If you’ve spent time in crypto circles, you’ve probably heard stablecoins referred to as “cash on-chain.” Stablecoins are tokens designed to hold a stable value usually pegged to a fiat currency like the U.S. dollar which makes them behave differently from volatile cryptocurrencies like Bitcoin or Ether. Because of that peg, investors treat stablecoins as a place to park value, earn yield, or move money quickly across exchanges and chains.
But “stable” is a design goal, not a guarantee. Stablecoins come in several flavors, each with its own trade-offs between transparency, counterparty risk, and yield opportunities. Below is an up-to-date look at how stablecoins work, why people use them, and sensible ways for investors to approach them.
How Stablecoins Keep Their Peg
Stablecoins fall into three broad categories:
Fiat-backed (custodial): Each token is backed by reserves of fiat or cash-equivalents (example, USDT, USDC). The issuer promises that holders can redeem tokens for the underlying currency. These dominate market share.
Crypto-collateralized: Tokens are backed by crypto collateral (often overcollateralized to absorb volatility). DAI is the leading example, using smart contracts to manage collateralization.
Algorithmic (non-collateralized): Supply is adjusted programmatically, tokens are burned or minted to correct price deviations. These schemes are the riskiest historically because they depend entirely on market confidence rather than direct reserves (most famously TerraUSD) show how fragile they can be.
Most of the current market is dominated by USD-pegged fiat-backed stablecoins. On-chain volumes and custody arrangements show USDT and USDC processing massive transaction flows, making them central plumbing for crypto markets.
Why Investors Use Stablecoins (the pros)
Low nominal volatility (relative to crypto).
Stablecoins aren’t perfectly risk-free, but they don’t swing 20–40% overnight like many other crypto assets. That relative stability makes them a convenient on-ramp/off-ramp and a short-term store of value on-chain. The stablecoin market is large (hundreds of billions in circulation) which supports liquidity across exchanges.
Fast, low-cost transfers across borders and exchanges.
Moving USD on-chain via a stablecoin can be faster and cheaper than traditional banking rails for certain corridors and use cases, especially for traders or global businesses.
Access to DeFi yields.
Stablecoins power a big portion of decentralized finance. Lenders, liquidity pools, and yield protocols often pay interest in stablecoins. That can translate to APYs well above traditional savings rates, though yields depend on platform and market conditions.
Simplicity for portfolio management.
For crypto investors, stablecoins provide a neutral unit of account, an easy way to take risk off the table without exiting the on-chain ecosystem.
Institutional movement and infrastructure integration.
Large issuers and growing regulatory clarity have pushed stablecoins into mainstream infrastructure. That institutionalization makes certain fiat-backed coins more attractive for larger portfolios.
Why “stable” Does Not Mean “risk-free” (the cons)
Reserve transparency and counterparty risk.
Fiat-backed stablecoins depend on whatever assets the issuer holds. Some issuers publish regular attestations or audit-style reports; others provide more limited disclosures. The reliability of those reserves and the legal structure that governs them matters. In short, if the issuer’s reserves are inaccessible, mismanaged, or illiquid, the peg can break. Circle and Tether publish reserve disclosures and attestations, but the nature and auditability of those reserves differ, and investors should read the reports closely.
Regulatory risk.
Stablecoins sit at the intersection focus. Europe’s MiCA framework and other regional rules are reshaping how issuers operate, from reserve requirements to custody rules. Regulation can increase confidence but also force issuers to change models or restrict services. Always track regulatory news in the jurisdictions where an issuer operates.
Depeg events and runs.
History shows pegs can fail. The TerraUSD collapse in 2022 is the most notorious example of algorithmic failure, even custodial coins have experienced depegs during liquidity stress (example, banking or market shocks). A depeg is painful and on-chain liquidity can evaporate quickly.
Custodial and platform risk (CeFi exposure).
Many yield opportunities require depositing stablecoins with centralized platforms. Those platforms introduce counterparty risk such as platform insolvency, hacks, or regulatory seizures that can lock or lose funds. The broader crypto industry has multiple cautionary tales (exchanges and lenders that failed or froze withdrawals), so yield isn’t a pure return, it’s return minus counterparty risk.
Operational risk and smart-contract bugs (DeFi exposure).
Using decentralized protocols doesn’t remove risk, smart contracts can be buggy or exploited. Even audited protocols have been exploited in edge cases.
Tax and legal uncertainties.
Tax treatment of stablecoin yields, swaps, or redemptions varies by jurisdiction. Regulators may also treat fiat-backed stablecoins differently than algorithmic ones, affecting how easily you can redeem or use tokens.
Risk Controls for Investors
If you decide stablecoins belong in your portfolio, treat them with the same diligence you would any other financial instrument.
Know the peg mechanics and reserves.
Read the issuer’s reserve reports and understand the instruments backing the peg (cash, T-bills, commercial paper, crypto). Weekly or monthly attestations are better than opaque quarterly statements.
Diversify across issuers (but not wildly).
Holding a mix of top-tier fiat-backed coins reduces single-issuer risk. However, don’t diversify into small, lightly backed tokens that trade by rumor.
Limit exposure to CeFi platforms offering high yields.
High APYs typically imply higher risk. Use regulated platforms where possible, and don’t keep more on any one platform than you could afford to lose.
Use DeFi cautiously, and prefer well-audited protocols + insurance.
If using DeFi, prioritize protocols with long operating histories, independent audits, and community scrutiny. Consider smart-contract insurance options for large exposures.
Watch for depeg signals.
Sudden wide bid-ask spreads, withdrawal limits, or reserve-report delays are signs to reduce exposure.
Understand redemption mechanics.
Some stablecoins can be redeemed directly with the issuer (on-ramp/off-ramp); others rely on secondary markets. Redemption terms affect liquidity and safety.
How investors Use Stablecoins Today
Trading and liquidity management: Traders keep stablecoins on exchanges for quick re-entry into positions and to avoid fiat rails’ delays.
Short-term yield: Many investors use a small stablecoin allocation to earn elevated short-term yields in CeFi or DeFi, while keeping the majority in safer cash alternatives.
Cross-border settlement: Businesses and remittance services use stablecoins to move value where traditional banking is slow or expensive.
On-chain treasury: Projects and DAOs often hold stablecoins as treasury reserves.
How to Use Stablecoins Responsibly
If you decide stablecoins belong in your toolkit, treat them like a short-term cash equivalent with conditional safety:
Use for operational liquidity (on-chain trading, payments, cross-border transfers).
Avoid parking your entire cash reserve unless the issuer’s reserves are fully transparent, redeemable, and legally protected in your jurisdiction.
Prefer regulated issuers and entities that publish frequent, clear reserve attestations.
Avoid complex DeFi strategies with large portions of your funds unless you understand the protocol risk and have diversified exposure.
Consider insurance and custody solutions if you’re an institutional user; retail users should factor in exchange counterparty risk.
Checklist Before You Invest in a Stablecoin
- Which type is it? (fiat-backed, crypto-backed, algorithmic) 2. What does the issuer’s reserve report actually show? Are reserves liquid and auditable?
3. Can you redeem directly from the issuer, or must you sell on a market?
4. Which regulations apply to this issuer and where are they domiciled?
5. Which platforms will you use to hold or earn yield, and what counterparty protections exist?
6. What’s your exit plan if the peg weakens?
