Definition
A stablecoin is a cryptocurrency designed to keep a stable value against a reference asset, most often the US dollar, so that 1 token aims to stay worth about $1.
How it works
Stablecoins hold their value in different ways. Fiat-backed or asset-backed stablecoins are issued by a company that states it holds reserves, such as cash and short-term government bonds, and redeems tokens for dollars. Crypto-collateralized stablecoins are created by locking other crypto in a smart contract worth more than the stablecoins issued, which is called overcollateralization; if the collateral loses too much value, the position is liquidated. Algorithmic stablecoins try to hold the peg mainly through supply rules and incentives, and some designs of this type have collapsed.
Dollar-pegged coins such as USDT and USDC are widely used to move money between platforms, to hold funds without leaving the crypto market and as the base currency in decentralized finance. Redemption and arbitrage keep the price near the peg: when the token trades below $1, traders who can redeem it for $1 have a reason to buy, and when it trades above $1, new tokens can be issued and sold.
A stablecoin is not a bank deposit, and deposit insurance generally does not apply. Risks include a depeg, when the price moves away from its target, problems with the issuer or its reserves, regulatory action and bugs in the smart contracts behind the token. Not every holder can redeem directly with the issuer.
Example (hypothetical numbers)
Suppose a user locks $1,500 of Coin E in a smart contract to create 1,000 units of Stablecoin S, each meant to be worth $1.
Collateral ratio = $1,500 ÷ $1,000 × 100 = 150%.
If Coin E falls 30%, the collateral is worth $1,500 × (1 − 0.30) = $1,050, and the ratio drops to $1,050 ÷ $1,000 × 100 = 105%.
The 1,000 stablecoins are still backed by more than $1,000 after a 30% fall, which is why crypto-collateralized designs lock more value than they issue; a larger fall would leave them undercollateralized.
Common mistakes
- Treating a stablecoin as risk-free or as the same thing as a bank deposit.
- Assuming all stablecoins work the same way, regardless of whether they are backed by reserves, crypto or algorithms.
- Ignoring the chance of a depeg during market stress or problems at the issuer.
- Forgetting that a dollar stablecoin still carries exchange rate risk for someone who spends another currency.
Related calculators
This glossary is for education only and is not investment advice. Examples use hypothetical numbers.