Most cryptocurrencies swing widely in price, which makes them awkward for payments. A stablecoin is a token that tries to avoid that by tracking something steady, almost always a national currency such as the US dollar. The promise is that one token can be exchanged for one dollar. Everything that matters about a stablecoin comes down to how credible that promise is.
Four ways to hold a peg
Stablecoins differ mainly in what stands behind them.
- Fiat-backed tokens are supported by reserves of cash and short-term government debt held by the issuer. They are the largest category.
- Crypto-backed tokens are supported by other crypto assets locked up worth more than the tokens issued, a cushion against price falls.
- Algorithmic tokens rely on software rules that expand or shrink supply to defend the peg, often with little or no reserve.
- Commodity-backed tokens hold assets such as gold.
In a fiat-backed design, a customer pays dollars to the issuer, receives tokens and can later hand them back for dollars. The peg holds as long as people believe that redemption will work. If they doubt it, they rush to redeem, and the issuer needs enough liquid reserves to pay everyone at once, a situation that resembles a run on a bank.
What the 2022 collapse showed
The most dramatic test of the algorithmic approach came in May 2022, when TerraUSD lost its dollar peg. TerraUSD was designed to hold its peg through an algorithm linked to a companion token, LUNA, rather than through reserve assets. When the peg broke, the price of both tokens fell close to zero, and the US Securities and Exchange Commission’s complaint puts the losses at at least 40 billion dollars of market value. The agency sued Terraform Labs and its founder in 2023, and in April 2024 a jury found them liable for defrauding investors.
The case is not evidence that every stablecoin will fail. It is evidence that a peg with no reserve behind it depends entirely on confidence.
How the rules now differ
Regulators have moved to fill the gap. In the United States, the GENIUS Act, signed into law on 18 July 2025, creates a federal framework for payment stablecoins. Summaries of the law describe requirements for issuers to back tokens one-to-one with narrow categories of reserve assets, including cash, insured bank deposits, short-term Treasury securities and certain overnight lending against Treasuries, and to publish reserve reports regularly. Holders must be able to redeem at par, and the law says payment stablecoins cannot be presented as backed by the US government or covered by federal deposit insurance. Treasury has been drafting implementing rules, and it has said it expects the law to take effect on 18 January 2027.
The European Union moved earlier. Under its Markets in Crypto-Assets Regulation, the rules for stablecoin issuers, which the law calls asset-referenced tokens and e-money tokens, applied from 30 June 2024. Holders of an e-money token have the right to redeem it from the issuer at face value in the currency it references, and issuers of asset-referenced tokens must maintain a reserve of assets and publish its value and composition monthly.
For users, the upshot is that a stablecoin’s risk now depends partly on where it is issued, and on whether the issuer is licensed under rules like these.
What central bankers say
The Bank for International Settlements, the central banks’ bank, took a skeptical line in its 2025 annual report. It tested stablecoins against three properties it expects of money: singleness, meaning acceptance at par with no questions asked; elasticity, meaning the ability to supply money flexibly; and integrity, meaning resistance to financial crime. Its conclusion was that stablecoins fall short of all three and cannot be the mainstay of the monetary system. The BIS allows that, if adequately regulated, they may play a subsidiary role, and it describes their main role so far as a gateway to the crypto ecosystem.
What a holder should check
Before using a stablecoin, ask who issues it and under which regulator, what exactly backs it and whether the reserves are verified independently, whether ordinary holders can redeem directly and at what cost, and how the token behaved in past periods of market stress. Bank deposits carry deposit insurance in many countries, while stablecoins generally do not.
Stablecoins also overlap with other ways of moving money. Banks have been building faster systems, as described in our explainer on instant payments, and the idea of representing other assets as tokens is covered in our guide to tokenized assets.
This is general information, not financial, investment, tax or legal advice.
