Stablecoins in the crypto ecosystem: how they work and why they are needed

A stablecoin is a cryptographic asset created with the goal of maintaining a constant value by pegging it to another financial instrument—be it a national currency, precious metals, or other assets. In highly volatile cryptocurrency markets, such tokens address a critically important task: providing stability and predictability, allowing market participants to plan their financial activities.

Currently, there are three main types of stablecoin structures: those backed by fiat currency, those relying on cryptocurrency reserves, and algorithmic models. The growing popularity and scale of stablecoins attract increased attention from financial regulators worldwide.

Why are stablecoins needed at all?

The world of cryptocurrencies is characterized by extreme instability. Bitcoin, Ethereum, and most altcoins demonstrate significant fluctuations in value, creating serious obstacles for their use in everyday transactions. Imagine: a coffee shop receives a payment in BTC equivalent to $5 today, and tomorrow the same amount of coins depreciates by half. Such swings make it impossible to conduct business on a crypto basis and manage income effectively.

Stablecoins solve this problem by reflecting the exchange rate of fiat currencies—dollars, euros, yen—or other stable assets, including gold and oil. They provide investors and traders with the opportunity to lock in profits without needing to convert funds back into traditional money, facilitate quick transfers within the blockchain, and manage volatility risks.

Mechanisms of pegging stablecoins to value

Each type of stablecoin uses its own method to maintain its exchange rate.

Fiat-backed systems

These stablecoins hold reserves of traditional currency (USD, GBP) in centralized accounts. For example, each TrueUSD (TUSD) token is backed by one US dollar. Users can convert dollars into stablecoins and back at an established 1:1 rate. TUSD employs a reserve verification system via Chainlink, allowing independent confirmation of full USD backing.

The advantage of this approach is the simplicity and reliability of the mechanism. The main drawback is centralization: collateral is held by a single issuer, requiring full trust in the organization and its compliance with financial regulations.

Crypto-backed solutions

Here, the collateral is the cryptocurrency itself. Due to the extreme volatility of crypto markets, such systems use over-collateralization—for example, creating 100 DAI requires depositing crypto assets worth $150.

DAI is the most prominent example. This token is pegged to the US dollar and operates on the Ethereum blockchain via the MakerDAO protocol. The system is managed by the community of MKR token holders, who vote on protocol parameters. Users create collateralized debt positions by locking crypto assets to obtain DAI.

The peg-maintenance mechanism is based on game theory: when DAI falls below $1, token holders are incentivized to return it and retrieve their collateral, reducing supply and raising the price. If DAI rises above $1, users are motivated to create new tokens, increasing supply and lowering the price.

Smart contracts fully manage this process, and users can audit the code themselves. However, the system depends on collective community decisions—if the DAO makes a poor decision, it could undermine stability.

Algorithmic stablecoins

The most experimental approach. These tokens do not hold reserves—instead, algorithms and smart contracts automatically manage supply. When the price drops below the target value, the system reduces the number of tokens in circulation through staking, burning, or buybacks. If the price rises above the target, new tokens are issued to decrease the value.

This is the most complex type to manage and the least common in application, as guaranteeing the peg through an algorithmic path is significantly more difficult.

Practical advantages

Use in daily operations. Stablecoins are suitable for settlements, salaries, and commercial transactions due to their preservation of purchasing power. A company can receive a payment and not worry that its value will halve tomorrow.

Blockchain technology ensures speed and transparency. Transferring stablecoins can be done to any part of the world in a compatible wallet within minutes, bypassing traditional banking systems. Risks of double spending and fraud are eliminated.

Portfolio hedging. Traders and investors reserve part of their funds in stablecoins to reduce overall volatility. This helps preserve liquidity for entering profitable positions and protects against sharp market crashes.

Ease of entry and exit. Selling a volatile asset for stablecoins keeps the trader within the blockchain ecosystem and allows quick reinvestment without converting to fiat.

Serious risks and limitations

Peg violation. History shows cases where stablecoins lost their connection to the target value. If the project fails to manage reserves or mechanics properly, the token can depreciate significantly and irreversibly.

Lack of transparency. Not all issuers publish full independent audits. Many are limited to periodic attestations conducted by private auditors on behalf of the issuers themselves. This does not guarantee that reserves actually exist in the claimed volume.

Centralization of fiat-backed systems. Collateral is held by a single entity subject to financial regulation and can be frozen, blocked, or redirected by regulators. Users are fully dependent on the reliability and integrity of the issuer.

Dependence on community governance. Crypto-backed and especially algorithmic stablecoins require active community participation in decision-making. Poor voting choices can lead to systemic failure.

Examples of implementation

DAI (MakerDAO). One of the most successful crypto-backed stablecoins. Pegged to USD on Ethereum. Managed by the decentralized organization MakerDAO, whose members hold the MKR token. The system uses over-collateralization and game theory mechanisms to maintain the $1 peg.

TrueUSD (TUSD). An independent fiat-backed stablecoin pegged to the dollar. The first to implement a real-time USD reserve verification mechanism, confirmed via Chainlink. This allows any user to independently verify full backing.

Regulatory status

Stablecoins attract the attention of regulators worldwide due to their unique combination of traditional finance and crypto technology. Since they are not purely speculative instruments but means of payment, they may fall under stricter regulation than regular cryptocurrencies.

Issuance of fiat-backed stablecoins in some jurisdictions requires a special license or approval from the central bank. Some countries are even developing their own centralized digital currencies (CBDC) based on similar principles.

Depending on your country’s legislation, stablecoins may be subject to general cryptocurrency regulation or require a separate legal status.

Final conclusions

Stablecoins have firmly established themselves in the crypto ecosystem and have become an indispensable tool for trading, investing, and payments. They are held on crypto exchanges, used for quick opening and closing of positions, serve as a store of value, and facilitate international transfers with minimal fees.

However, stablecoins remain crypto assets with their own risks. Some projects lose their peg, deplete reserves, or become involved in legal disputes. Therefore, before interacting with any stablecoin, conduct independent research, diversify assets, and do not rely solely on one instrument.

Important warning. This information is provided solely for educational purposes and does not constitute financial, legal, or investment advice. The value of crypto assets is highly volatile. Your investments may be completely lost. All investment decisions are made at your own risk and responsibility. Before performing any operations, consult qualified professionals.