Types of Stablecoins and How They Work

Types of Stablecoins and How They Work

8 min read

While other cryptocurrencies can be a bit of a rollercoaster, stablecoins aim for a smoother ride. They do this by pegging their value to more predictable assets, like fiat currencies or precious metals. Think of them as the U.S. dollar or the Euro of the crypto world—reliable and less prone to wild swings.

Now, why does this matter? Well, the utility benefits of cryptocurrencies are hard to ignore. We’re talking about quicker financial transfers, cheaper international transactions, and broader access to financial services. But let’s face it: not everyone has the stomach for the ups and downs of Bitcoin or Ethereum. That’s where stablecoins come in, bridging the gap between the stability of fiat currencies and the utility advantages of cryptocurrencies.

The buzz around stablecoins isn’t just confined to crypto enthusiasts. Traditional market investors and even regulators are starting to pay attention. So, whether you’re a crypto newbie or a seasoned investor, understanding the different types of stablecoins can give you a solid foundation in this emerging asset class.


Important Use cases for Stablecoins

stablecoins use case

You might wonder, “Okay, they’re stable, but what can I do with them?” Well, you’re in for a treat because stablecoins are incredibly versatile. Let’s break down some of their most important use cases:


Lowering Transaction Fees with Stablecoin Payments

If you’re a business owner, you’re likely familiar with the sting of transaction fees from financial institutions on fiat money transactions. You can significantly reduce those fees by accepting different stablecoin payments like fiat-backed stablecoins or crypto-backed stablecoins. It’s a win-win for your bottom line and your peace of mind.

Further Reading: Why Bitcoin Is No Longer King of Cryptos for Payments


24/7 Settlements in the Crypto Economy

In a world that never sleeps, why should your financial transactions? Stablecoins, operating on blockchain’s smart contracts, offer around-the-clock financial settlements. No more waiting for ‘banking hours’ to move your digital assets.


Affordable Cross-Border Remittances

High fees for international money transfers are a real pain, especially for overseas workers. Stablecoins, with their inherent price stability, offer a cost-effective alternative. Whether you’re using USD Coin or other popular stablecoins, you can send money globally without the hefty fees usually charged by off-chain financial institutions.

So, whether you’re navigating the business landscape, making international connections, or sending some love back home in money, stablecoins offer a versatile and cost-effective solution.


Types of Stablecoins

types of stablecoins


Fiat-Backed Stablecoins

When you think of stablecoins, the first type that probably comes to mind is fiat-backed stablecoins. These are the closest relatives to traditional fiat currencies like the U.S. dollar. For every fiat-backed stablecoin in circulation, a financial institution holds an equivalent amount of fiat currency in reserve. This one-to-one ratio ensures the stablecoin’s value remains, well, stable.

Popular examples include Tether (USDT) and USD Coin (USDC).


Commodity-Backed Stablecoins

Ever thought of owning gold but didn’t want to deal with the hassle of storing it? Commodity-backed stablecoins have got you covered. These stablecoins are backed by real-world assets like gold, precious metals, or even real estate.

Paxos Gold (PAXG) and Tether Gold (xAUT) are stablecoins that allow you to dip your toes into the gold market without owning physical gold bars.


Crypto-Backed Stablecoins

Crypto-collateralized stablecoins are a bit more complex but equally fascinating. Instead of relying on a central financial institution, these stablecoins use smart contracts to hold cryptocurrency reserves. For instance, if you’re a fan of Ethereum, you can lock it up in a smart contract and receive an equivalent amount in stablecoins like DAI.


Non-collateralized or Algorithmic Stablecoins

Last but not least, we have algorithmic stablecoins. These are the mavericks of the stablecoin world, as they don’t necessarily rely on collateral. Instead, they use computer algorithms to adjust their supply based on market demand automatically.

If the price goes above or below a certain target, the algorithm kicks in to either issue more tokens or reduce the supply, maintaining price stability.

These are four main types of stablecoins, each with its unique approach to maintaining value and offering utility in the crypto market.


Stablecoin Collaterals: What Backs Your Stablecoin?

The Traditional Route: Fiat Collateral

When it comes to stablecoins, the most straightforward collateral is good ol’ fiat currency. Think dollars, euros, and the like. These off-chain currencies are safely tucked away in a bank account and serve as the backbone for the stablecoin’s value. Thanks to a redemption mechanism, users can swap fiat-collateralized stablecoins for their fiat counterparts at any time on a 1:1 basis. So, if you’re holding a stablecoin pegged to the U.S. dollar, you can trade it for an actual dollar in a bank account.


The Digital Dynamo: Digital Asset Collateral

Now, let’s talk about crypto assets—those tokens that exist naturally on blockchain networks. These assets can serve as collateral for minting stablecoins.

But here’s the catch: Users must put in more than the stablecoin’s face value in digital assets. This means that crypto-backed stablecoins require overcollateralized design to ensure stability. Why? Because digital assets can be a rollercoaster of volatility. So, to keep things stable, these stablecoins are overcollateralized, ensuring their value is always at least 1:1.


The Tangible Touch: Commodity Collateral

Last but not least, we have commodities like metals, crops, and even energy sources. These are real-world assets, just like fiat, but they often require a redemption mechanism to maintain stability. Gold is the star player here, with platforms like Pax Gold letting anyone own tokenized gold that can be redeemed for the real thing.

So, whether it’s a dollar in a bank, a digital asset on a blockchain, or a gold bar in a vault, there’s a type of collateral for stablecoins. Each comes with its own set of rules and perks, but all aim to keep your stablecoin as steady as a rock.


Stablecoins vs. CBDCs: What’s the Difference?

stablecoins vs cdbc


While both stablecoins and Central Bank Digital Currencies (CBDCs) leverage blockchain technology, they are far from identical twins. Let’s dive into the key distinctions that set them apart.


Legal Landscape

One of the most glaring differences lies in their legal status. CBDCs are still largely theoretical constructs among central banks, although more countries are starting to create them. On the other hand, stablecoins are gaining legal recognition, especially in the United States and Europe. This comes with additional regulations, such as proof of reserves and wallet transparency, to mitigate fears of depegging.



CBDCs are centralized by design, meaning they are issued and governed by a central bank. Stablecoins, however, offer more flexibility. Both regulated banks and non-bank entities can issue them. Governance-wise, stablecoins can also be managed by various entities, not just central banks.


The Tech Under the Hood

CBDCs, being products of centralized banking systems, would likely use permissioned or proprietary technology. Stablecoins, in contrast, can operate on multiple open-source, non-proprietary, and permissionless blockchains. This gives stablecoins the added advantage of leveraging the distributed ledger technology inherent in blockchain.


Geographic Scope

Stablecoins are global citizens; geographic boundaries do not confine them and can be used anywhere in the world. CBDCs, however, are primarily designed for domestic use, although they may have cross-border capabilities. In short, stablecoins offer global convenience, while CBDCs are more region-specific.


Where to Keep Them

Stablecoins can be stored in any digital wallet that’s compatible with the currency in question. CBDCs, on the other hand, would likely require a proprietary wallet solution, issued either by the government or authorized banking intermediaries.

So, whether you’re considering stablecoins or CBDCs, understanding these key differences can help you make an informed choice. Each has its advantages and limitations, but both aim to revolutionize how we think about digital currency.


Stablecoins Risks You Should Know

Stablecoins may offer a sense of security, but they’re not without their risks.


The Depegging Dilemma

One of the most significant risks is the potential for a stablecoin to depeg from its target asset. This can happen due to various factors, such as liquidity events, “bank run” scenarios, or suboptimal reserve practices. When a stablecoin depegs, its value can fluctuate, defeating its primary purpose of stability.


Navigating the Regulatory Maze

Stablecoins are subject to different regulatory frameworks depending on their geographic location. Local financial institutions may impose specific regulations, adding another layer of complexity and risk for stablecoin users.


The Centralization Conundrum

Some stablecoins are issued by centralized entities, meaning they can freeze tokens at specific wallet addresses. This centralization risk can be a concern for those who value the decentralized nature of cryptocurrencies.


Hold the Keys: Key Management Risk

If you’re using a non-custodial wallet to store your stablecoins, the responsibility for key management falls squarely on your shoulders. Losing access to your private keys means losing access to your funds, making secure storage crucial.

So, while stablecoins offer a more stable alternative to traditional cryptocurrencies, they come with their own set of risks. Knowing these risks can help you make more informed decisions and safeguard your digital assets.


Unlock the Power of Crypto Payments with CoinPayments

coinpayments crypto payments

CoinPayments is a leading global crypto payment gateway. With support for popular stablecoins and over 100 altcoins, we offer businesses a seamless way to accept crypto payments. Why limit yourself when you can expand your payment options and grow your business globally?

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