What Is a Stablecoin?

A **stablecoin** is a type of cryptocurrency designed to maintain a stable value relative to a real-world asset, usually a fiat currency like the US dollar. Unlike Bitcoin or other volatile cryptocurrencies, stablecoins aim to minimise price swings, making them useful for transactions, savings, trading, and DeFi activities.

Why Stablecoins Exist

Cryptocurrency markets are known for volatility. Stablecoins provide a way to **hold value in a digital form without sharp price movements** — combining the stability of traditional money with the convenience of crypto.

Stablecoins act as a bridge between traditional currencies and the fast-moving world of digital assets.

Common Types of Stablecoins

1. Fiat-Backed Stablecoins

These stablecoins hold real currency (like USD or EUR) in reserve to back every token in circulation.

• Examples: USDC, USDT, BUSD
• Reserves are held in banks or custodial entities.
• Regular audits and transparency reports help users trust the peg.

2. Crypto-Backed Stablecoins

These are backed by other cryptocurrencies locked in collateral. Because crypto collateral can be volatile, these stablecoins are often **over-collateralised** to maintain stability.

• Examples: DAI
• Collateral is held on-chain using smart contracts.
• Over-collateralisation helps absorb price volatility of the backing assets.

3. Algorithmic Stablecoins

Rather than holding reserves, algorithmic stablecoins use software rules and market mechanisms to manage supply and keep the price stable.

• Examples: Some experimental protocols use algorithmic models.
• These can be more complex and carry higher risk.

How Stablecoins Work

A stablecoin’s value stays close to its target by backing, algorithmic adjustments, or collateral. The key idea is: when demand rises, supply adjusts; when demand falls, supply contracts — keeping the price around the agreed peg.

Stablecoins do not eliminate risk entirely — the mechanisms that maintain the peg matter. Some use audited reserves; others rely on code and market incentives. Always understand the model before using or holding any stablecoin.

Common Use Cases

• Trading: Move in and out of volatile positions without exiting to fiat.
• Payments: Send digital money globally with minimal price risk.
• DeFi: Provide liquidity, earn yields, and participate in decentralised markets.
• Savings: Preserve value without exposure to crypto price swings.

Risks and Considerations

While stablecoins aim to reduce price volatility, they are not risk-free. Major considerations include:

• Reserve transparency: Are the backing assets audited and independently verified?
• Counterparty risk: Fiat-backed stablecoins rely on trusted custodians or banks.
• Smart contract risk: Crypto-backed and algorithmic stablecoins run on code that may have vulnerabilities.
• Regulatory change: Laws and policies affecting stablecoin issuance and use can change rapidly.

Stablecoins are powerful tools when used appropriately — but understanding *how* they are backed and managed is essential before holding or using them.