1.3 Stablecoins in Context
What you'll learn: What makes stablecoins "stable," why this stability matters for real‑world use, and the basic approaches to maintaining a fixed value.
Bitcoin's price volatility makes it unsuitable for everyday transactions. Bitcoin fluctuated from $16,000 to over $69,000 in 2021 alone [1]. Stablecoins emerged to solve this problem by aiming to maintain a stable value, typically pegged to fiat currencies like the US dollar. Major examples include Tether (USDT), USD Coin (USDC), and DAI, which collectively represent over $150 billion in market capitalization as of 2024. Through various mechanisms, stablecoins aim to preserve purchasing power while retaining the benefits of blockchain technology: instant settlement, global accessibility, and programmability.
To understand stablecoins' role in the digital money ecosystem, we need to distinguish them from two other forms of on-chain digital money: deposit tokens (also called tokenized deposits) and central bank digital currencies (CBDCs). While all three represent digital value on blockchain networks, they differ in who issues them, what backs them, and how they're regulated. Figure 3 compares these three formats across key dimensions.
The table reveals three key differences between these on-chain money formats.
Issuer types vary: stablecoins can be issued by non-bank entities (like Circle or Tether) or banks, deposit tokens come strictly from regulated banks, and CBDCs are issued by central banks. Second,
Backing differs: stablecoins hold reserves in cash and Treasury bills, deposit tokens represent bank deposits, and CBDCs carry direct central bank backing.
Use cases diverge: stablecoins focus on retail payments and crypto trading, deposit tokens target institutional payments, and CBDCs aim for broad payment infrastructure.
These distinctions affect risk profiles, regulatory treatment, and practical applications.
Understanding the "Peg"
Think of visiting an arcade or casino. You exchange your dollars for tokens or chips that have a fixed value. One chip always equals one dollar. You can play games, hold onto them, or cash them back for dollars anytime. The arcade guarantees this exchange rate never changes. In financial terms, we say the chips are "pegged" to the dollar.
Unlike arcade chips, stablecoin prices can briefly deviate from $1 on exchanges, sometimes trading at $0.99 or $1.01. The peg is maintained through redemption rights and arbitrage: if the price drifts too far, people can profit by buying low and redeeming at $1, or minting at $1 and selling high. This mechanism typically keeps prices within a tight range.
Stablecoins work the same way, except they're digital and operate on the internet 24/7. One USDC always equals one US dollar. One EURT always equals one euro (almost always → see 2.5 Common Misconceptions). This fixed relationship, or "peg," is what makes stablecoins stable.
But here's the key difference from arcade tokens: stablecoins live on the same blockchain networks as Bitcoin and Ethereum. This means they can move anywhere in the world instantly, operate without banks, and work with smart contracts and other blockchain applications. You get the innovation of cryptocurrency with the stability of traditional money.
Why Stability Changes Everything
Let's revisit that coffee shop example from earlier. With Bitcoin, your $5 coffee might cost $4 or $6 by the time you finish drinking it. The shop owner faces the same problem: the $500 they earned this morning might be worth $450 or $550 by closing time. Nobody can run a business or manage their finances with that kind of uncertainty.
Stablecoins solve this problem. With price stability locked in, practical uses emerge that volatile cryptocurrencies can't serve:
Daily transactions: Buy groceries, pay bills, split dinner with friends, all without checking price charts first [2].
Savings: Keep emergency funds or save for future purchases without the risk of waking up to find your money worth 20% less.
Business operations: Price products, pay suppliers, manage payroll, and plan budgets with predictable values.
International transfers: Send money to family overseas knowing they'll receive exactly what you sent, minus only small network fees.
Financial applications: Developers can build lending platforms, payment systems, and other services without programming complex volatility protections.
Think of stability as the bridge between the experimental world of cryptocurrency and the practical needs of everyday money. Without it, blockchain technology remains interesting but limited. With it, we can reimagine how money works globally.
Market Adoption and Scale
The growth in stablecoin usage reflects real demand for blockchain-based stable value. At the beginning of 2024, total stablecoin supply stood at $130 billion. By January 2025, this had climbed to $207 billion, representing a 59% increase. Growth accelerated through 2025, reaching $280 billion by August, representing 75% year-over-year growth [6].
To put this in perspective: stablecoins now account for roughly 1% of the entire U.S. dollar supply, up from 0.63% at the start of 2024. This growth occurred despite incomplete regulatory frameworks, suggesting organic demand for the technology's benefits.
How Stablecoins Maintain Their Peg
You might wonder: how can a digital token always equal one dollar? There are three main approaches, each with different trade-offs.
Backed by real money: Companies like Circle (which issues USDC) and Tether (which issues USDT) keep actual dollars and government bonds in bank accounts. For every digital token they create, they hold one dollar in reserve. It's like a digital warehouse receipt: you can always exchange your token for the real dollar backing it. This is the simplest and most popular approach, used by over 90% of all stablecoins [3].
Backed by other cryptocurrencies: Some stablecoins, like DAI, use Bitcoin or Ethereum as collateral instead of dollars. To account for crypto's volatility, they require extra backing. Imagine putting down a $15,000 car as collateral for a $10,000 loan. That extra cushion protects against price drops. This approach avoids traditional banks but adds complexity [4].
Maintained by computer programs: Some projects tried using algorithms to automatically adjust supply when prices change, like a thermostat maintaining room temperature. If the price goes above $1, create more tokens. If it drops below $1, reduce supply. While elegant in theory, this approach has struggled in practice. The spectacular collapse of TerraUSD in 2022, where $42 billion vanished in days [6], showed these systems remain highly experimental.
For now, most users stick to fiat-backed stablecoins for their simplicity, transparency, and reliability. As you'll see in the next section, different regions choose different stablecoins based on access, regulatory frameworks, and use-case needs [5].
What Can Go Wrong: Lessons from Stablecoin Failures
Stablecoins offer significant benefits, but understanding their risks is crucial. History provides important lessons:
Terra/UST Collapse (May 2022) [4]
Lost: $60 billion in total ecosystem value
Cause: Algorithmic mechanism failed under selling pressure
Lesson: Purely algorithmic stability remains experimental and risky
USDC Depeg (March 2023)
Impact: Dropped to $0.87 before recovering to $1
Cause: $3.3 billion held at failed Silicon Valley Bank
Lesson: Even fiat-backed stablecoins face banking system risks
Iron Finance Crash (June 2021)
Lost: $2 billion in value went to near zero
Cause: Partial algorithmic backing created death spiral
Lesson: Hybrid models can combine worst aspects of both approaches
Key Risk Factors:
Reserve Risk: Quality and accessibility of backing assets
Custodial Risk: Safety of banks/institutions holding reserves
Smart Contract Risk: Code vulnerabilities in blockchain systems
Regulatory Risk: Sudden law changes affecting operations
Liquidity Risk: Ability to redeem during market stress
What This Means: These failures don't invalidate stablecoins but highlight the importance of choosing established, transparent, and properly regulated options. Just as people learned to distinguish between insured and uninsured bank deposits after the Great Depression, users are learning to evaluate stablecoin safety. The major fiat-backed stablecoins (USDT, USDC) have weathered multiple market crises while maintaining their pegs, but vigilance remains essential.
The Context That Matters
Stablecoins emerged because the market needed them. Bitcoin proved we could have digital money without banks, but its volatility made it impractical for everyday use. Traditional payment systems offer stability but lack the speed, accessibility, and programmability of blockchains. Stablecoins fill this gap perfectly.
This isn't just theoretical. As we'll explore in the next section, over 27 million people use stablecoins monthly [7] for real purposes: protecting savings from inflation in Argentina, sending money home from Dubai to Manila, running businesses in Lagos, and managing corporate treasuries in New York. Each use case demonstrates how stability makes blockchain technology practical for solving real-world problems.
Now that we understand what stablecoins are and how they work, we can explore their real-world impact. The true test of any financial innovation isn't its technical elegance but how people actually use it to improve their lives. From Buenos Aires to Lagos to New York, stablecoins are solving different problems for different communities.
Key Takeaways
A peg ensures one token maintains a fixed value (e.g. 1 USDC = 1 USD) through transparency and reserve mechanisms.
Stability makes crypto usable for everyday needs: buying things, saving, payroll without waking up to wild value swings.
There are three models: fiat‑backed (most common and trusted), crypto‑backed (more complex), and algorithmic (experimental and risky).
Stablecoins bridge traditional finance and blockchain, marrying stability with programmability.
Price stability unlocks use cases impossible for volatile crypto: easy payments, savings, payroll, and financial apps.
Resources
[1] Bitcoin is Too Volatile, Impractical, and Fails as a Store of Value: Bank of America - https://cryptopotato.com/bitcoin-is-too-volatile-impractical-and-fails-as-a-store-of-value-bank-of-america/
[2] Chainalysis – 2024 Latin America and Sub-Saharan Africa Adoption Reports - https://www.chainalysis.com/blog/2024-latin-america-crypto-adoption/ and https://www.chainalysis.com/blog/subsaharan-africa-crypto-adoption-2024/
[3] Stablecoin Landscape: What 2024 Reveals About 2025? - https://blog.cex.io/ecosystem/stablecoin-landscape-34864
[4] TerraUSD crash explained – Reuters - https://www.reuters.com/markets/us/bitcoin-back-below-30000-european-regulators-renew-crypto-warnings-2022-05-16/
[5] Stablecoin Adoption Grows Mid-2025 (Finimize) - https://finimize.com/content/stablecoins-arent-just-for-crypto-bros-anymore
[6 ] Plasma Redefining Stablecoin Settlement - https://assets.dlnews.com/dlresearch/DL_Research_Report_Plasma_Redefining_Stablecoin_Settlement_v3.pdf
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