Stablecoin Guide: Why Does the Crypto Market Need Such Assets?

Note: This is a detailed informational article. — Stablecoins are a type of cryptocurrency pegged to other assets such as fiat currencies or precious metals. — Stablecoins aim to provide price stability and reduce the inherent volatility risks in the cryptocurrency market. — Stablecoins are divided into three types: fiat-collateralized, crypto-collateralized, and algorithmic. — Due to their practicality and large market capitalization, regulators are beginning to pay attention to stablecoins.

Why Are Stablecoins Essential in the Crypto Ecosystem?

In the volatile world of cryptocurrencies, sharp price fluctuations are common. Bitcoin (BTC), Ethereum (ETH), and other tokens have been known for extreme volatility since their inception. While this creates opportunities for speculators, it also brings serious practical issues.

Imagine a coffee shop priced in BTC: today a cup costs $5 worth of BTC, but tomorrow, the BTC received could depreciate by 50%. Such drastic price swings make it difficult for businesses to plan cash flows, and consumers are reluctant to use unstable assets for daily payments.

Stablecoins emerged as a solution; they are carefully designed crypto assets intended to maintain a fixed value. Regardless of market turbulence, mainstream stablecoins like TUSD can anchor their value to reference assets, allowing users to enjoy the benefits of blockchain technology while maintaining price stability.

How the Three Stablecoin Mechanisms Work

Fiat-Collateralized Stablecoins: Simple and Reliable

Fiat-collateralized stablecoins hold actual fiat currency (such as USD or GBP) in reserves. For example, each TUSD token is backed by 1 USD held in a bank account. Users can convert fiat to stablecoins at a fixed rate at any time, and vice versa.

This model is the most straightforward but requires trust in the issuer. Stablecoin issuers must maintain real USD reserves off-chain and undergo regular public audits to prove their solvency.

Crypto-Collateralized Stablecoins: Complex Balancing

Crypto-collateralized stablecoins use different strategies: they use crypto assets as collateral. Due to the high volatility of crypto markets, these stablecoins typically require over-collateralization to prevent under-collateralization.

For example, DAI is the most well-known crypto-collateralized stablecoin on Ethereum, managed by the MakerDAO community. Creating 100 DAI requires staking $150 worth of crypto assets—i.e., a 150% collateralization ratio. Users lock cryptocurrencies in smart contracts, generate DAI tokens, and can freely use them: transfer, lend, or hold. To retrieve the collateral, they must repay an equivalent amount of DAI.

When DAI’s price drops below $1, market incentives encourage holders to redeem DAI for collateral, reducing circulation and pushing the price up. Conversely, when the price exceeds $1, it incentivizes users to create new DAI to increase supply and lower the price. This mechanism, maintained through game theory and algorithms, ensures long-term peg stability.

Algorithmic Stablecoins: The Most Innovative but Riskier

Algorithmic stablecoins are the most aggressive design among the three; they do not maintain any traditional reserves. Instead, algorithms and smart contracts directly control token issuance. This model is rare and difficult to manage.

When the price falls below the target (e.g., $1), the system reduces circulation through fixed returns, token burns, or buybacks. When the price rises, new tokens are issued to suppress the price. Theoretically elegant, but in practice, prone to losing control.

Core Advantages of Stablecoins

1. Making Daily Payments Feasible

The business world needs stability. Traditional cryptocurrencies are too volatile for everyday spending, but mainstream stablecoins maintain close ties to reference assets, making them reliable payment methods.

2. Blockchain Convenience + Fiat Currency Stability

Users can send stablecoins to any compatible crypto wallet worldwide (which can be created for free in seconds), eliminating double-spending and false transaction risks. This makes stablecoins suitable for a wide range of uses: from international remittances to smart contract payments.

3. Effective Portfolio Hedging Tool

Traders and investors use stablecoins to reduce overall risk exposure. During market downturns, converting some assets into stablecoins can lock in gains and keep dry powder, ready to buy back when prices rebound—this is known as a short-selling strategy. Stablecoins make entering and exiting positions convenient without converting to fiat.

Unavoidable Risks and Limitations

1. The Possibility of Losing the Peg

Although large projects have successfully maintained stability, many stablecoin projects face difficulties. If a stablecoin cannot maintain its peg, it may instantly devalue.

2. Lack of Transparency

Not all stablecoins publish regular full audits. Most only provide periodic attestations—conducted by private accountants on behalf of the issuer—which are less trustworthy than independent audits. Users find it hard to verify whether reserves truly exist.

3. Centralization Risks of Fiat-Collateralized Stablecoins

Fiat-backed stablecoins are generally more centralized than other cryptocurrencies. Collateral is managed by a single intermediary, which may be subject to financial regulation, giving the issuer significant control over the token. Users must blindly trust that the issuer holds the claimed reserves.

4. Community Governance Uncertainty

Crypto-collateralized and algorithmic stablecoins rely on community governance. Projects often adopt open decision-making mechanisms, giving users voting rights, but this means you need to actively participate or delegate decision-making to others—both approaches carry risks.

Real-World Stablecoin Cases

Crypto-Collateralized Example: MakerDAO’s DAI

DAI is the most well-known crypto-collateralized stablecoin, pegged to the US dollar, operating on Ethereum. The MakerDAO community manages the project through holding governance tokens MKR. MKR holders can propose changes and participate in voting. DAI uses over-collateralization to control volatility, with users managing collateralized debt positions (CDPs) via smart contracts. The entire process is automated and transparent.

Fiat-Collateralized Innovation: TrueUSD’s PoR Mechanism

TrueUSD (TUSD) is the first stablecoin pegged to the dollar with programmatic management and real-time reserve verification. Its USD reserves are verified via Chainlink’s Proof of Reserve (PoR) mechanism, allowing users to independently confirm that TUSD is fully backed by reserves.

Regulatory Attitudes Are Heating Up

Stablecoins are attracting increased attention from global regulators because they combine features of fiat currencies and cryptocurrencies. Designed to maintain price stability, they transcend speculative tools and facilitate low-cost, instant cross-border transactions. Some countries are even exploring issuing official government-backed stablecoins.

As a form of crypto asset, stablecoins may be subject to existing cryptocurrency regulations in your country. Issuing fiat-backed stablecoins may also require regulatory approval.

Conclusion

Today, it’s hard to find an investor or trader who hasn’t been exposed to stablecoins. They are often stored on crypto exchanges, helping users quickly seize new market opportunities. They also allow opening and closing positions without converting to fiat currency. Beyond trading and investing, stablecoins are used for payments and international transfers.

While stablecoins have become foundational in the crypto world and have driven the emergence of new financial systems, their risks should not be underestimated. Some stablecoin projects may fail to maintain their peg, misappropriate funds, or face legal actions. Despite their widespread use, they remain crypto assets with inherent risks.

To reduce risks, diversify your portfolio and conduct thorough research before trading.

Risk Warning and Disclaimer: This material is provided “as is,” without any guarantees, for general reference and educational purposes only. It should not be considered financial, legal advice, or a recommendation to purchase specific products/services. Consult relevant professionals yourself. This article is written by a third-party author, and the views expressed are solely those of the author. Digital assets are highly volatile, and investment returns are not guaranteed. You assume all responsibility for your investment decisions. For full terms, please refer to the relevant user agreement.