What Is a Stablecoin? How They Work, Where They Break

A stablecoin is a digital token designed to hold a steady value — usually one US dollar — while moving on a blockchain, the shared public database that records who owns what. Its price stays near the target because the issuer, or a set of rules, lets people create and redeem it at that value. That mechanism is where stablecoins succeed or fail.

What problem does a stablecoin solve?

A stablecoin combines the settlement properties of a blockchain with the unit of account people actually use. A blockchain is a database maintained simultaneously by many independent computers, so a transfer settles between two parties without a bank in the middle, at any hour, in minutes or seconds. Native blockchain tokens are volatile, which makes them useless for an invoice. A dollar stablecoin holds the dollar's value on those rails, which is why payroll, cross-border payments and treasury desks use it and not bitcoin.

Two terms recur below. Onchain means recorded on the blockchain itself, not in a company's internal ledger. A wallet is software or a device holding the cryptographic keys that authorise transfers from an address; whoever holds the keys controls the balance, which is what custody means here — a company holding them for you, or you holding them with no password reset.

How does a peg actually hold?

A peg holds through arbitrage backed by redemption, not through a promise. If a stablecoin trades at $0.99 and anyone can redeem it with the issuer for $1.00, buying it cheaply and redeeming it is free money — so people do, until the discount closes. At $1.01, minting new tokens at $1.00 and selling them is equally profitable, pushing the price back down. The peg is the visible result of that pressure.

Everything follows from this. If redemption is slow, restricted to large institutions, or suspended, the arbitrage weakens and the price drifts. A stablecoin with no credible redemption has nothing anchoring it but the belief someone else will pay a dollar tomorrow. Judging a stablecoin is really judging who can redeem, how fast, and for what.

Design 1: fiat-collateralized stablecoins

Fiat-collateralized stablecoins are backed by conventional assets held by a company — bank deposits and short-dated government debt — and are the dominant design by volume. USDT, issued by Tether, and USDC, issued by Circle, are the two largest by a wide margin: market trackers put USDT near $183 billion and USDC near $74 billion as of August 30, 2026, together roughly 88 percent of a stablecoin market of about $290 billion. The issuer creates tokens when it receives dollars and destroys them when it pays dollars out, so supply tracks the reserve.

The strength is simplicity: real assets, a real redemption right. The weaknesses are a bank's. You take credit and custody risk on the issuer and on the banks holding the reserve, and composition matters — cash and Treasury bills behave nothing like commercial paper in a crisis. These issuers can also typically freeze balances at specific addresses on a court order or sanctions listing: a feature to a compliance team, a risk to anyone assuming the asset is beyond reach. Disclosure practices differ; the USDC and USDT comparison goes through it.

Design 2: crypto-collateralized stablecoins

Crypto-collateralized stablecoins are backed by other digital assets locked in smart contracts — programs running on a blockchain — not by bank deposits. Because that collateral is volatile, these systems are overcollateralized: lock $150 or more of assets to issue $100 of stablecoin, and if the collateral falls toward the threshold the position is liquidated automatically to keep the system solvent. MakerDAO's DAI was the reference implementation. MakerDAO rebranded as Sky in August 2024 and now runs two tokens side by side — the original DAI and a newer USDS — convertible one-for-one through a contract, with SKY replacing MKR as the governance token.

What happened to that collateral is the more interesting part. Sky's reserve as reported in early 2026 was roughly 40 percent real-world assets, mostly tokenized US Treasury exposure, and roughly 35 percent USDC held in its peg stability module, with crypto collateral making up the remainder. The flagship decentralized stablecoin is now backed in large part by the same short-dated government debt and the same centrally issued stablecoin the design was created to avoid depending on.

The appeal is real: the rules and the collateral are visible onchain and no single company can be leaned on. The costs are capital inefficiency, dependence on liquidations working in the exact conditions that stress them, and reliance on price oracles — services feeding external prices into the contract, and a historic source of failure. And, as Sky's own composition shows, holding reserve-backed stablecoins as collateral reintroduces the issuer risk the design set out to remove.

Design 3: algorithmic stablecoins, and why the record is bad

Algorithmic stablecoins hold their peg through rules and incentives rather than assets — typically by minting and burning a second, volatile token to absorb demand shifts. The design has a failure record, and any explainer presenting it as a third equal option is misleading you. The reference case is Terra's UST, which lost its peg over the week of May 7 to May 13, 2022 and collapsed to near zero, destroying on the order of $40 billion of nominal value along with its paired LUNA token and pulling down lenders, funds and exchanges that had held or borrowed against it. LUNA's supply expanded from around 343 million tokens on May 9 to roughly 6.5 trillion a week later as the mechanism minted into a collapsing price. Terraform Labs founder Do Kwon was subsequently convicted and sentenced to 15 years in prison.

The structural flaw is a reflexive loop. The mechanism depends on the paired token holding value, and that token's value depends on confidence in the peg. When confidence goes, the system mints ever more of a falling asset to defend a failing peg and both reach zero — a run with no reserve to stop it. Smaller variants failed the same way before 2022, and later designs calling themselves algorithmic generally hold real collateral, making them hybrids. Treat the word as a reason to read the collateral disclosure closely, not as innovation.

What is depegging?

Depegging is when a stablecoin trades away from its target value — a dollar token changing hands at $0.97 or $1.03. It is not automatically a solvency event: brief discounts happen when redemption is slow, when a large holder sells into thin weekend liquidity, or when one venue runs short of buyers. What matters is whether the discount reflects a real question about the reserve, and whether it closes when redemptions reopen.

The best-documented example is USDC in March 2023. Circle disclosed that about $3.3 billion of the reserve sat at Silicon Valley Bank, which regulators had just closed; USDC fell to roughly 87 cents on March 11, 2023 and was back at a dollar by March 13 once US authorities confirmed SVB depositors would be made whole and redemptions resumed. The lesson is not that reserve backing failed but that the reserve's banking counterparties are part of the risk. Full account in is USDC safe.

How should you judge a stablecoin?

Six questions, in order of how much they matter.

Who is the issuer, and under what regulation? The EU's Markets in Crypto-Assets regulation is in full application and it bites: Circle obtained an electronic money institution authorisation from the French regulator ACPR in July 2024, so USDC and the euro-denominated EURC are available through licensed European venues, while Tether declined to seek authorisation and USDT has been removed from MiCA-regulated platforms serving the European Economic Area. The US GENIUS Act, signed July 18, 2025, sets 1:1 reserve, segregation, redemption-policy and monthly attestation requirements and bars issuers from paying holders interest — but it is not yet in force, taking effect on the earlier of January 18, 2027 or 120 days after regulators finalise implementing rules, which as of August 2026 they had not.

What is in the reserve, disclosed in enough detail to tell cash from credit? Who examines those disclosures — an accounting firm attesting to holdings at a point in time, or a full audit of financial statements? Both large dollar issuers now sit on the audited side of that line, Circle through its SEC filings as a listed company and Tether through the unqualified KPMG opinion on its 2025 accounts announced in August 2026; most smaller issuers do not. Who can redeem, at what size, how fast? Can the issuer freeze balances, under what process? And is your token the issuer's own or a bridged copy minted by someone else — several chains carry a "USDC" that is a bridge's claim on deposits elsewhere, not a Circle liability.

Answer those and you know more than most holders. What you cannot do is judge a stablecoin by today's price, which is exactly what most people do.

Where do stablecoins actually run?

Stablecoins run on general-purpose blockchains built for other things, which is why sending one has usually meant holding a second, volatile token to pay gas — the network's transaction fee. That is a real barrier for a finance team: you cannot pay a supplier in dollars without first buying a token you did not want. Arc, Circle's Layer-1 blockchain live on public mainnet since September 16, 2026, was built for this use: gas is paid in USDC, settlement is final in under a second, and its validators include Visa, Mastercard, BlackRock and ICE. See what Arc is.

Frequently asked questions

Is a stablecoin the same as a digital dollar or a CBDC?

No. A stablecoin is issued by a private company against reserves it holds; a central bank digital currency would be a direct liability of a central bank. A stablecoin is closer to a regulated e-money balance, and its safety depends on the issuer and its reserve, not on a sovereign.

Are stablecoins backed one-for-one by dollars?

The major fiat-collateralized ones report reserves equal to or greater than tokens outstanding, but "reserves" rarely means only cash — Treasury bills, repurchase agreements and bank deposits are typical, and Tether's reserve also includes gold, bitcoin and secured loans. Read the issuer's reserve reporting rather than the phrase "fully backed" on a marketing page. See what USDC is.

Do I earn interest on stablecoins?

Not by holding one: the issuer earns the yield on the reserve, you hold a token worth a dollar. Any yield offered comes from lending it, providing liquidity or a similar arrangement, each with its own risk of loss — a different product from the stablecoin. None of this is investment advice.

Which stablecoin should a business use?

That depends on your regulator, your banking partners and where your counterparties can receive funds — not on which is largest. The practical filter: issuer regulation, reserve transparency, redemption access at your size, and whether your chain carries the issuer's native token or a bridged copy.