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    March 29, 2026·By Miles Ledger

    Stablecoins Explained: What They Are and How They Work

    Stablecoins are cryptocurrencies pegged to a stable value - usually the US dollar. Here's how they work, why people use them, and what can go wrong.

    One of the most common criticisms of Bitcoin is that it's too volatile to use as money. You can't price a sandwich in bitcoin if the price might drop 30% next month.

    Stablecoins were invented to solve this. They're cryptocurrencies designed to maintain a stable value - usually pegged to the US dollar. $1 of USDC should always be worth $1. No volatility, no speculation. Just digital dollars that can move on a blockchain.

    But the word "stablecoin" covers very different technologies with very different risk profiles. Understanding the differences matters before you hold any.

    How stablecoins maintain their peg

    There are three main mechanisms:

    1. Fiat-backed stablecoins

    The simplest approach: a company holds actual dollars (or dollar-equivalent assets like T-bills) in a bank, and issues tokens 1:1 against those reserves. USDC (issued by Circle) and USDT (Tether) work this way.

    If you have $1 of USDC, Circle theoretically has $1 in a bank somewhere to back it. The token's stability depends on Circle maintaining those reserves and honoring redemptions.

    This works reliably. USDC and USDT have maintained their pegs through multiple market crises. The tradeoff: you're trusting a centralized company. If Circle is hacked, defrauded, regulated out of existence, or the bank holding their reserves fails, your "stable" coins could become unstable.

    2. Crypto-backed stablecoins

    Instead of dollars, these are backed by other cryptocurrencies - typically ETH or BTC. Because crypto is volatile, they're over-collateralized: you lock up $150 worth of ETH to borrow $100 of stablecoins. The extra buffer absorbs price swings.

    DAI (by MakerDAO) is the most established example. It's maintained its peg for years through significant market volatility. The mechanism is more complex than fiat-backed but doesn't require trusting a company.

    The risk: if collateral prices drop faster than the system can respond, the peg can break. Most systems have automatic liquidation mechanisms to prevent this, but extreme market conditions can overwhelm them.

    3. Algorithmic stablecoins

    The most experimental category. These attempt to maintain stability through supply adjustment algorithms, often without meaningful collateral backing. When demand drops, the algorithm burns tokens to reduce supply and support the price. When demand rises, it mints more.

    The most infamous example is TerraUSD (UST), which collapsed in May 2022. UST was supposed to be backed by a related token (LUNA), creating a feedback loop. When confidence cracked, the peg broke, the algorithm tried to stabilize it by minting more LUNA, which collapsed LUNA's price, which destroyed the collateral, in a death spiral that wiped out roughly $60 billion in value in days.

    Algorithmic stablecoins without robust collateral are considered extremely high-risk. Most of the projects that existed in 2021 are now worth zero.

    Why people use stablecoins

    Moving value between exchanges. Selling Bitcoin and moving the proceeds to another exchange takes minutes in USDC, versus days for a bank wire.

    Preserving dollar value in crypto-native environments. If you're participating in DeFi, you often need a dollar-denominated asset that lives on the blockchain. Stablecoins fill that role.

    Earning yield. Various platforms pay interest on stablecoin deposits - though the rates are significantly lower than the 20%+ yields advertised during the 2021 bull market, and most of those yields came with substantial risk.

    Escaping local currency inflation. In countries with weak currencies, holding USDC provides access to dollar-pegged value without needing a US bank account. For people in Argentina, Turkey, or Venezuela, this is genuinely useful. Though it's worth noting: this is dollar-denominated value, not bitcoin. Bitcoin's utility value in these contexts is different.

    Payments and remittances. Sending $50 internationally via USDC on a network with low fees is faster and cheaper than most traditional remittance options.

    What stablecoins are not

    Stablecoins are not savings accounts. They're not FDIC insured. A stablecoin issuer going bankrupt could mean you lose your funds.

    They're also not anonymous. Fiat-backed stablecoins are issued by regulated companies that comply with government requests to freeze or confiscate funds. Several USDC and USDT addresses have been blacklisted by their issuers at law enforcement request. This is very different from Bitcoin's properties.

    And most importantly: stablecoins denominated in US dollars inherit the US dollar's inflation. $1 of USDC today will buy less in 10 years. Bitcoin holders sometimes point out that a "stable" value against a depreciating currency isn't really stable - it's just slow decline.

    The regulatory picture

    Stablecoins are one of the most actively regulated areas of crypto. The US, EU, and UK are all developing or implementing stablecoin-specific legislation that will affect how they can be issued and used.

    The SEC's digital commodity classification covers the broader regulatory framework, which includes stablecoins.

    How stablecoins relate to Bitcoin

    Bitcoin and stablecoins solve different problems.

    Stablecoins give you digital money that's easy to spend and predictable in value - but controlled by issuers, subject to inflation, and dependent on the dollar.

    Bitcoin gives you an asset with a fixed supply, no controlling issuer, and a 15-year track record - but volatile and less convenient for everyday spending (though Lightning is closing that gap).

    They coexist because they serve different purposes. Understanding both helps you think clearly about what role each might play in your financial life.

    Sources

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    Written by Miles Ledger

    Bitcoin educator and builder. Creator of bitcoinverdict.com. Writes about Bitcoin in plain language for people who want to understand it, not trade it.

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