What is Stablecoin?

How it works

There are three flavors of stablecoin:

• Fiat-backed (USDC, USDT, PYUSD, FDUSD). A company holds dollar reserves (cash, T-bills, money-market funds) and issues tokens 1-for-1. Redemption: send the company a USDC, they wire you a dollar. Trust assumption: the issuer's reserves are real and accessible.
• Crypto-collateralized (DAI, LUSD). Smart contracts hold over-collateralized crypto (ETH, USDC) backing the stablecoin's supply. To mint $1 of DAI you typically lock ~$1.50 of collateral. If collateral value drops below threshold, the contract auto-liquidates. Trust assumption: the smart contracts work, oracle prices are accurate, collateral is liquid.
• Algorithmic (mostly defunct: UST, BUSD, AMPL variations). No real reserves. Pegging maintained via burn/mint mechanics tied to a separate "governance" token. Almost every algorithmic stablecoin has eventually collapsed; UST in May 2022 was the most spectacular ($40B wiped in days).

USDC and USDT together account for ~90% of stablecoin supply. DAI is the largest decentralized option but a meaningful chunk of its collateral is now USDC anyway.

Example

A typical stablecoin use case: a US-based crypto trader sells ETH for USDC after a rally, holds USDC as "dry powder" for the next entry. They earn ~5% APY parking it in Aave or Spark Protocol while waiting. When they buy back in, they swap USDC → ETH on a DEX in seconds.

The same flow without stablecoins would require off-ramping to USD via a bank wire (1–3 days, fees), holding cash, and on-ramping back when ready. Stablecoins cut the cycle from days to seconds.

Why it matters

Stablecoins are the connective tissue of crypto:

• Trading pairs — most active markets pair against USDT or USDC, not BTC
• DeFi collateral and yield — lending, perp margin, LP positions all rely on stables
• Cross-border payments — sending $10k of USDC to another wallet costs cents and arrives in seconds
• Inflation hedge in unstable economies — Argentina, Turkey, Venezuela have meaningful retail USDC adoption as savings

The risks vary by flavor:

• USDC — most transparent reserves (audited monthly), regulated. Briefly depegged to $0.88 in March 2023 when Circle disclosed $3.3B at SVB; recovered when SVB was made whole.
• USDT (Tether) — historically opaque about reserves; legally settled with NYAG in 2021 over reserve misrepresentation. Has since published more disclosure but still less transparent than USDC. Track record of holding the peg under stress.
• DAI — well-tested but ~30% backed by USDC, so it inherits some USDC risk indirectly.

For most users, USDC is the safest default. USDT has more global liquidity and works in places USDC isn't well-supported. DAI is for users who specifically want decentralized backing despite the indirect USDC exposure.