Stablecoins: Digital Dollars

The problem stablecoins solve

ETH can drop 20% in a week. Bitcoin has fallen 50% in a few months. If you are a freelancer getting paid in crypto, or a business accepting crypto payments, this volatility is a problem.

Stablecoins fix this. They are tokens designed to always be worth $1 (or another fixed value). You get the benefits of crypto (instant transfers, no bank needed, works 24/7) without the price rollercoaster.

Three ways to stay stable

There are three approaches to keeping a token worth $1. Each has trade-offs.

Fiat-backed: USDC and USDT

The simplest model. A company holds real dollars (and Treasury bonds) in a bank. For every USDC in circulation, there is $1 in reserves. When you want to redeem, the company burns the token and sends you dollars.

USDC (issued by Circle): Reserves are audited monthly by Deloitte. Backed by cash and short-term US Treasury bonds held in the Circle Reserve Fund, managed by BlackRock.

USDT (issued by Tether): The largest stablecoin by market cap. Has faced scrutiny over its reserves transparency but remains the most traded crypto asset by volume.

Crypto-backed: DAI

DAI uses smart contracts instead of a company. To create DAI, you lock up ETH (or other crypto) worth more than the DAI you mint. If you want $100 of DAI, you lock up at least $150 of ETH as collateral.

If the value of your collateral drops too low, the smart contract automatically sells it to protect the system. This is called liquidation.

Algorithmic: the risky experiment

Algorithmic stablecoins use code to adjust supply. When the price rises above $1, the algorithm mints more tokens. When it drops below $1, it burns tokens.

In May 2022, the algorithmic stablecoin UST (Terra) lost its peg and collapsed from $18 billion to near zero in days. Its companion token LUNA went from $80 to $0.0001. This event shook the entire crypto market and led to tighter regulation.

The stablecoin market today

Stablecoins are the most widely used tokens in crypto. They handle more transaction volume than ETH or BTC on most days.

Key takeaways

• Stablecoins are tokens designed to hold a steady $1 value, solving crypto's volatility problem.
• Fiat-backed (USDC, USDT) are the simplest and most widely used — backed by real reserves.
• Crypto-backed (DAI) are decentralized but complex, requiring over-collateralization.
• Algorithmic stablecoins have a poor track record — UST's $40B collapse is a cautionary tale.
• Stablecoins are critical infrastructure for DeFi, payments, and cross-border transfers.