Stablecoin

A stablecoin is a digital token that runs on a blockchain like other cryptocurrency but is engineered to track the value of a reference asset, overwhelmingly the U.S. dollar. The point is stability: a token worth a reliable $1 can settle payments, move money between crypto platforms, and serve as a holding place between trades, roles that a highly volatile coin cannot fill. How a given stablecoin tries to hold its value, and what actually stands behind it, varies enormously from one token to the next.

Stablecoins fall into three broad designs, and the differences matter for how much trust the peg deserves.

Fiat-backed stablecoins are the largest category. The issuer holds reserves of cash and short-term U.S. Treasuries and promises that each token is redeemable for one dollar. Their credibility rests entirely on whether the reserves are real, liquid, and actually equal to the tokens in circulation, which is why reserve composition and independent attestation are the central questions.

Crypto-collateralized stablecoins are backed by other cryptocurrency locked in a smart contract, and because that collateral is itself volatile, the system is deliberately over-collateralized: it may hold $150 of crypto behind every $100 of stablecoin so the peg survives a price drop. If the collateral falls fast enough, the contract sells it automatically to defend the peg.

Algorithmic stablecoins hold little or no reserves and instead try to hold the peg by expanding and contracting token supply through software rules. This design has the worst track record: the 2022 collapse of TerraUSD, an algorithmic stablecoin that lost its peg and fell to near zero in days, erased tens of billions of dollars and is the standing example of why "stable" describes an intention rather than a guarantee.

The U.S. legal picture changed in 2025. The GENIUS Act (Public Law 119-27), signed July 18, 2025, is the first federal law governing payment stablecoins. It limits who may issue them, requires issuers to hold reserves backing the tokens at least one-for-one in liquid assets such as U.S. dollars and short-term Treasuries, requires monthly public disclosure of reserve composition, applies Bank Secrecy Act anti-money-laundering rules, restricts marketing that would imply government backing or federal deposit insurance, and gives holders a priority claim if the issuer fails. Section 4(a)(11) bars a payment stablecoin issuer from paying holders any interest or yield simply for holding the token, so a stablecoin under this framework is a payment instrument, not an income-earning deposit. A stablecoin is not a bank deposit and carries no FDIC insurance regardless of how it is marketed.

A fiat-backed stablecoin works as a claim on reserves. You send dollars to the issuer (directly or through an exchange), the issuer mints an equal number of tokens, and you can later redeem tokens for dollars, which retires them. The market price stays near $1 because anyone can, in principle, arbitrage a gap: if the token trades at $0.99, buyers profit by purchasing it and redeeming for a full dollar, and that buying pushes the price back up.

The mechanism only holds while redemption is trusted. Consider a hypothetical holder with 5,000 tokens of a stablecoin pegged to $1, a nominal $5,000. If news breaks that the issuer's reserves are questionable and panicked selling drives the token to $0.92, that balance is momentarily worth 5,000 times $0.92, or $4,600. If the reserves turn out to be real and redemption resumes, the price returns toward $1; if they do not, the loss is permanent. That gap between "pegged to a dollar" and "worth a dollar right now" is the entire risk of the instrument.

Pros

• Holds a predictable value, which makes it usable for payments and for parking funds between crypto trades without exposure to crypto price swings.
• Settles quickly and around the clock on a blockchain, without waiting for bank hours or clearing days.
• Under the GENIUS Act framework, a compliant payment stablecoin must be fully reserved and disclose its reserves monthly, which is far more transparency than earlier stablecoins offered.

Cons

• The peg can break. A stablecoin can trade below its target, and an under-reserved or algorithmic one can fail outright, as TerraUSD did.
• It is not FDIC-insured and is not a bank deposit, so a failed issuer is a credit loss, not a covered claim.
• Compliant payment stablecoins pay no interest to the holder, so idle balances earn nothing while inflation erodes them.
• Redemption at par depends on the issuer honoring it; in a panic the ability to sell at $1 is exactly what disappears.