Stablecoins are digital currencies engineered to maintain a steady value by being pegged to assets like the U.S. dollar or gold. Think of them as combining the best of both worlds - the speed and innovation of the blockchain, without the wild price swings that make Bitcoin and other coins challenging to use in everyday life.
Why They Matter
For Daily Transactions and Commerce
Stablecoins are revolutionizing how we move money around the globe. Traditional international transfers can take days and cost a fortune in fees, while credit card processors charge merchants hefty percentages. Stablecoins solve these problems by enabling near-instant transfers worldwide at minimal cost. Whether you're paying for services, sending money to family abroad, or setting up recurring payments, they provide the perfect blend of digital efficiency and price stability.
For Traders
Traders love stablecoins because they're a safe place to park money between trades - all while staying on the blockchain. No more hassle of converting back to dollars and moving money off exchanges. Plus, many stablecoins offer seriously competitive yields through DeFi protocols, beating traditional bank rates by a mile.
The Market Today
The stablecoin market has become a cornerstone of the crypto ecosystem, now representing $224B in value (Feb 2025). As blockchain technology continues to reshape finance, stablecoins serve as a crucial bridge between traditional currency and digital innovation.
So how do they work? Let's look at the four main types of stablecoins and what makes each one unique: fiat-backed, crypto-backed, commodity-backed, and algorithmic stablecoins. Each has its own pros and cons depending on what you're looking for.
What Keeps a Stablecoin Stable?
Every stablecoin uses a mechanism designed to keep its price steady - much like how central banks work to maintain stable national currencies. These mechanisms vary in complexity and reliability, from simple dollar backing to sophisticated algorithms. When evaluating different stablecoins, understanding these stability mechanisms is crucial because they determine how well the coin will hold its value during market stress.
Think of it like this: a stablecoin is only as good as its ability to maintain its peg. The strongest stablecoins have proven they can stay stable even during crypto market crashes or high-volume trading days. The weaker ones might work fine in normal conditions but risk breaking their peg when markets get turbulent.
The key difference lies in their stability mechanisms, which broadly fall into these categories:
Fiat-Backed Stablecoins
Fiat-backed stablecoins are crypto coins backed by traditional currency like the U.S. dollar. The value of a coin is pegged to the value of a U.S. dollar in a 1:1 ratio. Theoretically, all fiat-backed stablecoin issuers should hold 1 U.S. dollar in reserve for each coin that has been issued. And when a coin is exchanged for an equivalent U.S. dollar, the coin must be removed from circulation (“burned”). In this manner, stablecoin issuers can control the coin supply in response to demand.
Fiat-backed stablecoins are both simple and popular. The largest fiat-backed stablecoins are Tether (USDT) by Tether Limited, USD coin (USDC) by Circle and Coinbase, Binance USD (BUSD) by Binance, Gemini dollar (GUSD) by Gemini, and Pax dollar (USDP) by Paxos. Because these stablecoins are pegged directly to the U.S. dollar and could potentially affect the value of the dollar, they are more regulated than many of the other types of stablecoin. In fact, USDC, GUSD, and USDP are audited by independent accounting firms.
Depending on your perspective, the regulatory environment surrounding fiat-backed stablecoins may be considered a positive or a negative. Some consider government regulation as a positive because it leads to increased transparency. However, others disagree, arguing that government regulation introduces external control into the blockchain network.
So, while fiat-based stablecoins offer advantages such as relative stability and limited price fluctuation, their existence also violates many of the principles adopted by blockchain purists. For example, the companies that issue fiat-backed stablecoins maintain central control over the supply side of the coin. But decentralization is one of the core principles that led to the creation and adoption of the blockchain network. This dichotomy has led some to question whether fiat-backed stablecoins are even a viable concept within the blockchain network. After all, cryptocurrency was created to replace fiat money, not to embrace it.
Here are some of the pros and cons of fiat-back stablecoins to keep in mind:
Crypto-Backed Stablecoins
Crypto-backed stablecoins use cryptocurrency as collateral instead of fiat money. The exchange process (from crypto to stablecoin and vice versa) is executed with the help of smart contracts. For example, when purchasing a crypto-backed stablecoin, “you lock your cryptocurrency into a smart contract to obtain tokens of equal or less representative value. You can then put your stablecoin back into the same smart contract to withdraw your original collateral amount.” Crypto-backed stablecoins are typically over-colateralized, meaning that excess crypto is held in reserve to back up each stablecoin. This is necessary to protect against volatility. For example, cryptocurrency worth $1 million might be held in reserve in order to purchase $500,000 worth of stablecoin. In this instance, the value of the crypto could decline by 50% and not affect the price stability of the stablecoin.
The largest crypto-backed stablecoin is DAI, created and maintained by the Maker Protocol. DAI is pegged to the U.S. dollar and is run entirely on the blockchain. It is built on the Ethereum chain and uses several types of crypto as collateral such as ETH and USDC. The primary benefit of using DAI is that it is decentralized and autonomous, meaning that there is not a single person or company that can control it. Additionally, it is built on-chain and does not require users to move their assets off the blockchain to gain price stability. Due to its decentralized and autonomous nature, DAI is also less susceptible to government regulation. For these reasons, DAI is the stablecoin of choice for many blockchain purists. However, crypto-backed stablecoin like DAI do come with some potential downsides. Crypto-backed stablecoin have made significant progress toward achieving price stability, but they have not eliminated the risk of volatility. A rapid devaluation of the collateral cryptocurrency could still threaten the stability of a coin like DAI. In fact, DAI nearly unpegged from the U.S. dollar in March 2020 when ETH lost a third of its value in a single night. Similarly, crypto-backed stablecoins are not immune to price fluctuations. DAI has ranged in price from $1.10 to $.90 during brief periods.
Commodity-Backed Stablecoins
Commodity-backed stablecoins differ from other types of stablecoin in that they use commodities rather than currency as collateral. Typically, the collateral is a precious metal such as gold, silver, or palladium, however, there are also stablecoins that use real estate and oil as well. The most popular type of commodity-backed stablecoins use gold as collateral and the administrators of the coin store gold bars in bank vaults or security deposit boxes for coin holders. For example, stablecoins such as Paxos Gold (PAXG), Tether Gold (XAUT), and Perth Mint Gold (PMGT) are pegged so that one coin is equal to one ounce of gold. And coins are redeemable for currency or a physical amount of gold. PAXG can be redeemed for gold bars in the United Kingdom, XAUT in Switzerland, and PMGT in Australia.
Unlike fiat and crypto-backed stablecoins, commodity-backed stablecoins are collateralized by a tangible asset with real value. And ideally, the selected commodity should increase in value over time. And gold, for example, has a long history as a currency reserve, having served that purpose for centuries. Commodity-backed stablecoins also have some negatives to keep in mind, however. All commodities fluctuate in price over time, which might make it difficult to predict the value of commodity-backed stablecoins into the future. Physical commodities other than real estate also require storage. Storage and other fees can sometimes diminish or eliminate the profits that holding the commodity over the long-term might otherwise produce. And finally, a commodity like gold can be fairly easy to fake with tungsten, for example, especially if the stablecoin holder does not have the expertise required to tell the difference between precious metals of similar appearance.
Algorithmic Stablecoins
As the name implies, algorithmic stablecoins use an algorithm to maintain price stability. The exchange process from crypto to stablecoin and vice versa stays on the blockchain and is self-executing through the use of smart contracts. Like many of the other stablecoins mentioned previously, algorithmic coins are most commonly pegged to the U.S. dollar. But unlike the other types of stablecoin that depend on collateral to maintain their price, algorithmic stablecoins accomplish stability by manipulating the supply of total coins in circulation. Typically, the algorithm will remove coins from circulation (by purchasing them) when the coin price drops too low and increase coin supply when the price rises too high. It is important to note that some algorithmic stablecoins are also collateralized. For example, the previously mentioned DAI coin is both controlled by an algorithm and uses cryptocurrency as collateral.
The most popular algorithmic stablecoins available today are DAI by MakerDAO, Magic Internet Money (MIM), Frax (FRAX), and Mai (MAI). The primary benefits provided by these coins involve their decentralized and trustless nature. Smart contracts control the currency exchange, the algorithm maintains the peg, and the entire process exists on-chain. Theoretically, algorithmic stablecoins are less exposed to human error and human intervention as compared to some of the other types of stablecoin. As a result, algorithmic stablecoins are preferred by many blockchain purists. Unfortunately, they have some structural weaknesses that have led to problems. As the demise of terra USD (UST) clearly showed, algorithmic stablecoins can become unpegged when demand falls rapidly. Small movements away from the U.S. dollar peg can lead to panic selling and eventual collapse. As a result of the negative PR surrounding the UST demise, many government officials have started calling for increased stablecoin regulation.
Yield-Bearing Stablecoins
A new category of stablecoins is emerging with the creation of yield-bearing stables.
Unlike traditional stablecoins that simply hold value, these stablecoins generate returns for holders by earning yield from on-chain lending, staking, or other yield-generating mechanisms. The most notable example is PayPal’s PYUSD, a fully regulated stablecoin backed by U.S. dollar deposits and short-term treasuries, designed to offer both price stability and potential returns.
For businesses, yield-bearing stablecoins create new opportunities for treasury management and capital efficiency. Instead of holding idle cash, companies can park funds in stablecoins that generate passive yield while maintaining liquidity for operations. DeFi protocols like Aave, Compound, and MakerDAO also offer enterprise-grade lending and borrowing solutions for stablecoins, further expanding their utility beyond payments and trading.
However, these stablecoins come with their own risks, including regulatory uncertainty, regional restrictions, and potential exposure to the performance of underlying assets. Businesses must carefully assess risk profiles, particularly when using them for long-term treasury strategies.
How Bitwave Supports Stablecoin Adoption for Businesses
At Bitwave, we help businesses harness the power of stablecoins for payments, treasury management, and financial reporting with the same level of control and compliance they expect from traditional financial tools.
Our platform automates stablecoin transaction tracking, accounting, and tax reporting by seamlessly integrating with leading ERPs (like NetSuite, Sage, Xero, and Quickbooks).
Whether you’re using stablecoins to pay vendors, manage payroll, or optimize cross-border transactions, Bitwave ensures that every transaction is properly accounted for and easy to reconcile. As stablecoin adoption continues to grow, Bitwave is the trusted partner for enterprises looking to streamline operations and unlock the full potential of on-chain finance.
Disclaimer: The information provided in this blog post is for general informational purposes only and should not be construed as tax, accounting, or financial advice. The content is not intended to address the specific needs of any individual or organization, and readers are encouraged to consult with a qualified tax, accounting, or financial professional before making any decisions based on the information provided. The author and the publisher of this blog post disclaim any liability, loss, or risk incurred as a consequence, directly or indirectly, of the use or application of any of the contents herein.
