What are stablecoins?
A stablecoin is a cryptocurrency pegged to a “stable” asset (such as the U.S. dollar, gold, or a basket of currencies) that aims to reduce price volatility through an anchoring mechanism. For example, 1 USDT is always theoretically equal to 1 U.S. dollar. Unlike traditional fiat currencies, stablecoins are based on blockchain technology, and their transactions and settlements do not rely on the traditional banking system, but are implemented through public blockchain networks such as Ethereum and Solana. This feature makes it a bridge between the crypto world and real finance, and it has unique advantages in cross-border payments, decentralized finance (DeFi), and other fields.
The birth of stablecoins stems from the actual needs of the cryptocurrency market. The high volatility of early assets such as Bitcoin and Ethereum hindered their function as a medium of exchange. Investors urgently need a tool that can retain the technical characteristics of crypto assets and avoid price fluctuations. In 2014, the launch of the world’s first stablecoin USDT marked the official start of this field. Since then, the size of the stablecoin market has rapidly expanded from less than US$500 million to US$100 billion, becoming an indispensable cornerstone in the crypto ecosystem.
Core Mechanism and Classification of Stablecoins
To understand what stablecoins are, we need to start with their mechanism for maintaining price stability. Currently, mainstream stablecoins can be divided into three categories: fiat currency reserve collateralized, crypto asset collateralized, and algorithmic.
Fiat currency reserve collateralized stablecoins are represented by USDT and USDC, which are issued by centralized institutions and collateralized by fiat currency in bank accounts. For example, for every USDT issued, Tether needs to deposit $1 in the bank. This model relies on users’ trust in the issuer, but its advantages are simple operation and strong liquidity. However, the transparency of such stablecoins has long been questioned. Take USDT as an example. Although Tether claims that its reserves are sufficient, the incomplete audit report often makes it criticized as an “opaque money printing machine.” In contrast, USDC is regarded as a more transparent alternative because its issuer Circle strictly follows US regulatory requirements and regularly discloses audit reports.
Crypto asset collateralized stablecoins achieve value anchoring through on-chain over-collateralized crypto assets. For example, MakerDAO’s DAI requires users to deposit ETH or other crypto assets with a value higher than the loan as collateral, and automatically adjusts the lending rate through smart contracts to maintain a peg to $1. Although this model is highly decentralized, it has low capital efficiency, and the price fluctuations of the collateral assets may cause systemic risks. In March 2020, the ETH price plunge caused DAI to temporarily decouple, forcing MakerDAO to introduce centralized stablecoins such as USDC as supplementary collateral, sparking controversy over the “purity of decentralization.”
Algorithmic stablecoins attempt to break free from the constraints of collateral and rely entirely on supply and demand algorithms to regulate prices. Its representative projects include Ampleforth (AMPL) and the collapsed TerraUSD (UST). Taking UST as an example, it mints UST by destroying the associated token LUNA and adjusts market supply and demand through an arbitrage mechanism. However, the collapse of UST in May 2022 exposed the fatal flaws of the algorithmic model: when market panic triggered a sell-off, the plummeting LUNA price caused UST to lose its value support, and the two fell into a “death spiral”, and eventually the market value returned to zero. This incident warns that there is a huge gap between the “trustless” ideal of algorithmic stablecoins and the actual market mechanism.
Practical scenarios and profit opportunities of stablecoins
What is the core value of stablecoins? In addition to being a medium of exchange, its application in payment, savings and investment is continuing to expand.
In cross-border payments, stablecoins significantly reduce the friction costs of the traditional banking system with the instant settlement characteristics of blockchain. For example, companies can complete international remittances in minutes through USDT, while the traditional SWIFT network usually takes several days. In addition, in areas with high inflation or limited access to US dollars, people regard stablecoins as a value storage tool to replace their own currencies.
For investors, stablecoins provide a variety of income channels. Users can earn interest in the following ways:
Decentralized lending and liquidity mining: deposit stablecoins into protocols such as Compound and Aave, and earn income by lending assets or providing trading liquidity, with an annualized interest rate of 5%-20%.
Centralized financial management platforms: Exchanges such as Binance and Coinbase provide current or fixed-term financial products, but they need to bear the credit risk of the platform.
Flexible returns of algorithmic stablecoins: For example, AMPL adjusts user holdings daily through the “Rebasing” mechanism, which theoretically allows long-term holders to obtain inflation hedging returns.
However, high returns come with high risks. The collapse of UST in 2022 caused investors to lose all their money, and the bankruptcy of the centralized platform Celsius also warned of custody risks. Therefore, evaluating the returns of stablecoins requires comprehensive consideration of protocol security, collateral transparency and market liquidity.
Risks and regulatory challenges of stablecoins
Although stablecoins are designed as “safe havens”, their inherent risks cannot be ignored.
In terms of market risks, even fiat-collateralized stablecoins may be decoupled due to short-term supply and demand imbalances. During the crypto market crash in May 2021, USDT fell to $0.95, triggering concerns about a run. Credit risk is concentrated on the reserve management of centralized issuers. If institutions misappropriate reserve funds or encounter regulatory freezes (such as Circle cooperating with US law enforcement agencies to freeze user USDC), the credit of stablecoins will collapse instantly.
For algorithmic stablecoins, mechanism fragility is the biggest hidden danger. The collapse of UST proves that the anchoring mechanism that relies on market arbitrage is vulnerable in extreme market conditions. In addition, the reliability of the oracle data source is crucial. For example, DeFiDollar relies on Chainlink to provide real-time price data to balance multi-currency reserves. If the oracle is attacked or manipulated, the entire system may fail.
Regulatory scrutiny of stablecoins is becoming increasingly strict. The US Treasury Department calls for the inclusion of stablecoin issuers in the banking regulatory framework and requires regular disclosure of reserve audit reports. The EU Crypto-Asset Market Regulation Act (MiCA) requires stablecoin issuers to hold equivalent liquid assets and prohibits payment stablecoins from being controlled by commercial institutions. These policies are intended to prevent a recurrence of the Terra-style crisis, but they may also inhibit innovation.
Future Outlook: Transparency and Diversification
What is the future of stablecoins? The answer may lie in the combination of transparent technology and diversified anchored assets.
Oracles such as Chainlink provide real-time verification of off-chain assets for stablecoins such as TrueUSD (TUSD) and PAXG through the “Proof of Reserves” mechanism, enhancing user trust. On the other hand, the rise of central bank digital currencies (CBDCs) may reshape the competitive landscape. If projects such as China’s digital RMB and Europe’s digital euro are compatible with blockchain, they may challenge the market position of existing stablecoins.
In addition, innovative models are still being explored. Some projects try to combine partial collateral with algorithmic regulation, or include real-world assets (such as real estate and bonds) in collateral to improve capital efficiency. Despite the bumpy road ahead, the positioning of stablecoins as the infrastructure of the “value Internet” is unshakable.
Conclusion
What is a stablecoin? It is a tool for the crypto world to fight volatility, a test field for the integration of traditional finance and blockchain, and a frontier for the game of regulation and innovation. From the controversy over USDT to the collapse of UST, this field has continuously verified the dialectical law of “trust” and “trustlessness”. In the future, only through technical transparency, regulatory compliance and mechanism optimization can stablecoins truly realize their “stability” promise and become a universal value yardstick in the digital economy era.
