Stablecoins explained: What they do, how they work, and why risks remain

Core Concept - Stablecoins are cryptocurrencies designed to maintain a consistent price relative to another asset, typically the U.S. dollar, contrasting with the volatility of traditional cryptocurrencies like bitcoin and ethereum [1] Types of Stablecoins - Stablecoins are categorized based on their value maintenance methods, including collateralized by fiat, commodities, or cryptocurrencies, and algorithmic manipulation [4] - Fiat-backed stablecoins use reserves of government-issued currency as collateral, ideally monitored by independent custodians [5] - Commodity-backed stablecoins are collateralized with hard assets like gold, with examples including Pax Gold (PAXG) [5][6] - Crypto-backed stablecoins use cryptocurrencies as collateral, often overcollateralizing to maintain price stability [8] - Algorithmic stablecoins utilize computerized rules for price stability but have historically been prone to depegging [9] Purpose and Use of Stablecoins - Stablecoins aim to combine the efficiency and privacy of cryptocurrencies with price stability, serving as a medium of exchange rather than an investment [10][11] - Use cases for stablecoins include streamlined cryptocurrency trading, predictable international payments, and digital loan collateral [13] Regulation of Stablecoins - Several countries, including the U.S., Japan, the EU, and Hong Kong, have enacted stablecoin legislation, with the U.S. governing stablecoins under the GENIUS Act [12] - The GENIUS Act mandates that stablecoins must be 100% backed by liquid assets and requires issuers to disclose their reserves monthly [14] Risks Associated with Stablecoins - Stablecoins can experience depegging, which undermines trust and can result from poor collateral management or significant economic events [15] - Centralization in collateralized stablecoins raises privacy concerns and introduces risks of fraud or manipulation [18]