Stablecoins: Crypto’s Killer Use Case

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Money is constantly evolving. While cash and online bank accounts are the main way most businesses and individuals transact today, this will not be the case for long. This is because a new form of digital money has emerged; one that moves faster, works globally, and operates without the inefficiencies of the legacy financial system. 

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Enter stablecoins, a unique form of cryptocurrency that moves trillions of dollars each month and facilitates more daily transaction volume than Visa and Mastercard combined. Most people think of cryptocurrency as volatile, speculative, and risky. But not all crypto assets are designed this way, which is why leading institutions like Paypal, Bank of America, and JPMorgan are now building and scaling new stablecoin solutions. 

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This article aims to fully unpack what stablecoins are, what the different types are, and where this exciting new asset class is headed next.

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What are Stablecoins?

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Stablecoins are a specific class of cryptocurrency designed to maintain a stable value, typically pegged to a traditional asset like the US dollar, gold, or other financial benchmarks. Unlike most other cryptocurrencies like Bitcoin and Ethereum, stablecoins offer predictability and reliability, making them an essential component of the growing digital economy.

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The extent of adoption is evident in the numbers. By the end of 2024, stablecoins were involved in over two thirds of all onchain transactions, and the total stablecoin supply across all major projects now exceeds $230B. 

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Beyond serving as a liquidity source in crypto-native markets, stablecoins also act as act as a global dollar liquidity pool, enabling:

• Efficient trading and settlements: Traders and investors use stablecoins as a safe intermediary when moving between assets.
• Borderless payments: Stablecoins allow users to send and receive money globally, often with lower fees and faster settlement times than traditional banking rails.
• Protection against inflation: In emerging markets and unstable economies, stablecoins provide a dollar-pegged alternative to weak local currencies.

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However, not all stablecoins function the same way. They differ in their mechanisms for maintaining stability, collateralization methods, and degree of decentralization.

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The Five Main Categories of Stablecoins

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Stablecoins may all share the goal of maintaining a stable value, but the way they achieve this varies widely. Some rely on traditional financial reserves, while others use crypto collateral, algorithmic mechanisms, or even yield-generating assets. These structural differences impact everything from stability and capital efficiency to regulatory scrutiny and adoption, shaping how each type fits into the broader financial ecosystem.

Fiat-Backed Stablecoins

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Fiat-backed stablecoins are the most common type of stablecoin and are designed to maintain a 1:1 peg with traditional currency, such as the US dollar, or euro. They achieve this peg through direct fiat reserves and market arbitrage. If the price falls below $1, traders buy the stablecoin at a discount and redeem it for $1 in cash through whitelisted entities that have the ability to directly mint and burn tokens. This in turn reduces the supply of tokens in the involved liquidity pool or order book, restoring the peg.

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On the other hand, if the price rises above $1, traders will move to capture the arbitrage, by minting the stablecoin with $1 of fiat and then selling at a premium, thereby rebalancing the price. This method of ensuring these tokenized assets are continuously backed by actual fiat is what makes them reliable, allowing them to scale globally.

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These stablecoins are issued and managed by companies that maintain their reserves in banks, cash equivalents, treasury bills or government securities. For instance, Tether’s USD₮, the world's largest and most widely used stablecoin, is backed by a mix of cash, US Treasury bills, and other secure, highly liquid assets. This ensures they can meet redemption demands at all times.

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The main advantage of fiat-backed stablecoins is their risk profile and stability. They are widely integrated across crypto exchanges, DeFi applications, and payment networks, making them the most practical stablecoins for daily use. These stablecoins require trust in the issuing entity, as users must rely on the issuer’s claims that they actually hold sufficient reserves. This has led to regulatory scrutiny, which in turn has prompted companies like Tether to regularly attest to their reserves in the interest of transparency.

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Crypto-Backed Stablecoins

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Crypto-backed stablecoins function similarly to fiat-backed stablecoins but use cryptocurrency as collateral instead of fiat reserves. Since cryptocurrencies are highly volatile, these stablecoins must be over-collateralized to maintain their peg. This means that for every $1 of stablecoin issued, there is more than $1 worth of crypto locked up as collateral to ensure the stablecoin remains fully backed, even as the price of the collateral drops.

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The most well-known example is DAI, issued by MakerDAO. To mint DAI, users must deposit collateral, such as Ethereum (ETH) or Wrapped Bitcoin (wBTC), into a Maker Vault. If a user wants to generate $1,000 worth of DAI, they might need to collateralize $1,500 worth of ETH, ensuring that even if ETH's price drops, the stablecoin remains adequately backed. If the collateral value falls too much, the system automatically liquidates some of it to maintain solvency and ensure DAI remains stable at $1.

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Crypto-backed stablecoins are more decentralized and transparent than fiat-backed stablecoins, as all transactions and collateral reserves are verifiable onchain. However, their reliance on volatile collateral makes them less capital-efficient, and sharp market crashes or black swan events can force cascading liquidations, causing instability.

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While crypto-backed stablecoins like DAI have been successful, their reliance on over-collateralization limits their scalability. Additionally, many now rely on centralized stablecoins (such as Circle’s USDC) as part of their collateral mix, raising concerns about their true decentralization.

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Algorithmic Stablecoins

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Algorithmic stablecoins attempt to maintain their peg without collateral by using automated supply and demand adjustments. Instead of being backed by assets, these stablecoins use economic incentives to keep their price at $1.

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One common model involves a dual-token system, where one token serves as the stablecoin and the other absorbs volatility. TerraUSD (UST) is the most infamous example. It relied on its sister token, LUNA, to maintain its peg. When UST’s price dropped below $1, the protocol allowed users to burn $1 of UST in exchange for LUNA, reducing supply and pushing the price back up. Conversely, if UST’s price exceeded $1, users could burn LUNA to mint $1 worth of UST, increasing UST supply to bring the price back down.

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This system worked well under normal conditions, but the system collapsed after UST lost its peg and failed to recover, triggering a wave of short-selling and panic. As confidence in LUNA crumbled, mass sell-offs led to hyperinflation, flooding the market with excess supply and driving LUNA’s price to near zero. With LUNA and UST respectively sitting at roughly $22B and $18B market caps prior to crashing, this event marked one of the biggest failures in crypto history, highlighting the risks of algorithmic models.

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Other algorithmic stablecoins have used different approaches, such as rebase mechanisms (where supply automatically adjusts to maintain value) or coupon-based redemption systems, but none have proven sustainable over time. Since Terra’s collapse, the crypto industry has largely moved away from purely algorithmic stablecoins, favoring hybrid models that incorporate some collateral backing.

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Hybrid Stablecoins

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Hybrid stablecoins attempt to blend the best elements of both collateralized and algorithmic stablecoins. By using a combination of real asset backing and algorithmic stabilization mechanisms, these stablecoins aim to be more capital-efficient than fully collateralized models while avoiding the instability of purely algorithmic designs.

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The key feature of hybrid stablecoins is their fractional collateralization model. Unlike fully collateralized stablecoins (which maintain a 1:1 backing with reserves), hybrid stablecoins hold only a portion of their supply in reserves, while relying on an algorithmic mechanism or a secondary token to maintain stability. This means that not every unit of a hybrid stablecoin is backed by a full dollar of collateral at all times.

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One of the best-known examples is Frax (FRAX), which utilized a fractional-algorithmic model when it first launched, meaning it was partially backed by collateral and partially stabilized algorithmically. That said, the Frax community has voted to transition FRAX to a fully collateralized model, removing its algorithmic component to enhance stability and moving the token’s design closer to fiat-backed stablecoins like USD₮.

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In theory, this dynamic adjustment allows hybrid stablecoins to maintain stability while requiring less locked capital than fully collateralized models. However, this system relies on continuous market confidence and active arbitrage. If confidence in the governance token (such as FXS) falters, or if collateral ratios are not adjusted quickly enough, the peg can break - potentially leading to a downward spiral similar to what occurred with purely algorithmic stablecoins like Terra’s UST. As a result, hybrid stablecoins remain relatively unproven at scale and are not yet widely adopted compared to fiat-backed or crypto-collateralized stablecoins.

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Yield-Bearing Stablecoins 

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Unlike traditional fiat-backed stablecoins, which passively hold reserves in bank deposits or short-term government securities, yield-bearing stablecoins distribute earnings from staking, financial arbitrage, or tokenized real-world assets. The aim is to give users the stability of a dollar-pegged asset while providing passive, built-in earning opportunities. Two notable examples of this category are Ethena’s USDe and Ondo’s USDY, which use distinct methods to generate yield while maintaining their peg.

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Unlike fiat-backed stablecoins, USDe is not directly collateralized by US dollars but rather by staked crypto assets like Ethereum (ETH). USDe generates yield by combining staking rewards and derivatives markets to keep the token price stable. This delta-neutral strategy involves hedging positions, staking ETH while shorting it in derivative markets, ensuring that price movements cancel out. The mechanism stabilizes USDe at a value meant to track the U.S. dollar, even without direct dollar backing, thereby classifying it as a synthetic dollar.

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Similarly, Ondo, USDY is another yield bearing token, generating yield from US Treasuries. The token accrues yield daily 

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Yield-bearing stablecoins are an intriguing alternative to traditional stable assets, and new variants will continue to be introduced. That said, they may also introduce new risks depending on their design, from exposure to derivatives markets and counterparty risks in perpetual funding rates to regulatory uncertainties regarding tokenized securities.

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Which Stablecoin is the Best?

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The question of which stablecoin is the best does not have a simple answer - at least, not one that will stay the same forever. That said, as of 2025, Tether’s USD₮ remains the undisputed leader in real-world usage and global adoption, with over $1T in transfer volume this past month alone:

• Market Dominance & Liquidity: USD₮ is the largest and most liquid stablecoin, with a market cap exceeding $150B (~65% of the total dollar-backed stablecoin supply). It is the preferred trading pair on nearly every crypto exchange, making it the most widely used digital dollar.
• Multi-Chain Support: USD₮ is available on Ethereum, Tron, Solana, Polygon, BSC, and more, giving it unmatched flexibility and reach.
• Resilience in Market Crashes: Unlike some stablecoins that have depegged, USD₮ has survived multiple crises (including the 2023 US banking collapse that temporarily depegged USDC).
• Widespread Utility in Global Payments: USD₮ is widely used in emerging markets where local currencies are unstable, providing a reliable, censorship-resistant alternative for savings and remittances.

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But focusing only on which stablecoin is the best today misses the bigger picture. The more important question is: Where are stablecoins headed next?

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The Future of Stablecoins

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Right now, stablecoins exist on blockchains that were not purpose-built for them. They are forced to operate within protocols that were designed to support a broad range of applications. This leads to inefficiencies including high fees, transaction congestion, security trade-offs, and slow finality times, all of which prevent stablecoins from reaching their full potential as a truly universal form of internet money.

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This is why Plasma exists. Rather than simply supporting stablecoins as an afterthought, Plasma is the purpose-built blockchain for stablecoin payments, combining gasless USD₮ transactions and Bitcoin’s security to create a more efficient and scalable foundation for stablecoin adoption.

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The real future of stablecoins is not just about which token dominates. It is about ensuring they have the right infrastructure to serve as a base settlement layer for global finance. In the long run, the winning stablecoins will be the ones that operate on a blockchain optimized for stability, efficiency, and broad adoption.