As modern finance becomes more and more digital, many consumers wonder if cryptocurrencies could take the place of traditional currencies. However, most cryptocurrencies are still too volatile for everyday use. Prices for Bitcoin and Ethereum can rise and fall drastically in minutes, making them unreliable for payments or savings.
Stablecoins were created to address this problem. They are a digital asset designed to provide users with the benefits of digital money without the wild price swings of cryptocurrencies. Understanding stablecoins is essential if you want to use a digital currency for everyday payments and savings.
We’ve created this guide at Remitly to explain what stablecoins are, how they work, the different types available, and why they matter in today’s digital economy. Whether you’re new to crypto or just curious, read on to learn the basics of stablecoin.
What is a stablecoin, exactly?
A stablecoin is a type of cryptocurrency that maintains a steady value by being pegged to another currency, such as the US dollar, the Euro, or even gold. Its main purpose is to stay stable and avoid the price swings that coins like Bitcoin and Ethereum often experience. For example, a stablecoin linked to the US dollar is generally worth $1 at all times.
Think of it like a casino chip. You exchange your cash for a chip that keeps a fixed value, making it easy to spend. Stablecoins work the same way in the digital world, giving you a simple and predictable way to use, store, and send money online.
How do stablecoins stay stable?
To remain stable, stablecoins use different backing methods that work like safety nets, helping them keep a steady value even when the crypto market fluctuates.
Here’s a simple breakdown of the four main types of stablecoins and how each one stays stable:
Fiat-collateralized stablecoins
These are the most common stablecoins. Each is backed by an equal amount of traditional or fiat currency, like the US dollar, kept safely in a bank account. This means that for every stablecoin in circulation, there’s a matching dollar (or another fiat currency) set aside to support it.
So when you use fiat-collateralized stablecoins, you can trust each coin is backed one-to-one with real-world currency. Popular examples include Tether (USDT), issued by Tether Limited, and USD Coin (USDC), created by Circle and Coinbase.
Crypto-collateralized stablecoins
Instead of being backed by cash, these stablecoins are supported by other cryptocurrencies. Because crypto prices can swing quickly, these stablecoins use extra collateral to keep their value steady.
This means you may need to lock up more crypto than the actual value of the stablecoins you want to create. For example, you might deposit $200 worth of cryptocurrency to mint $100 worth of a stablecoin like Dai. The extra collateral acts as a buffer, helping the stablecoin stay stable even if the crypto used as backing drops in price.
Commodity-collateralized stablecoins
These stablecoins are backed by real-world assets like gold, silver, or oil. Each coin represents a claim to a specific amount of that commodity, allowing you to benefit from its value without having to store anything physically.
Stablecoins like Paxos Gold (PAXG) give you digital ownership of gold, with each coin linked to one gram of real gold held in a secure vault. This backing gives the stablecoin true value, appealing to those who want a safer, traditional asset in digital form. It’s a simple way to get exposure to commodities without the hassle of handling them yourself.
Algorithmic stablecoins
Algorithmic stablecoins work differently because they aren’t backed by assets. Instead, they use smart contracts—automated programs on a blockchain—to control the coin’s supply. If the price goes above the target value, the system creates more coins to bring it down. If it drops below the target, the supply shrinks to push the price back up.
This fully automated approach is innovative, but also riskier. A well-known example is TerraUSD (UST), which collapsed in 2022 after losing its dollar peg and caused large losses for users. This shows that while algorithmic stablecoins can be creative solutions, their stability depends entirely on the algorithm performing as expected.
Why do people use stablecoins?
Before we discuss the risks, let’s take a closer look at how people use stablecoins.
A safe haven from crypto volatility
Stablecoins give investors a way to protect their money during market swings. For example, if you hold Bitcoin and see the price dropping, you can convert it into USDC or USDT to preserve value without leaving the crypto ecosystem. This keeps funds accessible for future trades or investments without having to cash out in dollars.
Everyday transactions
Stablecoins are increasingly used for daily payments and peer-to-peer transfers. Imagine paying a friend back for lunch while traveling abroad. Sending USDC can be faster and cheaper than traditional bank transfers. Some online merchants, like Travala.com and Shopify, also accept stablecoins, which reduces reliance on credit cards and high processing fees.
Accessing Decentralized Finance (DeFi)
Stablecoins play a key role in DeFi because their stable value makes financial planning safer. You can lend Dai on a DeFi platform and earn interest without worrying about sudden price drops. They’re also used as collateral to borrow other cryptocurrencies, giving you more control over their digital assets.
Hedging against inflation
In countries where local currencies lose value quickly, stablecoins can serve as a hedge against inflation. For example, if you’re in Mexico, you can convert pesos into a USD-backed stablecoin to protect savings from high inflation. This helps maintain purchasing power and safeguard long-term funds without relying entirely on banks.
Simplifying cross-border commerce
Stablecoins are also an attractive choice for businesses involved in international money transfers. For example, if you’re a designer in the Philippines, you could receive USDT from a US client within minutes, avoiding bank fees and long transfer times. This streamlines global transactions and makes commerce more efficient.
Supporting smart contract applications
Stablecoins are ideal for automated blockchain transactions that need a predictable value. For example, on a decentralized insurance platform, you can set payments in USDC so the recipients get a fixed amount regardless of market swings.
You can also use stablecoins for recurring subscriptions or escrow services, ensuring reliable and smooth executions of agreements.
What are the risks and concerns?
Stablecoins bring stability and convenience to the crypto world, but they come with certain risks:
- Transparency of reserves: Users need to be sure that there is actually enough currency backing the stablecoins. Independent audits can help prove that reserves actually exist and each coin is fully supported.
- De-pegging risk: Even stablecoins can temporarily lose their value, especially during market turbulence. For example, an algorithmic or crypto-backed stablecoin might drop below its target if many people sell at once or if the backing assets lose value.
- Regulatory scrutiny: Governments and financial authorities are closely watching stablecoins. New rules could affect how they’re issued, traded, or used, and might require stricter reporting.
- Counterparty risk: Holding a stable coin requires that you trust the issuer, or, in some cases, a smart contract, to manage the system responsibly. If the issuer goes bankrupt or a smart contract malfunctions, you could lose some or all of your digital currency holdings.
- Limited adoption and liquidity: Not all stablecoins are widely accepted. Some may not be available on major exchanges or might have low trading volumes, making it harder to convert them into cash or other cryptocurrencies.
A stable bridge to the future
Stablecoins help solve the crypto volatility problem that makes many cryptocurrencies hard to use. They’re tied to assets like the US dollar, gold, or even other cryptocurrencies. This helps maintain a predictable value that users can trust. They make it easier to avoid sudden price swings, store value, and join the digital finance world with confidence.
By being a stable digital asset, stablecoins enable fast, low-cost transactions and power major parts of the DeFi ecosystem, including lending, borrowing, and trading. While they still come with risks, stablecoins serve as an important bridge between traditional finance and digital assets, keeping things more predictable.
FAQs
Is stablecoin a good investment?
Stablecoins aren’t meant to grow in value like regular investments. Their main purpose is to stay at a steady price, which makes them useful for transactions or short-term storage of money. If you’re hoping for long-term growth, other cryptocurrencies or investment options may be a better fit.
Is Bitcoin a stablecoin?
No, Bitcoin is not a stablecoin. Its price moves up and down based on market supply and demand, which makes it more volatile. Stablecoins are designed to stay at a consistent value, giving users more predictability.
Are stablecoins safe?
The safety of a stablecoin depends on how it’s backed. Stablecoins supported by real-world assets and issued by trusted companies are usually considered more secure. Algorithmic stablecoins can be riskier because they depend entirely on code and market behavior. Be sure to research the issuer and understand what supports the coin.
Where can I buy stablecoins?
You can buy popular stablecoins like USDT and USDC on most major cryptocurrency exchanges, such as Coinbase, Binance, and Kraken. Some crypto wallets and payment apps also let you purchase them directly. Just be sure to use a secure platform and check fees before buying.
Can stablecoins be used internationally?
Yes, stablecoins can be sent across borders almost instantly and often with much lower fees than traditional banks. They’re especially helpful for international payments and remittances, making them a practical option for anyone dealing with multiple currencies.
Do stablecoins earn interest?
Some stablecoins can earn interest when you use them on lending platforms or certain DeFi apps. The interest rate depends on the platform and the specific stablecoin you choose. Be sure to read the terms carefully and understand the risks before depositing your coins to earn interest.