Stablecoins: what is it in simple terms

Stablecoins occupy a special place among digital assets, serving as one of the most fundamental instruments in the modern architecture of cryptocurrencies.

While Bitcoin earned the title of "digital gold" and Ethereum became the platform for innovative smart contracts, stablecoins have effectively assumed the role of the digital dollar. They introduced much-needed stability, usability, and a familiar value peg into the decentralized finance (DeFi) ecosystem, making the crypto market accessible to a wider range of users.

To fully grasp the importance of stablecoins, we must delve into their core principles and understand the critical problems they are designed to solve.

Why is Stability Essential in the Crypto Ecosystem?

Cryptocurrencies have unlocked incredible possibilities for global payments and investments, yet they simultaneously introduced a significant challenge: extreme volatility. It is precisely because of these intense and unpredictable price fluctuations that an acute need arose for an asset that could act as a reliable medium of exchange. Stablecoins emerged as the answer, combining the convenience of cryptocurrencies with the price stability characteristic of traditional fiat money.

The Core Problem: Uncontrolled Market Volatility

Crypto market participants constantly face a situation where the value of their digital assets can change by tens of percent within a matter of hours. Imagine using Bitcoin for payments or savings: your purchasing power could sharply increase or collapse, creating massive financial risk. These uncontrolled price swings are driven by speculative demand, high sensitivity to news cycles, and general market sentiment.

This volatile price dynamic makes standard cryptocurrencies excellent tools for high-risk investors but virtually unusable for everyday transactions and long-term value preservation. If you transfer a large sum in Bitcoin, its value may shift critically while the transaction is still being processed. This is why the market urgently required a solution capable of delivering stable value.

The Simple Genius: A Digital Dollar for the Crypto World

The concept of a stablecoin is profoundly simple: it is a cryptocurrency whose exchange rate is consistently maintained at a fixed level, typically pegged to the US Dollar. In the vast majority of cases, one stablecoin (e.g., USDT or USDC) is always engineered to equal exactly one US Dollar. While some stablecoins may be pegged to the Euro, Gold, or a basket of assets, the fundamental principle remains the same.

This peg guarantees users that they can operate with a digital asset without worrying about sudden price spikes or drops. A stablecoin instantly becomes the ideal unit of account, a reliable medium of exchange, an efficient tool for trading, and a comfortable asset for preserving value within the crypto sphere. Essentially, it is a digital representation of the dollar, powered by blockchain technology.

The Essential Bridge Between Traditional and Digital Finance

Stablecoins play a critical role by solving several key problems that would otherwise be insurmountable in the decentralized world. Foremost, they enable fast and ultra-cheap international transfers, bypassing cumbersome and slow bank payment systems like SWIFT. Sending any amount in USDT can take seconds with minimal fees, requiring no intermediaries or lengthy waiting periods.

Furthermore, they provide stability within the crypto market itself. Traders can instantly move capital out of volatile assets into a stablecoin, hedging against downturns. In countries facing high inflation, stablecoins offer a vital alternative as a reliable, dollar-denominated account. Finally, they serve as the cornerstone for the entire DeFi sector, providing the necessary liquidity for lending, deposits, and decentralized exchanges. Stablecoins are the necessary digital bridge connecting traditional money (TradFi) and the progressive world of Web3.

What is a Stablecoin, and How Does it Differ from Volatile Cryptocurrencies?

Simply put, a stablecoin is a cryptocurrency created with the sole purpose of keeping its price fixed and equal to the price of a real-world asset, most often the US Dollar. But for a complete understanding, a clear distinction must be made between stablecoins and their volatile counterparts, such as Bitcoin or Ethereum.

A Simple Definition: A Fixed-Rate Cryptocurrency

Stablecoins are digital tokens that use various complex mechanisms to ensure their price always remains at the $1 level. This means 1 USDC, 1 USDT, or 1 DAI always aims for the same value. This fixation is achieved either by holding real fiat reserves, by being collateralized by other crypto assets, or through complex algorithms that manage the market supply of the coin.

The main takeaway for the user is this: a stablecoin's primary goal is not to appreciate in value, but to remain reliable and predictable. You must be certain that if you buy a stablecoin today, you can sell it at the same price tomorrow and a year from now.

The Key Difference: Asset Peg vs. Speculative Value

While the value of ordinary cryptocurrencies is freely determined by market speculation, investor expectations, and news, stablecoins are deliberately tied to an external, stable asset. This is their key differentiator and advantage.

Compare the two:

• Volatile Cryptocurrency: Price floats freely and is used as an investment for capital growth. It is volatile by definition, and its value is speculative.

• Stablecoin: Price is strictly pegged to fiat (typically the dollar). It is used as a reliable medium of exchange and settlement. It is stable, and its value is guaranteed by assets or code.

Stablecoins are not about high risk and rapid growth; they are about **reliability and predictability**, making them indispensable for real-world use cases.

Analogy: A Digital Receipt for Real Money in a Vault

To grasp stablecoins, imagine a simple metaphor. You give $100 to a financial company, which places it in a secure vault and, in return, issues you 100 digital tokens. These tokens are the stablecoins. Each token is the company's obligation to return $1 to you upon request.

You can instantly send these digital receipts to anyone globally, use them to pay for services, or as collateral in DeFi. When you wish, you can return these tokens and retrieve the real dollars from the vault. They are not the dollars themselves, but their digital representatives, confirming your right to the underlying reserve.

How Stablecoins Work: The Core Collateral Mechanisms

The central question always is: what forces a stablecoin to maintain its value at exactly $1? The success of a stablecoin hinges on the mechanism that guarantees this peg. Stablecoins use various combinations of reserves, collateral, or algorithms to effectively manage supply and demand.

Fiat-Backed (USDT, USDC): A Dollar in the Bank for Every Token

This model is the most common and straightforward, built on a strict 1:1 principle. The issuing company, such as Tether or Circle, takes a real dollar from the user, holds it in a bank account or invests it in highly liquid assets (like short-term US Treasury bonds), and only then issues exactly one stablecoin (USDT or USDC). The user can redeem this token for a real dollar at any time.

The advantages of this model include:

• Maximum price stability, as it is backed by fiat.

• High liquidity and the broadest support across all crypto exchanges.

• Convenience for fast global settlement.

The main drawback is the need for trust in the issuer and the presence of custodial risk, as the reserves are controlled by a centralized entity that can potentially freeze wallets.

How It Works: Reserves, Audits, and Trust in the Issuer

To maintain the peg, the issuing company must guarantee that the volume of its reserves equals or exceeds the volume of tokens issued. Reserves are not necessarily pure dollars in a bank; they may consist of short-term government bonds, deposits, and cash equivalents. The company must regularly demonstrate the existence of these reserves through independent attestation or audit.

The more transparent and reliable the issuer is in providing reports on its asset structure and conducting independent checks, the higher the trust in its stablecoin and the more securely its peg is maintained. Fiat-backed stablecoins are fundamentally reliant on the financial and legal integrity of their creators.

Crypto-Collateralized (DAI): Backed by Other Crypto Assets

Crypto-collateralized stablecoins, such as DAI from MakerDAO, offer a decentralized alternative. In this case, the token is backed not by fiat money in a bank, but by other, more volatile cryptocurrencies locked in a smart contract.

The operational principle: a user deposits a volatile cryptocurrency (e.g., ETH) into a special smart contract as collateral and receives DAI tokens in return. To retrieve their collateral, they must repay the DAI. Essentially, DAI acts as a stablecoin-denominated loan.

The Decentralized Approach: Smart Contracts and Over-Collateralization

The key feature of DAI is the use of over-collateralization. To mint, for example, 100 DAI, a user must deposit collateral worth $150–200 in ETH. This is a necessary safety measure against a sharp drop in the ETH price. If the value of the collateral falls below a certain threshold, the smart contract automatically liquidates a portion of the collateral to protect DAI's stability. Thus, DAI provides decentralized stability managed not by people, but by immutable code.

Algorithmic Stablecoins: Balancing Supply and Demand Without Reserves

Algorithmic stablecoins represent an attempt to create the ideal decentralized stablecoin, which maintains its $1 peg purely through mathematics, without using real reserves or over-collateralization. The algorithm manages the coin's supply: if the price rises, it automatically mints and issues new tokens to drive the price down; if the price falls, it burns tokens to raise it.

The High-Risk Model: Why Algorithmic Stablecoins Fail to Hold the Peg

Despite their theoretical elegance, algorithmic stablecoins have proven to be extremely fragile in practice. Their stability critically depends on sustained market demand. In the event of a liquidity crisis or panic selling, the algorithm fails to cope, and the model rapidly collapses. The most dramatic example was the collapse of TerraUSD (UST), which, despite a $18 billion capitalization, lost its peg and crashed, demonstrating the extreme risk inherent in such models. Today, most experts consider this type of stablecoin too dangerous for mainstream adoption.

The Most Popular Stablecoins: Which to Choose and Why?

The stablecoin market is not limited to a single player. Understanding the key differences between market leaders is critical for making the right financial decision.

USDT (Tether): The Market Pioneer with Transparency Concerns

USDT is the absolute leader by market capitalization and dominates the space. It is the veritable "engine" of the crypto economy, providing liquidity for trading, international settlements, and hedging. Its advantages are undeniable—maximum liquidity, support on virtually every blockchain network, and enormous trading volume. However, USDT has long been criticized for insufficient transparency regarding the structure of its reserves and has faced regulatory scrutiny, leading some investors to question its reliability.

USDC (Circle): Highly Regulated and Regularly Audited

USDC holds the second position and positions itself as the most transparent and regulated stablecoin. Issued by the companies Circle and Coinbase, it operates under stringent oversight from US regulators. USDC regularly publishes detailed attestations regarding the structure of its reserves, which consist primarily of actual dollars and short-term US Treasury bills. For investors who prioritize legality, transparency, and regulation, USDC is often the preferred choice.

DAI: The Decentralized Crypto-Collateralized Alternative

DAI offers a unique, fully decentralized alternative. Governed by the MakerDAO community, it is completely transparent and does not rely on banks or government regulators. Its collateral consists of other cryptocurrencies, and the entire risk management system is built into the code. DAI is chosen by those who are fundamentally opposed to centralized control and trust mathematics and code, not corporations.

Other Options: TUSD, USDP—What Are the Differences?

Beyond the giants, other stablecoins exist that may hold local significance or serve specific niches. For instance, TUSD (TrueUSD) and USDP (Pax Dollar) are reliable and audited but have significantly lower liquidity and are not as widely available on global platforms. The choice should always depend on the required level of liquidity and the user's comfort level with centralized control.

Practical Applications: Where and How to Use Stablecoins?

Understanding how stablecoins have integrated into the financial landscape demonstrates their true value. They have become the indispensable foundation upon which much of the crypto market rests.

Capital Protection: "Parking" Funds During Market Downturns

During market turmoil, when volatility spikes, investors and traders use stablecoins as a "safe harbor." When the price of Bitcoin drops sharply, they quickly sell their volatile assets and convert them into stablecoins. This allows them to preserve the value of their capital, avoiding losses, and calmly wait for the market to bottom out before making a profitable reentry. This is essentially the fastest way to "park" funds in a stable currency directly within the crypto system.

Fast, Low-Cost Transfers: International Transactions Without Banks

Stablecoins have delivered a true revolution in international payments, offering a superior alternative to traditional and slow SWIFT transfers. While a bank wire can take several days and cost tens of dollars, a transfer of USDT or USDC is completed in seconds or minutes with minimal fees, operating 24/7. This has created massive opportunities for businesses, freelancers, and individuals, essentially providing everyone with the ability to own and operate a global, bankless dollar account.

Exchange Trading: The Primary Trading Pair for Crypto Assets

Look at any major crypto exchange: the vast majority of trading pairs (BTC/USDT, ETH/USDC, etc.) are pegged to stablecoins. This is because traders require a stable asset that does not change in value to serve as a reliable benchmark. Stablecoins act as the liquid "digital dollar," providing a constant and dependable base for all trading operations and forming the market's core liquidity.

The DeFi Ecosystem: Lending, Borrowing, and Yield Farming

The decentralized finance (DeFi) sector could not exist without stablecoins. They are the heart of DeFi, providing the predictability required for complex financial operations. Users can lend stablecoins, borrow against other crypto assets, and participate in liquidity pools. Thanks to their stability, the risk of collateral liquidation is reduced, and the yield generated from stablecoins on protocols becomes more predictable and attractive.

The Full Risk Map: What Can Go Wrong?

Despite their stability, stablecoins are not risk-free assets. They are subject to specific dangers that vary depending on their collateral model.

Issuer Risk: Bankruptcy or Mismanagement (The Case of Tether)

For fiat-backed stablecoins like USDT, the primary risk lies in their centralization. The user must fully trust the issuing company that controls the reserves and mints the tokens. If the company mismanages the assets by investing them in risky instruments, or faces severe legal challenges, the stablecoin risks losing its peg to the dollar. The history of Tether, which has repeatedly faced criticism over the lack of reserve transparency, serves as a constant reminder of this risk.

Regulatory Risk: State Bans and Restrictions

Stablecoins operate at the intersection of two worlds, attracting the attention of government regulators globally. Governments may impose restrictions on their issuance, demand stringent user verification (KYC), or, in extreme cases, completely prohibit their use within their jurisdiction. Such regulatory pressure can quickly destabilize even a large stablecoin, as seen with BUSD, which was forced to cease issuance due to claims from US authorities.

Technical Risk: The De-Peg Event and Its Aftermath

A "de-peg" is a situation where the stablecoin's price temporarily or permanently deviates from its target value of $1. This can occur for many reasons: from mass panic and sell-offs to technical failures or problems with the reserve-holding banks. In March 2023, for example, USDC temporarily dropped to $0.88 when problems with a key banking partner holding some of its reserves became known. Restoring the peg requires immediate and decisive action, and for many smaller projects, a de-peg proves fatal.

Historical Caution: The Collapse of the Algorithmic Stablecoin UST (Terra)

The most instructive and tragic story in the stablecoin world was the collapse of the algorithmic UST in May 2022. This stablecoin, which lacked real-world backing, relied entirely on a complex mechanism linked to its sister coin, LUNA. When panic selling began, the algorithm could not maintain equilibrium. The peg was lost, and UST crashed virtually to zero within two days, wiping out over $40 billion in investor capital. This case proved definitively that **algorithms without robust collateral cannot withstand a real market storm.**

Debunking the Myths: Stablecoin Truths and Misconceptions

Like any new financial instrument, stablecoins are surrounded by numerous misconceptions and myths that need to be dispelled.

"They Are Not Real Cryptocurrency"—Why This Is False

Some crypto enthusiasts tend to consider stablecoins an incomplete cryptocurrency because they do not aim for price growth and are often issued by centralized entities. However, this is a misconception. Stablecoins function on a blockchain, use smart contracts, and enable peer-to-peer transactions without intermediaries. They possess all the technical characteristics of a cryptocurrency, but their purpose is not speculation but to provide **price stability** within the ecosystem. Their goal is to be a stable medium of exchange, not an investment asset.

"They Are Completely Safe"—A Dangerous Delusion

Stablecoins are certainly much more stable than Bitcoin or Ethereum, but this does not equate to absolute safety. As we have seen, they are susceptible to a range of risks: from smart contract code bugs and liquidity issues to issuer bankruptcy risk or regulatory pressure. Using stablecoins requires a conscious choice and understanding of which type of collateral (fiat-backed, crypto-backed, or algorithmic) you are willing to trust.

"They Are Only Used for Money Laundering"—Statistics vs. Myth

This myth is often propagated by critics of cryptocurrency. In reality, the vast majority of stablecoin transactions are legitimate. According to analytics data, the share of illicit stablecoin operations accounts for less than 1% of the total volume, a figure often lower than the percentage of suspicious transactions in the traditional banking sector. Stablecoins are vital for international settlements, trading, and protecting savings in unstable economies.

The Future of Stablecoins: Central Bank Digital Currencies (CBDC)

The emergence of stablecoins and their rapid success as "digital dollars" has not gone unnoticed by governments. Central banks worldwide have recognized the need to modernize their monetary systems, leading to the development of their own digital currencies—CBDCs (Central Bank Digital Currencies), such as the digital yuan or e-Euro.

Competition or Coexistence: Stablecoins vs. State Digital Currencies

CBDCs are essentially electronic money issued and fully controlled by the central bank. Unlike private stablecoins, which are designed for global payments and DeFi, CBDCs are primarily intended for the domestic economy and are under complete state control. In this race, private stablecoins are likely to retain their dominant role in two key areas: in decentralized finance, where freedom from government control is paramount, and in international cross-border payments, where state currencies often face jurisdictional barriers.

Development Trends: Greater Transparency and TradFi Integration

The future of stablecoins is shaped by several key trends. Firstly, there will be increased transparency of reserves: major issuers will be compelled to provide detailed and regularly audited reports on their assets. Secondly, we anticipate deeper **integration with traditional financial institutions**, where stablecoins will be utilized by banks and funds. Finally, the share of reliable, decentralized stablecoins, resilient to centralized risks, will grow, allowing the market to move away from fragile algorithmic models.

Conclusion: Stablecoins as the Foundation of the Digital Economy

Stablecoins are not just another type of cryptocurrency; they are the essential component that built the critical bridge between the traditional world of finance and blockchain innovation. They brought predictability and reliability to the crypto space, without which the mass adoption of digital assets would be impossible.

Summary: When to Use Stablecoins and Which Type to Choose

Stablecoins become indispensable when your goals are not speculative growth but rather these key factors:

• You need capital stability to avoid market volatility.

• High speed and low cost are required for international transfers.

• You plan to actively participate in decentralized financial instruments (DeFi).

The choice of type must be conscious: for maximum liquidity and regulatory clarity, **USDC** is preferred; for the broadest market reach, **USDT**; and for those who value decentralization above all, **DAI**.

The Golden Rule: Trust, But Verify Reserves and Audits

The most crucial difference between a stablecoin and Bitcoin is that stablecoins require a degree of trust—in the issuer, the smart contract, or the algorithm. To minimize risks, always follow this golden rule:

• Study the reserve structure: what are they backed by, and how liquid are they?

• Verify the independent audits and reports of the issuing company.

• Avoid new, untested, and especially algorithmic projects.

• Diversify your holdings; do not concentrate all funds in a single stablecoin.

Stablecoins are a powerful tool, not a cure-all. Use them wisely, understanding all the associated risks and benefits.