What is a stablecoin? Crypto pegged to the dollar

A stablecoin is a crypto token designed to keep a steady price, almost always one US dollar. It moves on a blockchain like any other token, but someone promises, or some piece of code tries, to keep each one worth exactly $1. What sits behind that promise is the whole story: cash and government bonds, other crypto, or nothing but an algorithm.

In short

• A stablecoin is a token meant to be worth a fixed amount, usually $1, so people can hold and move dollars on a blockchain.
• It holds its peg only if holders believe they can swap it for a dollar's worth of something real, whenever they want.
• Coins backed by cash and short-term bonds have mostly held; the best-known algorithmic coin, TerraUSD, collapsed in May 2022.

Why do stablecoins exist?

Most cryptocurrencies swing in price by several percent in a day, which makes them awkward to price things in or to park money in between trades. Bitcoin can lose a fifth of its value in a week. A stablecoin gives crypto users a dollar that lives on the same networks as everything else they use, so they can move between tokens, settle a trade or send money abroad at any hour without going back through a bank.

That is why stablecoins became the plumbing of crypto trading and of decentralized finance. In 2025 the two largest were Tether's USDT and Circle's USD Coin (USDC), both pegged to the dollar, according to the Bank for International Settlements. Some people outside the United States also hold them as a way to keep savings in dollars when their own currency is losing value.

How does a stablecoin keep its price at $1?

The price holds through redemption. If a company will always give you $1 for one token, nobody sensible sells it for much less, because a trader can buy it at $0.99, redeem it for $1, and pocket the difference. If it trades above $1, the issuer can create new tokens for $1 each and sell them. That arbitrage, buying cheap and redeeming at face value, pulls the price back to the peg.

So a stablecoin is only as good as the claim behind it. The Federal Reserve's economists, in a 2022 note on stablecoin design, sort them into three kinds by what backs that claim.

Design	What backs each token	Examples	What can go wrong
Off-chain collateral	Dollars, bank deposits and short-term government bonds held by a company	Tether (USDT), USD Coin (USDC)	The reserves are smaller, riskier or harder to reach than claimed
On-chain collateral	Other crypto locked in smart contracts, usually more than $1 per token	Liquity USD (LUSD), Dollar on Chain	The collateral falls in value faster than it can be sold
Algorithmic	Little or nothing; code expands and shrinks the supply	TerraUSD (UST), Ampleforth	Confidence breaks and the mechanism spirals

The first kind is the most common by far. It works like a money market fund with a token on top: the issuer holds the reserves and promises redemption. The second kind replaces trust in a company with overcollateralization, holding perhaps $150 of crypto for every $100 of tokens so that a price drop can be absorbed. The third tries to need no reserves at all.

What happened to TerraUSD?

TerraUSD (UST) was an algorithmic stablecoin paired with a second token, LUNA. The rule was that 1 UST could always be swapped for $1 worth of newly created LUNA, and $1 of LUNA for 1 UST. If UST slipped below $1, traders could buy it cheap, swap it for $1 of LUNA, and sell the LUNA. Burning UST in the swap would shrink its supply and push its price back up.

Walk through the numbers and the weakness shows. With LUNA at $80, swapping 1 UST creates 0.0125 LUNA. As people rushed to exit, more UST was swapped, LUNA's supply grew, and its price fell. At $1 a LUNA, one UST created 1 new LUNA. At 10 cents, it created 10. Every exit created more LUNA to sell, which pushed LUNA down further, which meant each swap had to create still more. The peg rested on LUNA's price, and LUNA's price rested on faith in the peg.

Demand had been swollen by a lending program called Anchor, which advertised yields of up to 20% on UST deposits, according to the US Securities and Exchange Commission. In May 2022, large withdrawals pushed UST below $1, the swaps began, and within days both UST and LUNA were worth close to nothing. The SEC charged Terraform Labs and its founder, Do Kwon, with fraud in February 2023. Its fall opened a year of crypto failures that ended with the collapse of FTX that November.

Are reserve-backed stablecoins safe?

They are safer than algorithmic ones, not risk-free. The risk is in the reserves and in whether holders can get at them. In October 2021, the US Commodity Futures Trading Commission fined Tether $41 million, finding that from 2016 to 2018 its reserves fully covered the tokens in circulation on only 27.6% of the days it sampled, though it had told users they were 100% backed (CFTC).

Even well-run reserves can wobble. In March 2023, Circle disclosed that about $3.3 billion of USDC's reserves were held at Silicon Valley Bank, which regulators had just closed, and USDC briefly fell below 87 cents until it was clear the deposits were safe (CNBC). A stablecoin backed by a bank deposit inherits that bank's risk, much as ordinary money in a bank account does, but without deposit insurance for the token holder.

How are stablecoins regulated?

The rules are new and still being written. In the United States, the GENIUS Act became law on 18 July 2025 (Public Law 119-27). It requires payment stablecoin issuers to hold at least one dollar of safe reserves, such as cash, insured deposits and short-term Treasury bills, for every token they issue, and to publish what those reserves are every month. It takes effect 18 months after it was signed, in January 2027, or 120 days after regulators issue their final rules, whichever comes first. The European Union regulates stablecoins under its Markets in Crypto-Assets rules, known as MiCA.

Regulators care for two reasons. A run on a large stablecoin could force a fire sale of the Treasury bills behind it. And tokens that move across borders without a bank in the middle are attractive for evading sanctions and laundering money.

Still argued

Supporters say well-reserved stablecoins make dollar payments faster and cheaper and extend the dollar's reach. The Bank for International Settlements argued in its 2025 annual report that they fail the basic tests for the core of a monetary system: each coin is a claim on one private issuer, supply can't expand on demand, and holders are often anonymous. Whether they draw deposits away from banks is also disputed. This note explains how stablecoins work; it isn't advice to hold any of them.

Check yourself

• Without looking back, explain how redemption pulls a stablecoin's price back toward $1.
• Why did each UST swapped for LUNA make the next swap worse?
• What risk remains even for a stablecoin fully backed by cash in a bank?

Sources

• The stable in stablecoins — Board of Governors of the Federal Reserve System, 2022
• SEC charges Terraform and CEO Do Kwon with defrauding investors — U.S. Securities and Exchange Commission, 2023
• CFTC orders Tether and Bitfinex to pay fines totaling $42.5 million — U.S. Commodity Futures Trading Commission, 2021
• Stablecoin USDC breaks dollar peg after firm reveals it has $3.3 billion in SVB exposure — CNBC, 2023
• Public Law 119-27, the GENIUS Act — U.S. Government Publishing Office, 2025
• The next-generation monetary and financial system — Bank for International Settlements, Annual Economic Report 2025