Stablecoins work by pegging their market value to a stable asset. Because their value does not fluctuate as wildly as free-floating cryptocurrencies, they are more suited for use as a means of payment in everyday transactions and as store of value.  

Once a stablecoin has been issued and pegged to the stable asset, it is then made available to the public via a blockchain ledger, which records who owns it and any transactions they make with it. The value on the ledger is linked to the stablecoin, which means the owner can exchange their stablecoin back to fiat money easily and at the same price.  

Stablecoins are often utilized as a bridge between more volatile crypto assets and fiat currencies; crypto holders convert bitcoin or ether into a stablecoin and then to a fiat currency like the U.S. dollar, which can make it easier to spend their funds. 

Stabilizing its value makes it more likely for stablecoins to be used in everyday commerce than cryptocurrencies, but it’s not that simple. One of the key outstanding issues for stablecoins centers around just how they maintain that so-called stable value — that is, the mechanisms by which these pegs are controlled and how the value is backed by real value. 

Yes. Of hundreds of stablecoins in circulation, most are pegged to the U.S. dollar, but there are others pegged to commodities like gold or oil, other crypto assets, or a basket of fiat currency or cryptocurrencies. Some stablecoin issuers use an algorithm to adjust the stablecoin’s supply based on demand to help maintain prices stability. Though the math is complex, essentially more coins are issued when the price goes up and burned when the price falls. Whether algorithmic or asset-backed, most stablecoin schemes have not been tested under a stress scenario. The collapse of the algorithmic stablecoin Terra demonstrates that stablecoins are not insulated from broader crypto market volatility.

For stablecoins to remain truly stable, the issuer must make an enforceable commitment to issue and buy back the stablecoin at the current value of the asset to which it is pegged, as well as to hold assets backing the stablecoins in circulation as collateral so that they can be redeemed at any time. The risk they could pose to consumers or to markets generally if they are not adequately collateralized is a major concern to regulators. 

Collateralization is really important.  If a stablecoin is fully collateralized, it means for that every stablecoin in circulation, there a unit of its reference asset — U.S. dollars or gold, for example — held in reserve by the stablecoin issuer. In other words, the value of a fully collateralized U.S. dollar stablecoin with one million coins in circulation would be backed by one million dollars in cash and equivalents held in reserve by the stablecoin issuer. Of course, without regulation it can be difficult to know if the issuer of your stablecoin has provided proper collateralization. While some crypto firms have moved toward a voluntary “proof of reserves,” or “PoR,” but there is not yet an industry or government standard for doing this. 

Stablecoin regulation varies by country. As in the broader digital asset industry, regulation of stablecoins is extremely fragmented. Some prohibit the use of stablecoins for payments or prevent banks from issuing them, while others are proposing new regulations, from requiring issuers to have significant cash reserves or limiting issuance to licensed banks only.   

Certainly the wait-and-see approach from regulators has dramatically changed. Don’t blink an eye or you’ll miss a new regulator weighing in or refreshing their position. Many regulators have amended or are looking to amend existing rules to cover activities involving digital assets (U.K., Singapore, South Africa, Australia). In some circumstances, legislators have enacted or are looking to enact new digital-asset-specific regulations (EU, Switzerland, Gibraltar, U.S). 

Trying to navigate this jigsaw puzzle of regulation makes it incredibly challenging to innovate with legal certainty. Many markets, including the U.S and the U.K. are ramping up their regulatory efforts while in the EU, issuers are now subject to rigorous regulatory requirements such an obligation to hold reserves of assets and compliance with detailed rules covering governance, disclosure, conflict of interest, complaints handling mechanisms, the custody and investment of the reserve assets and planning for orderly wind-down.   

Yes, many are. Central banks have been eyeing the rise of both free-floating cryptocurrencies and stablecoins with concern because most believe that, if left unregulated, stablecoins have the potential to destabilize a financial system and risk another worldwide recession like we experienced in 2008. And without regulation, there’s concern from governments that they could also enable illicit financial activity like money laundering and tax evasion. 

Central bank digital currencies — which have been launched in the Caribbean and Nigeria and are being piloted in some of the world’s largest economies, including China, South Korea and Saudi Arabia, according to the Atlantic Council's CBDC tracker – would be equivalent in value to a country’s legal tender (dollar bills, for example). They are designed to be used the same way — as a form of digital money that can be used to pay for things, just like private stablecoins. But unlike private stablecoins, CBDCs would be issued by a country’s central bank (like dollar bills) and would carry the same guarantee as paper currency. Some major markets such as the EU are speeding up legislative efforts to issue a CBDC, while the U.S. on the other hand now prohibits the establishment, issuance and use of CBDCs in the U.S., citing risks to financial stability, individual privacy and national sovereignty. 

In 2019, the world was carefully watching developments related to a stablecoin project proposed by Meta (Facebook at the time). Though Meta has since abandoned the project, it left behind a legacy of increased global interest among financial institutions and heightened regulatory scrutiny in the digital asset space. 

The major stablecoins players are the issuers of Tether and USDC, the largest stablecoins by total value. Among the more recent entrants: PayPal, which launched its stablecoin in 2023, and Fiserv, which announced Monday a new digital asset platform anchored by its own stablecoin. Mastercard, meanwhile, announced Tuesday new capabilities and partnerships with many of these players to support multiple stablecoins on its network, scale new uses cases and more deeply embed security and compliance.  Some expect banks to launch their own stablecoins, or new digital versions of today’s commercial deposits. But even if banks don’t issue their own stablecoins, it’s likely there will be increasing integration of stablecoin-related services within traditional banks via crypto-bank partnerships.