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Stablecoins explained: types and risks

THE SHORT ANSWER

A stablecoin is a token designed to track a reference asset, often a currency. Stability depends on reserves, redemption options or its mechanism. It can lose its peg: “stable” describes a target, not a guarantee.

What are Stablecoins?

A token targeting one dollar is not automatically a dollar in a bank account. Understand what supports its peg and how a holder can exchange or redeem it.

  • Trading pairs on cryptocurrency exchanges
  • Reduce exposure to another cryptoasset’s price while retaining stablecoin-specific risks
  • Cross-border payments and remittances
  • Decentralized finance (DeFi) applications

Possible uses, subject to conditions

  • A target of lower volatility against the reference asset
  • Digital transfers with fees that depend on the network
  • On-chain transfers available around the clock
  • Use in some DeFi protocols

Types of Stablecoins

Fiat-Backed

An issuer holds reserves: cash, deposits or financial assets depending on the model. Check composition, attestations and redemption terms, which can depend on country and holder.

Crypto-Backed

Collateral is managed by a protocol, often with overcollateralization and liquidation. Some systems combine cryptoassets, stablecoins and financial assets: “decentralized” does not mean no exposure to intermediaries.

Algorithmic

Supply changes or incentives aim to maintain a target price. If demand or confidence disappears, the mechanism can fail; a target price is not an available reserve.

Risks to Consider

  • Loss of peg, insufficient reserves or restricted redemption; a market price can differ from the target.
  • Bugs, issuer freezing permissions and added risk for a token bridged from another network.
  • Currency risk: a dollar stablecoin can change in euro value even while its dollar peg holds.
  • Availability and rights vary by jurisdiction. A reserve attestation guarantees neither the entire service nor the absence of losses.

Sources and further reading

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