Stablecoins: Definition and Origin

Stablecoins are blockchain-based tokens pegged to fiat currencies, commodities, or a basket of assets, maintained through reserve custody or collateral mechanisms to ensure price stability. They aim to combine the programmability of digital assets with the low volatility of fiat currencies. The concept originated in 2014 when Bitcoin’s severe volatility impacted pricing. The Bitfinex team launched USDT, pegged to the U.S. dollar, to provide a “blockchain dollar” unit of account for miners and exchanges. Subsequently, with the rise of ICO fundraising, DeFi lending, and cross-border remittances, stablecoins evolved from a hedging unit to a global payment and settlement channel, leading to the emergence of diverse models such as USDC and DAI, and prompting regulators worldwide to launch sandbox pilots and reserve disclosure standards.

How Stablecoins Work

Stablecoins rely on pegging mechanisms to track the price of another asset. Their implementations vary widely and are generally categorized into the following three types:

1.  Fiat-Backed Stablecoins:

These stablecoins are backed by fiat currencies such as the U.S. dollar, Euro, or Hong Kong dollar. For example, each TUSD token is backed by 1 U.S. dollar in reserve. Users can exchange fiat for stablecoins at a fixed rate and redeem them in return. This mechanism is relatively straightforward but heavily relies on centralized custody and third-party transparency.

2.  Crypto-Backed Stablecoins:

Similar to fiat-backed models, but reserves are in the form of cryptocurrencies (e.g., ETH). Due to the high volatility in crypto markets, these stablecoins typically use over-collateralization (e.g., 1 DAI requires $1.5 worth of ETH as collateral). These systems operate via smart contracts, with some projects governed by Decentralized Autonomous Organizations (DAOs), allowing users to participate directly in protocol adjustments. If collateral value falls below liquidation thresholds, forced liquidation occurs. If the stablecoin falls below $1, the system reduces supply to push the price back up, and vice versa.

3.  Algorithmic Stablecoins:

This model does not rely on reserves but instead uses algorithms to dynamically adjust the supply of tokens to maintain price stability. For instance, if the price falls below the target, the system automatically burns or locks up tokens to raise the value; if the price exceeds the target, more tokens are issued to bring the value down. This model is harder to operate successfully and depends on sound design and market consensus.

Advantages of Stablecoins

As digital tokens pegged to fiat or major assets, stablecoins offer unique conveniences to investors, traders, and everyday users. On the one hand, they combine the global accessibility and near-instant settlement of blockchain technology with the price stability of low-volatility assets like the U.S. dollar, enabling individuals and businesses to make everyday payments worldwide without worrying about exchange rate fluctuations or off-chain transfer delays. At the same time, stablecoins provide more flexibility in portfolio management: traders can instantly convert volatile assets into “digital cash” on the same chain to lock in profits, reduce portfolio risk, and seamlessly re-enter when new opportunities arise. This is especially critical in DeFi lending, cross-border e-commerce, and remittance scenarios—stablecoins have become an indispensable liquidity hub in the crypto ecosystem.

Disadvantages of Stablecoins

Stablecoins are not without risks. First, the peg stability is not guaranteed—historically, several projects have de-pegged or even collapsed to zero due to insufficient reserves or flawed mechanisms. Second, reserve transparency varies widely: not all issuers provide real-time audits, leaving token holders reliant on third-party attestations or trust in the team. Furthermore, fiat-collateralized models inherently depend on centralized custody, which is vulnerable to regulatory control and custodian manipulation; decentralized crypto-collateralized or algorithmic models heavily rely on community governance and market sentiment. If consensus falters, they also face systemic risks. Therefore, while stablecoins offer convenience, they also demand greater risk awareness and governance prudence from investors.