Bitcoin can move ten percent in a day. That’s exciting if you’re speculating and miserable if you’re trying to pay a supplier or park money between trades. Stablecoins were built for that second job: they are crypto tokens designed to keep a steady price, usually one US dollar.
“Designed to” is the important part. Different stablecoins use very different machinery to stay at $1, and that machinery decides how much you should trust them.
Three ways to hold a peg
1. Backed by cash and short-term bonds
The largest stablecoins work like a digital IOU. A company issues one token for every dollar it receives and holds reserves — bank deposits, US Treasury bills and similar assets — to cover redemptions. Large holders can usually swap tokens back for dollars directly with the issuer, and that redemption promise is what keeps the market price close to $1.
The questions to ask are boring but essential: what exactly is in the reserves, who checks them, and how often are the reports published?
2. Backed by other crypto
Some stablecoins are created by locking up more crypto than the tokens are worth — say $150 of ether for $100 of stablecoins. If the collateral falls in value, the system automatically sells it to protect the peg. It’s transparent, because everything happens on-chain, but it depends on smart contracts behaving correctly during a crash.
3. Algorithmic
Algorithmic stablecoins try to keep the price at $1 with code that expands or shrinks supply, often paired with a second, volatile token. When confidence holds, it works. When it breaks, it can break very quickly: the collapse of TerraUSD in May 2022 wiped out tens of billions of dollars in a matter of days and is the textbook example of what happens when a peg relies on belief alone.
Why traders use them
- A parking spot. Selling into a stablecoin lets you step out of a volatile coin without leaving the exchange or waiting for a bank transfer.
- Trading pairs. Many crypto markets are quoted against a dollar stablecoin rather than against the dollar itself.
- Transfers. Sending a stablecoin across borders can be faster than a wire, though network fees vary a lot between blockchains.
What can go wrong
A stablecoin is only as good as the issuer and the reserves behind it. Even well-backed tokens have briefly slipped below a dollar when a bank holding part of their reserves ran into trouble. Regulators can freeze issuers, and issuers can freeze individual addresses. And holding a stablecoin on an exchange still exposes you to that exchange — the wallet question from our hot vs cold wallet guide applies here as well.
There’s a currency angle too. A dollar stablecoin protects you against crypto volatility, not against the dollar. If you think in euros or pounds, your “stable” balance still moves with the exchange rate — the same pairs we discuss in how pips and pip value work.
A quick checklist before you hold one
- Find out which of the three models it uses.
- Read the latest reserve report and note the date.
- Check how it traded during past market stress.
- Don’t keep more on an exchange than you need for the next trade.
For long-term savings, some investors prefer to compare stablecoins with older stores of value; our piece on gold versus bitcoin looks at that side of the debate.
