps before going further into DeFi.

Are they safe? The honest answer

The phrase "stablecoin" implies more certainty than actually exists. Here's a cleaner way to think about it:

Well-established fiat-backed stablecoins (USDC, USDT) carry low but nonzero risk. Tether, the largest, holds approximately 81% of its reserves in cash equivalents like Treasury bills, with the rest in secured loans, Bitcoin, and other assets. That's more transparency than it used to have, but less than an actual bank. USDC, issued by Circle (which received a national trust bank charter from the OCC in December 2025), is generally considered more tightly regulated and audited.

The key risk with fiat-backed coins is a bank run scenario — if too many holders try to redeem at once, a forced sale of reserves could cause problems. The same risk exists with money market funds, which is why regulators take it seriously.

Crypto-backed stablecoins carry smart contract risk and collateral cascade risk. If the collateral drops in value faster than the protocol can liquidate, you can have under-collateralised coins in circulation briefly.

Algorithmic stablecoins are categorically higher risk. After TerraUSD, most of the market has quietly acknowledged this. The EU's MiCA regulation (which came into force in 2023 and covers European investors directly) has placed strict restrictions on algorithmic stablecoins. Several jurisdictions considered banning them from exchanges entirely.

There's also platform risk that applies to all types: if you hold stablecoins on a centralised exchange that collapses (see: FTX, 2022), your stablecoins are caught up in it regardless of how well-designed they are. How you store crypto matters as much as what you hold.

What the 2025 GENIUS Act changed

For a long time, stablecoins existed in a regulatory grey zone. That changed in July 2025, when the US passed the GENIUS Act — the first major federal crypto legislation — with bipartisan support (68–30 in the Senate, 308–122 in the House).

The practical effects for anyone holding or considering stablecoins:

Issuers must now back stablecoins 1:1 with cash or short-term Treasuries, and disclose their reserves monthly. Stablecoin holders get legal priority in insolvency proceedings — meaning if an issuer goes bankrupt, you're first in line, ahead of other creditors. Only licensed entities (bank subsidiaries, OCC-supervised nonbanks, or state-chartered entities with federal approval) can issue stablecoins in the US. Algorithmic stablecoins don't fit this framework and effectively can't be issued under it.

Critics note the Act has gaps: no FDIC insurance, no Federal Reserve backstop, and questions remain about whether yield-bearing products (platforms paying you interest on stablecoin holdings) are effectively exempt. Consumer groups have argued it doesn't provide enough protection against fraud. Economists have drawn parallels to the "free banking era" of the 1800s, when private notes circulated alongside government currency.

Still, it's a meaningful step toward treating stablecoins like financial instruments rather than regulatory experiments.

What this means for you

If you're in crypto at any level — whether you're actively trading or just holding some Ethereum — you'll almost certainly encounter stablecoins. They're useful: faster than wire transfers, easier to use within DeFi, and a sensible place to park value when you want to reduce exposure without cashing out.

The practical rules are simpler than the theory:

Stick to major fiat-backed stablecoins with audited reserves (USDC is the most transparent; USDT is the most liquid). Avoid anything promising unusually high yields from algorithmic mechanisms — that's the TerraUSD model in a new coat. Keep stablecoins on platforms you trust, ideally with self-custody for larger amounts. And if you're in Europe, check whether a coin complies with MiCA regulation before using it.

The word "stable" in stablecoin describes the goal, not a guarantee. Treat them accordingly, and they're a genuinely useful instrument. Treat them like a savings account backed by a government, and you've misunderstood what you're holding.