Cryptocurrencies are known above all for the fact that their value can rise and fall dramatically. Bitcoin or Ethereum can change price by several percent within a single day, and during periods of heightened volatility the swings can be even more pronounced.

That is precisely why it may seem a little strange at first glance that one of the most important parts of the crypto world has become assets whose main goal is exactly the opposite.

Not changing their value.

What does the crypto world actually need an asset for, whose price is not supposed to change significantly?

If we want to use the blockchain not only for speculating on price growth but also for transferring money, trading, payments, or other financial services, we also need something within it that will function as a relatively stable unit of account.

It is exactly this role that stablecoins have started to fill.

A stablecoin is a digital token whose value tries to mirror the value of another asset. Most often this is the US dollar, so one token is meant to be worth approximately one dollar. However, there are also stablecoins pegged to the euro, gold, or other values.

This gave rise to something very interesting. An asset that uses blockchain infrastructure similarly to Bitcoin or Ethereum, but that tries to behave, price-wise, more like traditional money.

Stablecoins have thus gradually become one of the most prominent bridges between the traditional financial system and the world of cryptocurrencies.

Why stablecoins came into being

Bitcoin showed that value could be transferred over the internet without a bank or other central payment institution. Ethereum expanded on this idea with smart contracts and the ability to create entire financial applications.

One practical problem remained, however.

The price of the cryptocurrencies themselves keeps changing.

Imagine we want to pay someone the equivalent of 1,000 dollars via the blockchain. If we use an asset whose price can rise or fall significantly within a few hours, a simple question arises: how much are we actually sending?

The same problem arises with trading. An investor might, for example, sell Bitcoin because they don't want to be exposed to its price movements for a certain period. But if they had to convert the funds back into regular dollars through the banking system every single time, part of the benefit of blockchain infrastructure would lose its point.

A stablecoin makes it possible to stay within the crypto environment. An investor can sell Bitcoin for a token pegged to the US dollar and then hold that token in a wallet, transfer it to another platform, use it in decentralized finance, or send it to someone else.

Stablecoins thus solved one of the practical problems of the crypto market: how to get a relatively stable value directly onto the blockchain.

What a stablecoin is and what its "stability" means

A stablecoin is a type of crypto asset designed to maintain its value against a certain reference value.

The simplest example is a stablecoin pegged to the US dollar.

If everything works correctly:

1 token ≈ 1 US dollar.

The approximately sign is important here.

A stablecoin is commonly traded on the market just like other cryptocurrencies. Its price therefore doesn't have to be exactly one dollar every single second. It can move slightly above or below this value in the short term.

The goal of a stablecoin's mechanism is for the price to return to the reference value.

This relationship is called a peg, meaning a price anchor. If a dollar-pegged stablecoin trades at approximately one dollar, we say it is holding its peg.

If the price starts to drift away significantly, we talk about a depeg.

And this is exactly where one important thing needs to be emphasized:

The word "stable" does not mean "safe."

It only means that the given token uses a certain mechanism that tries to keep its value stable. Whether this mechanism actually works, and what risks lie beneath it, is a different question.

How the value of one dollar is maintained

In the classic stablecoin model, stability rests above all on reserves, the possibility of redemption, and how the market functions.

Let's imagine a simplified stablecoin called USDX.

The issuer receives 1,000 dollars from a client and, against this, creates 1,000 USDX tokens. The dollar value stays in reserves, and the tokens can start circulating on the blockchain.

If the client later returns the tokens to the issuer and meets the conditions for direct redemption, they can get the corresponding dollar value back.

Arbitrage also plays an important role.

If, for example, a stablecoin trades at 0.98 dollars while it can be redeemed under set conditions for one dollar, there is an incentive to buy the token cheaply and then redeem it at a higher value. This increases demand, and the price is pushed back toward one dollar.

The same principle can work in reverse if the stablecoin trades above one dollar.

The key point to understand, then, is that a stablecoin doesn't hold its value just because "1 USD" is written on it. There has to be an economic or technological mechanism behind it that motivates the market to respect that value.

Not all stablecoins work the same way

This brings us to one of the most important points.

Two tokens can both claim their value is meant to be one dollar, yet still function in completely different ways.

The difference lies above all in the answer to the question:

What actually holds their value?

Stablecoins backed by traditional assets

The best-known model is stablecoins backed by a specific issuer and reserve assets.

This group includes, for example, USDC, issued by the company Circle, or USDT, issued by the company Tether.

The principle is fairly simple. Against the tokens in circulation there are reserves that are meant to allow them to be redeemed for the reference currency under set conditions.

These reserves don't have to consist only of cash. They can include, for example, bank deposits, short-term government bonds, or other highly liquid financial instruments.

The user is therefore not relying primarily on an algorithm, but on the issuer and the quality of the reserves standing behind the token.

The advantage of this model is its relative clarity and its ability to connect blockchain infrastructure with assets from the traditional financial system.

The disadvantage is that a central institution re-enters the blockchain environment. The network itself may be decentralized, but the stablecoin doesn't have to be.

The user has to trust that the issuer really does hold the corresponding reserves, that these reserves are sufficiently high-quality and liquid, and that the issuer will be able to meet its obligations.

Stablecoins like USDC and USDT thus illustrate well that the blockchain can change the role of intermediaries, but doesn't always eliminate them entirely.

Stablecoins backed by cryptocurrencies

Another model is stablecoins whose backing doesn't sit in the issuer's bank account, but directly on the blockchain.

The user deposits cryptocurrencies into a smart contract, and against this collateral, stablecoins can be created.

Because the value of cryptocurrencies fluctuates, over-collateralization is often used.

In simplified terms, it may be necessary to deposit, say, 150 dollars' worth of cryptocurrency in order to create 100 dollars' worth of stablecoins.

If the price of the collateral falls too much, the system can automatically liquidate part of the position.

The advantage is less dependence on a single company. The disadvantage is greater technological complexity and the risk tied to the collateral, the smart contracts, or the blockchain itself.

Algorithmic stablecoins

The third group is algorithmic stablecoins.

These try to hold a stable price without a classic full reserve of traditional assets. Instead, they use algorithms, supply changes, economic incentives, or a relationship with another token.

On paper, this model can look very elegant.

The problem arises the moment the mechanism stops working or loses the market's trust.

And that is exactly what the TerraUSD case demonstrated.

Basic types of stablecoins

Backed by traditional assets

What helps hold its value: Reserves in cash, bank deposits, or other liquid assets
Main risk: The issuer, and the quality and availability of reserves
Example: USDC, USDT

Backed by cryptocurrencies

What helps hold its value: Crypto collateral locked in smart contracts
Main risk: A drop in collateral value, liquidations, and technological risk
Example: Crypto-collateralized stablecoins

Algorithmic

What helps hold its value: Algorithms, supply changes, and economic incentives
Main risk: Loss of trust and failure of the stabilization mechanism
Example: TerraUSD (historical example)

The same market price can therefore be the result of a completely different mechanism. That is exactly why, when comparing stablecoins, it's important to look not just at their peg, but also at the way they try to maintain it.

Case study: TerraUSD - when stability falls apart

TerraUSD, known by the ticker UST, was an algorithmic stablecoin pegged to the US dollar.

Its stability was linked to a second token of the Terra network, the cryptocurrency LUNA. The system allowed 1 UST to be exchanged for LUNA worth one dollar, and vice versa.

If, for example, the price of UST fell below one dollar, a trader could buy UST cheaply and then exchange it in the system for LUNA worth one dollar. This mechanism was meant to create an economic incentive to push the price of UST back toward its peg.

As long as the market believed that LUNA had sufficient value and that the whole system would keep working, UST managed to hold near one dollar.

In May 2022, however, the situation reversed, and UST began losing its peg.

People started dumping UST, and the system responded by minting more LUNA tokens, whose price was simultaneously crashing.

The more LUNA that was created, the lower its value fell. And the lower its value fell, the less the market trusted that it could stabilize UST.

This is how the so-called death spiral came about.

Within a few days, the entire system essentially collapsed, and tens of billions of dollars in value vanished from the market.

The TerraUSD case demonstrated one fundamental thing:

It's not enough to know that something is a stablecoin. You need to know why it's supposed to be stable.

Two tokens can show roughly the same price on screen, but behind that price there can be completely different mechanisms and completely different risks.

What stablecoins are used for

Stablecoins originally gained importance mainly as a tool for crypto trading.

Today their use is considerably broader.

Trading

An investor can sell Bitcoin, Ethereum, or another cryptocurrency into a stablecoin without having to immediately transfer funds back to a bank account.

A stablecoin thus functions as a relatively stable unit between individual trades.

Transfers

Stablecoins can be transferred via the blockchain between wallets and supported platforms.

This makes it possible to move value without having to go through the traditional banking system with every single transfer.

International payments

The blockchain makes it possible to transfer a stablecoin between users regardless of where they are located.

This doesn't automatically mean that every such transfer is cheaper or faster than a traditional bank payment. It depends on the specific network, fees, and provider.

Stablecoins have, however, created a new way to move dollar or euro value digitally and around the clock.

DeFi

Stablecoins are one of the basic building blocks of decentralized finance.

They are used in asset swaps, lending, borrowing, or liquidity management. Their importance lies precisely in the fact that they create a relatively stable unit of account within an environment where most other assets fluctuate significantly.

Payments

More and more payment companies and fintech services are exploring the use of stablecoins for everyday payments and transaction settlement.

In such cases, the user may no longer even perceive the stablecoin as a cryptocurrency. It can function purely as a technological layer in the background.

This is exactly where the worlds of cryptocurrencies and traditional payments are gradually starting to connect.

A stablecoin is not the same as money in an account

If we have 1,000 dollars in a bank account and hold 1,000 USDC alongside it, an app might show almost the same value.

Legally and technologically, however, these are not the same thing.

Money in a bank account represents a claim against the bank, and in the European Union, eligible bank deposits are typically covered by a deposit insurance scheme up to a set limit.

A stablecoin, by contrast, is a digital token.

Its properties depend on the issuer, the reserves, the legal regime, and the specific construction.

With some stablecoins, there is a right to redemption against the issuer. With others, stability works through crypto collateral or an algorithm.

In simplified terms:

1 dollar in a bank account and a stablecoin worth one dollar on the market may have the same price, but they are not the same asset.

A stablecoin is not a CBDC

Another term that is often confused with stablecoins is CBDC, or Central Bank Digital Currency, meaning a central bank's digital currency.

The difference is fundamental.

A stablecoin is issued by a private company or a decentralized protocol.

A CBDC is issued by a central bank.

So if a digital euro were created, it wouldn't be a euro stablecoin issued by a private company. It would be central bank money in digital form.

With a stablecoin, we ask:

Who is the issuer, and what backs the token?

With a CBDC, we ask:

Which central bank issues it, and what rules apply to it?

Stablecoins and CBDCs are therefore not two names for the same thing. They are two different approaches to digital money.

Stablecoins and European MiCA regulation

As the importance of stablecoins has grown, regulators have also started addressing their functioning more intensively.

In the European Union, the key framework is the MiCA - Markets in Crypto-Assets Regulation.

MiCA does not treat "stablecoin" as a single universal category.

It distinguishes, above all, two types of tokens with more stable value.

E-money token, or EMT

If a token tries to hold its value against a single official currency, for example the euro or the US dollar, MiCA labels it an e-money token.

Put simply, this is a token that tries to digitally represent one specific currency.

Asset-referenced token, or ART

The second category is the asset-referenced token.

According to MiCA, this is a crypto asset other than an e-money token that tries to maintain a stable value by referencing another value, right, or combination thereof, including one or more official currencies.

For the average user, this distinction may look like a legal detail, but its significance is practical.

If a token claims to represent a stable value, it's important to know who issues it, what it holds in reserves, how redemption works, and who monitors compliance with these rules.

MiCA, of course, does not guarantee that a stablecoin cannot lose its peg or face a technical problem.

Regulation does not eliminate risk.

What it does change is the rules by which this risk is handled.

What risks stablecoins carry

Stablecoins were created in order to reduce price volatility.

They did not, however, eliminate risk as such.

They only shifted it into other areas.

Depeg

The most visible risk is losing the peg to the reference value.

If a stablecoin is supposed to be worth one dollar and the market starts doubting its ability to hold that value, its price can fall.

Issuer risk

With centralized stablecoins, the user depends on the company issuing the token.

A financial, operational, or legal problem at the issuer can affect trust in the stablecoin itself.

Reserve risk

What matters is not only whether a stablecoin has reserves, but also what those reserves consist of.

Cash or short-term government bonds have different risk characteristics than less liquid or more volatile assets.

Technological risk

A stablecoin is still a blockchain token.

It can therefore face risks tied to smart contracts, the specific blockchain network, bridges between blockchains, or user error.

Regulatory risk

A change in legislation can affect who is allowed to issue a stablecoin, which platforms may offer it, or under what conditions it can be used.

This is exactly why, when evaluating a stablecoin, it's necessary to look not only at its current price but also at the whole mechanism standing behind it.

What to check about a stablecoin

Stablecoins can look very similar at first glance. If two tokens are worth roughly one dollar, it may seem there's no meaningful difference between them. As we've seen from the previous examples, however, the same price doesn't yet mean the same way of functioning, nor the same risk.

Before using or holding a stablecoin, it is therefore worth asking a few basic questions.

Who issues the stablecoin? Behind some stablecoins stands a specific company that manages the reserves and handles its issuance and redemption. Other stablecoins operate through a decentralized protocol or smart contracts. The answer to this question alone will hint at who or what the token's stability depends on.

What backs or collateralizes its value? A stablecoin can be backed by cash, bank deposits, short-term government bonds, cryptocurrencies, or another mechanism. It's not enough to know that a token "has reserves." It's also important to know what these reserves consist of and how easily they can be converted back into money if needed.

How does redemption work? With stablecoins backed by traditional assets, it's important to know whether and under what conditions the tokens can be exchanged back for the reference currency. The possibility of redemption is exactly one of the mechanisms that help keep a stablecoin's price close to its peg.

How transparent are the reserves? With centralized stablecoins, trust in the issuer is essential. It therefore makes sense to check whether it discloses the composition of its reserves, information about how they are managed, and regular reports on whether the reserves actually match the number of tokens in circulation.

On which blockchain does the stablecoin operate? The same stablecoin can exist on multiple blockchain networks. These can differ in speed, transaction fees, security, and how they function. A user should therefore pay attention not only to the stablecoin itself, but also to the network through which they use it.

What is its regulatory standing? As stablecoins have grown in importance, their legal and regulatory framework has increasingly come into focus. In the European Union, this area is entered by the MiCA regulation, which sets rules for certain types of tokens with stable value and their issuers. Regulation on its own does not guarantee safety, but it can help better identify who is responsible for the token and under what rules it operates.

Has the stablecoin held its peg in the past? Short-term deviations from the reference value can occur even with large stablecoins. More significant or repeated depegs, however, can point to a problem with reserves, liquidity, the system's design, or market trust.

When evaluating a stablecoin, then, it's not enough to look only at its current price. It's more important to understand the whole mechanism that holds that price in place.

The key question for readers: Not just "How much is the stablecoin worth?" but above all "What holds its value, and why should we believe it will still hold it tomorrow?"

Conclusion

Stablecoins arose as an answer to one of the main practical problems of the crypto market - high volatility. They brought onto the blockchain a unit that tries to hold a more stable value, and in doing so made trading, transfers, payments, and the operation of decentralized finance simpler. Thanks to them, the blockchain started being used not only for volatile digital assets, but also as infrastructure for transferring value that behaves similarly to traditional currencies.

At the same time, however, there is no single universal stablecoin model. USDC, USDT, crypto-collateralized stablecoins, or the former TerraUSD may all show the same price on screen, but completely different mechanisms stand behind that price. This is exactly why it's important not to look only at whether a token is worth approximately one dollar, but above all at who issues it, what backs it, how redemption works, and what risks are tied to its construction.

Stablecoins are perhaps one of the best examples of how the crypto world and the traditional financial world are gradually becoming interconnected. On one hand, they make use of blockchain, smart contracts, and digital wallets. On the other hand, behind them often stand bank accounts, government bonds, regulated issuers, and traditional currencies. When evaluating them, it is therefore important to look beneath the peg itself and understand the mechanism that creates it.

This text serves informational and educational purposes only and does not constitute investment advice. Crypto assets are volatile, and you may lose the entire amount invested.