Stablecoins explained: how they work and what can go wrong

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Stablecoins are cryptocurrencies designed to hold a steady value, usually one US dollar or one euro per coin. They are used to move money between crypto exchanges, to pay across borders and as a resting place between trades. The word stable describes the aim, not a guarantee. This guide explains how the main types work and where the risks lie. It is educational only and is not financial advice.

The main types

Stablecoins try to hold their peg in different ways.

Fiat-backed. A company issues one coin for each unit of currency it holds in reserve, in cash, short-term government debt or similar assets. Holders can, in principle, redeem coins with the issuer for the underlying currency, though often only large or verified customers can do so directly.
Crypto-backed. Coins are created by locking up other cryptocurrencies as collateral, usually worth more than the coins issued, to absorb price falls. Smart contracts sell the collateral if its value drops too far.
Algorithmic. These rely on code and market incentives rather than reserves to hold the peg. This design has the worst track record: algorithmic stablecoins have collapsed to a fraction of their target value, with heavy losses for holders.
Commodity-backed. Some coins track an asset such as gold held in storage.

Why a peg can break

A stablecoin is only as good as what stands behind it and the confidence people have in it. Things that can go wrong:

Reserves are not what they seem. If a fiat-backed issuer holds riskier or less liquid assets than it claims, or not enough, it may not be able to honour every redemption.
A run on the coin. If many holders try to cash out at once, even a well-backed issuer may need time to sell assets, and the market price can fall below the peg meanwhile.
Bank problems. Reserves held at a bank that fails can be frozen, at least temporarily.
Collateral crashes. A crypto-backed coin can struggle if its collateral falls very fast.
Death spirals. An algorithmic coin can lose its peg and then lose confidence entirely.
Smart contract bugs and hacks can drain funds.

Other risks to weigh

Issuer control. Many fiat-backed issuers can freeze coins at specific addresses, for example under a court order. That is a feature for law enforcement and a risk for the holder.
Counterparty risk. Holding a stablecoin means trusting the issuer, and often an exchange or wallet provider too.
No deposit protection. A stablecoin is not a bank deposit. In general, schemes that protect bank savers do not cover stablecoins, so if an issuer fails you may lose money.
Yield offers. Platforms that pay interest on stablecoins are lending them out or taking other risks to do so. Some such platforms have failed and frozen withdrawals.

How regulation is changing

Rules for stablecoins are developing quickly. In the European Union, the Markets in Crypto-Assets Regulation (MiCA) sets requirements for stablecoin issuers, including reserves and redemption rights. In the United States, the GENIUS Act, signed in 2025, created a federal framework for payment stablecoins with one-to-one reserve requirements. The UK has been developing its own regime. Regulation can reduce some risks but does not remove them, and many stablecoins in circulation may fall outside a given country's rules.

Questions to ask before holding one

Who issues it, and where is the issuer regulated?
What backs it, and how often are the reserves independently reported or audited?
Can holders redeem directly, and on what terms?
Has it lost its peg before, and how did it recover?
Where will you hold it, and what happens if that platform fails?

The bottom line

A stablecoin can lose value, sometimes suddenly. Losses are possible, and you should only use what you can afford to lose. Check your national regulator, such as the FCA in the UK, for warnings and rules, and your tax authority for how stablecoin transactions are treated, since swapping one cryptoasset for another can be a taxable event. Have you used stablecoins, and what made you trust or avoid a particular one? Share your experience in the comments.