What Is a Stablecoin? How It Works and How It Differs From Bitcoin

Key takeaways

• A stablecoin is a crypto token built to hold a steady value, usually one US dollar. Bitcoin makes no such promise.
• The peg relies on reserves held by an issuer, the right to redeem tokens for dollars and traders who profit when the price drifts.
• Designs differ in what stands behind the token: cash and short-term securities, other crypto, or an algorithm. The algorithmic kind has failed badly.
• A stablecoin is not a bank deposit. The main risks are reserve quality, issuer failure, a lost peg and the issuer’s power to freeze tokens.
• Bitcoin has a fixed supply and no issuer. A stablecoin has an issuer and a dollar price, so it inherits the dollar’s inflation.

What is a stablecoin?

A stablecoin is a cryptocurrency token designed to hold a steady price, most often one US dollar per token. People use one to move or park value on a blockchain without riding the swings of an asset like bitcoin.

Bitcoin’s price moves a lot, for reasons covered in Why Is Bitcoin So Volatile? A stablecoin tries to remove that movement by tying its value to something outside crypto, nearly always the dollar.

A gift card is a fair comparison. The plastic has no value of its own. It is worth $25 because a store has promised to accept it for $25 of goods. A stablecoin is a similar promise, made by an issuer and recorded on a blockchain, and it is only as good as the assets behind it.

How does a stablecoin keep its value?

A stablecoin keeps its value through reserves, redemption and arbitrage working together. The one-dollar price is a target the design defends, not a law of nature.

• Reserves. The issuer holds assets meant to be worth at least as much as the tokens in circulation.
• Redemption. Eligible customers can hand tokens back to the issuer and receive dollars. Direct redemption is often limited to approved or larger customers, so most holders simply sell on an exchange.
• Arbitrage. Traders buy and sell to profit from small price gaps, and that trading pulls the price back toward the target.

An illustration shows the loop. Suppose a token slips to 98 cents on an exchange while the issuer will redeem it for a dollar. A trader with redemption access can buy at 98 cents, redeem for a dollar and keep the difference, and that buying pushes the market price back up. Above a dollar, the logic runs in reverse: a trader deposits a dollar, receives a new token and sells it.

The loop depends on trust. If people doubt the reserves or the issuer’s ability to pay, buyers stop stepping in and the price can fall below a dollar. That break is called a depeg.

What types of stablecoins are there?

Stablecoins are usually grouped by what stands behind them: cash and short-term securities, other crypto, or an algorithm.

Type	What stands behind it	Main weakness
Fiat-backed	Cash and short-term securities held by an issuer	Trust in the issuer, and in the quality and safekeeping of the reserves
Crypto-backed	Other crypto locked in smart contracts, worth more than the tokens issued	Collateral can fall fast and force sales; software bugs
Algorithmic	Code and market incentives, often with a companion token, and little hard backing	Confidence can vanish and the design can spiral

Fiat-backed tokens are the best-known kind. The reserves are meant to match the tokens one for one, and some issuers publish reports on them, though the detail and independence of those reports differ.

Crypto-backed tokens are usually overcollateralized, meaning more than a dollar’s worth of crypto is locked for each token. The cushion exists because the collateral can lose value, and if it falls too far, the system sells it automatically.

Algorithmic designs lean on code and incentives instead of reserves. In May 2022, a large algorithmic stablecoin lost its dollar peg and collapsed within days, and the companion token meant to support it collapsed too. Holders suffered large losses, and wider stress followed in crypto markets. It is the standard cautionary example of a peg that rested on confidence alone.

What are the risks of holding a stablecoin?

The main risks are reserve quality, issuer failure, a lost peg, no deposit insurance, freezing and changing rules. Holding a stablecoin swaps price risk for counterparty risk: you stop relying on the market and start relying on a company.

• Reserve quality. Cash is safer than assets that can lose value or be hard to sell quickly. Ask what the reserves hold and who checks.
• Issuer failure. If the issuer fails, holders may become creditors in a legal process, with no guarantee of a dollar per token.
• A lost peg. Even tokens with cash-like reserves have briefly traded below a dollar in a panic. Algorithmic ones can fail for good.
• No deposit insurance. A stablecoin is not a bank deposit. FDIC deposit insurance covers eligible deposits at insured banks, not tokens, and https://www.fdic.gov/ explains how it works. Bitcoin Bank Accounts and Savings makes the same point for crypto in general.
• Freezing. Many issuers can freeze tokens at specific addresses. They say this lets them respond to court orders, hacks and sanctions, but it also means your tokens depend on the issuer’s decisions. Bitcoin held in your own wallet cannot be frozen by any company, a central theme of The Power of Self-Custody.
• Rules. US federal legislation for payment stablecoins, known as the GENIUS Act, was passed in 2025. Details and effective dates change, so check current rules from official sources. Is Bitcoin Regulated in the US? gives the wider context.

What are stablecoins used for?

People mainly use stablecoins to move money between exchanges, to make payments and to hold dollars where dollar accounts are hard to get.

• Moving money between exchanges. Traders keep value in a dollar token between trades, and tokens can move at any hour, including weekends.
• Payments. A dollar token can be sent across borders or paid online without bitcoin’s price swings, though the recipient usually still has to convert it into spendable local money. How to Spend Bitcoin covers payment routes and the tax catch for bitcoin, and some of the same questions apply to a dollar token.
• Dollar access abroad. In some countries, people use stablecoins to hold dollar-like value when the local currency is unstable. Local laws on this differ.

Taxes still apply. Trading bitcoin for a stablecoin is generally treated as a sale of the bitcoin, which can create a gain or a loss even though no dollars reach a bank account. How Is Bitcoin Taxed in the US? covers the general rules, and a qualified tax professional can apply them to your situation.

How is a stablecoin different from bitcoin?

A stablecoin differs from bitcoin in who stands behind it, how its supply is set and what it is for. Bitcoin is a scarce asset with no issuer. A stablecoin is a company’s promise to deliver a currency.

	Bitcoin	Dollar stablecoin
Supply	Fixed schedule, capped at 21 million	Grows and shrinks as the issuer creates and redeems tokens
Who stands behind it	No issuer; software and a network of nodes	An issuer expected to hold reserves and honor redemptions
Can a company freeze it?	Not if you hold your own keys	Often, by the issuer
Inflation	Not tied to any currency	Tracks the dollar, so it inherits the dollar’s inflation

Neither is better in general, because they do different jobs. A stablecoin gives up bitcoin’s price swings, and its fixed supply, in exchange for dependence on an issuer. Because it tracks the dollar, it also shares the dollar’s exposure to rising prices: if prices rise across the economy, a dollar token buys less.

Why Does Bitcoin Have Value? examines the case for holding bitcoin, and How Many Bitcoin Are Left to Mine? lays out a supply schedule that no issuer can change.

What should you check before using a stablecoin?

Check what backs the token, how redemption works, whether the issuer can freeze tokens and what happens if the issuer fails. Four direct questions separate careful products from vague ones.

• What backs each token, who reports on it and how often?
• Who can redeem directly, and on what terms?
• Can the issuer freeze or block my tokens, and under what policy?
• What happens to holders if the issuer fails?

Tokens kept on an exchange add that platform’s risk to the issuer’s, and interest offers usually mean your tokens are being lent out. For decisions about your own money, a qualified financial professional can help. If the topic is new to you, the Start Here path covers the fundamentals in order.

Where to go next

• Bitcoin Bank Accounts and Savings: What Actually Exists: custody risk, deposit insurance and how to move bitcoin to a bank.
• Why Is Bitcoin So Volatile? And Can Anyone Predict a Crash?: the price swings a stablecoin is built to avoid.
• How to Spend Bitcoin: Paying With It, Cards and Taxes: the real ways to pay with bitcoin.
• How Is Bitcoin Taxed in the US? A General Guide: what counts as a taxable event.