What is a stablecoin?

Stablecoins have become one of the most important pillars of the digital asset ecosystem. In a market where Bitcoin can lose or gain 10% in a matter of hours, the idea of ​​a cryptocurrency that maintains a predictable value was revolutionary from the start.

Today, with the MiCA (Markets in Crypto-Assets) regulation fully implemented in the European Union since 2024, this type of asset also faces a regulatory framework that is redefining who can issue them and under what conditions.

In this article you will find a complete explanation of what a stablecoin is, how its stabilization mechanism works, the different types that exist, their real uses in the crypto ecosystem and the risks that any user should know before using them.

What is a stablecoin?

A stablecoin is a cryptocurrency designed to maintain a stable value over time. Unlike Bitcoin or Ethereum, whose price fluctuates according to market supply and demand, stablecoins peg their value to an external reference asset. usually a fiat currency such as the US dollar or the euro, although they can also be linked to commodities such as gold.

The central idea is to preserve the advantages of digital assets—fast, direct transactions accessible from anywhere in the world—while eliminating the main barrier to adoption in the crypto ecosystem: volatility. A merchant who accepts Bitcoin payments risks losing 15% of their payment the next day. With a dollar-denominated stablecoin, that risk disappears.

The mechanism for achieving this stability varies depending on the type of stablecoin. In the simplest models, each issued token is backed by an equivalent unit of the underlying asset, held in custody by a central entity. In more sophisticated models, stability is achieved through crypto collateral or algorithms that automatically adjust the number of tokens in circulation.

Why were stablecoins created?

The origin of stablecoins is directly linked to the problem of volatility in cryptocurrency markets. From the early years of Bitcoin, it became clear that an asset whose price can multiply or halve tenfold in a matter of months makes it difficult to use as a means of payment or as a predictable store of value.

This volatility has multiple causes: the speculative nature of many market participants, the relative immaturity of the ecosystem, the initial lack of regulation, and the sensitivity of prices to macroeconomic news or events. Stablecoins emerged as a practical response to this problem, allowing users and businesses to operate within the blockchain ecosystem without direct exposure to these fluctuations.

The founder of MakerDAO (now Sky MoneyRune Christensen expressed it clearly in the early years of the protocol: "The real key to unlocking the full potential of blockchain will come with the widespread adoption of stablecoins." Years later, his analysis has proven correct: without stablecoins, the DeFi protocols that move hundreds of billions of dollars in liquidity would not exist in their current form.

Types of stablecoins according to their backing mechanism

Not all stablecoins work the same way. The fundamental difference lies in how each project ensures that the token's value remains stable. There are four main categories.

Backed by fiat currency

This is the most widespread model and, in principle, the easiest to understand. Each token issued is backed by an equivalent amount of fiat currency—usually dollars—held in a bank account or by a regulated custodian. The backing ratio is typically 1:1: for every USDC in circulation, Circle maintains one dollar in auditable reserves.

The most relevant examples of this type are USDC (issued by Circle), Tether (USDT), and EURC (also from Circle, denominated in euros). Within the European ecosystem, EURR and EURC are significant as euro-denominated stablecoins under MiCA regulation. The fiat-based model offers simplicity and transparency when audits are conducted properly, but it implies a point of centralization: the issuer must be trustworthy and must maintain the reserves it declares.

One structural limitation is that, by relying on a central entity, these stablecoins inherit the risks of the traditional financial system. If the issuer faces liquidity or regulatory problems, the peg can be compromised.

Backed by other crypto assets

This model replaces fiat currency reserves with crypto assets like ETH or other tokens from the blockchain ecosystem. The goal is to maintain the advantages of decentralization without relying on traditional financial institutions, but the challenge is clear: collateral is also volatile. The usual solution is overcollateralization. If a stablecoin is backed by ETH in a 1:2 ratio, it can absorb significant drops in the price of Ethereum without losing its peg to the dollar. MakerDAO's DAI protocol, one of the most established examples of this model, allows users to deposit ETH and other approved assets as collateral to generate DAI, always maintaining a collateralization ratio above 100%. Most stablecoins operating under this scheme are ERC-20 tokens from the Ethereum ecosystem.

Management complexity is greater than in the fiat model, and in extreme market conditions —sudden and rapid drops in collateral— the liquidation mechanisms must function precisely to prevent the system from losing its anchor.

Backed by raw materials

Some stablecoins peg their value not to fiat currencies but to commodities: gold, silver, or oil are the most common examples. They function similarly to the fiat model: each token represents a specific quantity of the physical asset, which must be held in custody and auditable by an independent third party.

Digix Gold (DGX) is one of the most frequently cited historical examples, where each DGX token was equivalent to one gram of physical gold stored in audited ingots. This model is particularly attractive to those seeking exposure to commodities within the blockchain ecosystem, without the logistical costs of the physical market. The main limitation is liquidity: the markets for these stablecoins tend to be less deep than those for USDC or USDT.

Algorithmic stablecoins

The fourth model is the most conceptually ambitious and has attracted the most attention, both for its innovation and its failures. Algorithmic stablecoins are not directly backed by any external asset; instead, they use smart contracts and economic incentive mechanisms to automatically adjust the token supply according to demand, seeking to maintain parity with the reference asset.

The principle is similar to that used by central banks to manage the money supply, but executed through code on a public blockchain. When the token price rises above parity, the protocol issues new tokens to increase the supply and lower the price. When it falls, token buyback or burn mechanisms reduce the supply to restore value.

The collapse of TerraUSD (UST) in May 2022—which wiped out over $40.000 billion in market capitalization in a matter of days—highlighted the systemic risks of this model when the stabilization mechanism cannot absorb massive liquidity outflows. The most relevant lesson is that trust in the algorithmic model is, in itself, part of the collateral: if that trust collapses, the system can enter a self-destructive spiral. Projects like Ampleforth and Frax Protocol continue to explore variations of this model with more conservative or hybrid designs.

Public stablecoins and CBDCs

Alongside private stablecoins issued by companies, another category has gained prominence: central bank digital currencies, known as CBDCs. These are issued or overseen directly by central banks and represent the digital version of the issuing country's official currency.

Unlike private stablecoins, a CBDC has direct state backing and is legal tender. The European Central Bank has been developing the digital euro project for years, with plans to enter a more advanced phase between 2026 and 2028. Its aim is to complement physical cash, not replace it, and to offer European citizens a sovereign digital means of payment.

The distinction between private stablecoins and CBDCs matters because their implications are different. A CBDC implies greater central bank control over monetary flows and potential transaction oversight. A private stablecoin like USDC operates more independently but assumes the operational and credit risks of its issuer. The MiCA framework in the European Union has stipulated that euro-denominated stablecoins with widespread circulation must meet reserve requirements, undergo audits, and obtain a credit institution or electronic money license, which is forcing consolidation in the sector.

Real-world use cases for stablecoins

Preserving value in volatile markets

The most immediate use of stablecoins is to offer a safe haven within the crypto ecosystem itself. When a user anticipates a market correction, they can move their digital assets to USDC or USDT without having to go through the traditional banking system or incur the time and costs of a fiat transfer. Trading on the blockchain with stablecoins allows for agile movement between positions without leaving the ecosystem.

International payments and remittances

Stablecoins eliminate friction in cross-border payments. Sending USDC anywhere in the world takes seconds and costs fractions of a cent on networks like Solana or Ethereum Layer 2 networks.

In comparison, an international bank transfer can take between one and five business days and incur fees of between 2% and 7% of the amount. For emerging markets where the local currency suffers from severe inflation—Argentina, Venezuela, Nigeria—dollar-denominated stablecoins have become a practical and accessible savings mechanism that doesn't require a foreign bank account.

DeFi and liquidity protocols

DeFi (Decentralized Finance) protocols are likely the biggest consumers of stablecoins in the ecosystem. Decentralized exchanges (DEXs) use liquidity pools where stablecoins are an essential component: they allow users to trade digital assets without a centralized counterparty. Lending protocols like Aave or Compound allow users to contribute USDC or DAI as collateral to borrow other assets, or to lend their stablecoins to other users in exchange for staking rewards.

According to DefiLlama data (May 2025), the total value locked (TVL) in DeFi protocols exceeds $90.000 billion, with stablecoins representing a significant portion of the available liquidity. Without stable assets serving as a common denominator, DeFi markets would be significantly less efficient.

International trade and supply chains

Beyond the crypto ecosystem, stablecoins have applications in international trade. B2B transactions between companies in different countries can be settled in stablecoins, eliminating banking intermediaries, reducing currency conversion costs, and shortening settlement times from days to minutes.

Pilot projects with stablecoins are being tested in supply chains to guarantee automatic payments when agreed conditions are met through smart contracts, without the need for manual processing.

Stablecoins, the bridge the crypto ecosystem needed

Stablecoins aren't the perfect solution to the volatility of the digital asset ecosystem, but they represent the most efficient compromise the industry has found to date. They've enabled DeFi to reach real scale, made international payments more efficient for millions of people, and allowed users in high-inflation economies to access a digital store of value with minimal barriers to entry.

The challenge in the coming years is not technical but regulatory and related to trust. MiCA is redefining who can issue stablecoins in Europe and under what conditions, and this consolidation process will be crucial in determining which current players will continue operating in the European market in the medium term.

For any user who wants to understand the crypto ecosystem in depth, understanding how stablecoins work is an essential starting point: they are the silent infrastructure on which much of what makes this ecosystem interesting is built.

If you want to explore how stablecoins are integrated into protocols DeFiThe next natural step is to understand what the staking and the liquid stakingor delve deeper into how MakerDAO works and its decentralized collateralization model.

FAQ – What is a stablecoin?