Stablecoins are a digital form of money that aim to maintain a stable value, such as a 1:1 peg to fiat currencies like the US dollar.

Stablecoins are transacted on blockchains–the ledger system modeled after Bitcoin’s technology. However, unlike Bitcoin, stablecoins rely on centralized authorities, such as the issuer and/or blockchain operator to maintain price stability and to process transactions.

Whereas bitcoin experiences dollar-price volatility, stablecoins intentionally maintain dollar-price stability, making them popular for certain transactions, short-term holdings, or as a bridge to buy or sell other assets, including bitcoin.

For people living in certain countries, especially those with high inflation or limited banking access, stablecoins offer a practical way to hold value in a monetary asset that’s equivalent to a globally recognized currency. This opens the door for people who lack a traditional bank account or who are encumbered by the restrictions and limitations imposed by legacy financial systems.

How do stablecoins work?

Stablecoins are a digital asset intended to maintain a stable exchange rate with a chosen fiat currency, like the US dollar. This stability is achieved through a set process of issuance, backing, transacting, and redemption.

Here’s the basics of how a USD-backed stablecoin generally works:

1. Acquiring stablecoins: To get stablecoins, you typically buy them through an exchange platform using your debit card or bank account, and exchanging fiat cash for an equivalent amount of stablecoins (e.g., $1,000 USD for $1,000 USDT).
2. Issuing and backing: Platforms acquire stablecoins from the issuer, who receives and holds the fiat cash in reserve as backing, typically as cash or cash-equivalents, like US treasuries, or a mixture of both. Upon receiving fiat cash, the issuer “mints” (creates) an equivalent amount of stablecoins on a designated blockchain, such as TRON or Ethereum, ensuring a 1:1 backing of reserved fiat cash to circulating stablecoins.
3. Holding in a wallet: Once acquired, your stablecoins are delivered to either your wallet that’s built-in to the platform where you bought the stablecoins or to an external wallet of your choosing.
4. Making transactions: With stablecoins in your wallet, you can hold a balance, send payments globally to anyone with a compatible wallet, or trade for other assets, like bitcoin. Off-platform transactions (sending to external wallets) are recorded on the designated blockchain and typically incur a transaction fee based on the data size rather than dollar value of the transaction.
5. Redeeming back to fiat: To convert stablecoins back to fiat cash, you typically redeem them on a platform, which aggregates redemptions in bulk to be returned to the issuer in exchange for fiat cash.
6. Burning stablecoins: When stablecoins are returned to the issuer for redemption, the issuer returns fiat cash or liquidates reserved assets to fulfill the request. Once redeemed, the stablecoins are “burned” or removed from circulation, maintaining the 1:1 peg by reducing the supply.

Stablecoins generally follow the account model, where each user’s balance is tracked on the given blockchain, updating balances with each transaction. This contrasts with Bitcoin’s UTXO model, which keeps account of individual transaction inputs and outputs.

Stablecoins on one blockchain (like Ethereum) can’t be directly transferred to another blockchain (like TRON) without using a cross-chain bridge or converting to a native version of the stablecoin on the target blockchain. Centralized stablecoin issuers can often facilitate this process but may charge fees.

The result of this process is that stablecoins allow people to buy, hold, and transact with a dollar-pegged asset quickly and easily, without being limited by legacy impediments of the traditional financial system.

Why do people use stablecoins?

Stablecoins can offer certain benefits to people, especially in regions with high inflation, strict capital controls, or limited access to banking services.

Here are some common reasons for using stablecoins:

• Inflation protection: In countries where local currencies are rapidly losing value, stablecoins offer a way to hold liquid assets pegged to a more stable currency, like the US dollar. Although stablecoins are not inflation-proof, since the dollar itself is inflating, they can provide a better option for short-term holdings compared to their volatile or inflationary local currency.
• Access to financial tools: Stablecoins make it possible for people without bank accounts to access dollar-denominated assets, savings, and international payment options, simply with an internet connection. This opens financial access to millions of people worldwide who are “unbanked”.
• Avoiding capital controls: In places where there are currency exchange limits or restrictions on cross-border payments, stablecoins can be a way to move money domestically or internationally without going through traditional banks or facing heavy restrictions.
• Gateway to Bitcoin or other assets: By acquiring stablecoins, people can easily access the global, highly-liquid bitcoin-stablecoin market, allowing them to convert to bitcoin when they’re ready for longer-term, inflation-resistant savings.

Stablecoin risks and limitations

Stablecoins are not without risks, especially when compared to bitcoin. Below are some of the risks and limitations associated with stablecoins.

• Centralization: Stablecoins rely on centralized issuers to hold assets that back the stablecoin’s value, typically in fiat currency or cash-equivalents, like Treasury bills.
• Counterparty risk: Stablecoin issuers, platforms, or even blockchain operators themselves, carry risks associated with their continued operations. They may also have the power to freeze, block, or reverse transactions if legally or regulatorily pressured.
• Network and security risks: Stablecoins are issued and transacted on various third-party blockchain networks, which exposes users to the underlying network’s operational risks. If the network goes down, faces congestion, or suddenly incurs periods of high fees, stablecoin transactions could become uneconomical or delayed. Additionally, networks may have central authorities with the power to block or reverse transactions, which could create disruptions or limit users’ access.
• De-pegging and failure risks: Stablecoins carry the risk that an issuer will be unable to honor large or sudden influxes of redemption requests. This is especially true in the case of crypto-backed or algorithmic stablecoins, which back their stablecoins with crypto assets or algorithm-based smart contracts to manage supply and demand dynamically. If an issuer cannot fulfill redemption requests in a timely manner, the 1:1 exchange rate may be broken, causing instability or even failure.
• Exposure to fiat inflation: Stablecoins are pegged to fiat currency, making them vulnerable to arbitrary fiat inflation. If the value of the US dollar declines due to money printing or the central bank’s expansionary monetary policy, stablecoin holders will experience a corresponding loss of purchasing power.
• Policy risk: Countries where financial freedom isn’t valued or where financial restrictions are imposed may change official stances on stablecoins. Authorities could limit peoples’ ability to buy, hold, or transact stablecoins impacting their utility within that jurisdiction.

Comparing stablecoins to bitcoin

For people in high-inflation or financially restricted countries, stablecoins offer a potential alternative to local fiat currency. If stablecoins are accessible, it’s likely that bitcoin is as well, bringing a completely different set of benefits, assurances, and risk profile. While stablecoins aim to maintain stability, bitcoin is designed to be scarce, secure, and resistant to censorship.

Here’s a basic breakdown comparing stablecoins to bitcoin:

Feature	Stablecoins	Bitcoin
Backing	Typically fiat cash or equivalents held by central issuer	A decentralized network of nodes, miners, holders, and developers
Centralization	Centralized issuer and blockchain operator	Decentralized, no central authority
Supply limit	Unlimited (depends on fiat currency supply)	Fixed at 21 million bitcoin
Transaction model	Account model	UTXO model
Inflation exposure	Yes, tied to fiat inflationary swings	No, supply follows a pre-programmed schedule
Use case	Short-term stable value, cross-border transactions	Long-term store of value, borderless transactions, and financial self-sovereignty
Censorship resistance	Limited; can freeze transactions	High; resistant to censorship

While stablecoins can offer financial stability, cross-border accessibility, and an entry point into bitcoin, they don’t provide the same inflation protection or censorship resistance as bitcoin.