Stablecoins: Bridging Crypto and Traditional Finance

What Is a Stablecoin?

A stablecoin is a cryptocurrency designed to maintain a stable value — typically pegged 1:1 to the US dollar, though pegs to EUR, gold, and other assets exist. The goal: capture the programmability and borderlessness of crypto while avoiding the volatility that makes BTC and ETH poor mediums of exchange.

The stablecoin market crossed $230 billion in 2025, making it one of the most consequential fintech innovations for traditional financial infrastructure. Payment companies, banks, and regulators are all deeply engaged — for different reasons.

Why Stablecoins Exist: The Use Cases

1. Crypto trading and DeFi plumbing When traders want to “go to cash” within crypto, they don’t want to cash out to actual dollars (slow, taxable event). They move to stablecoins. Stablecoins are the primary liquidity pair on every major DEX and are used as collateral throughout DeFi.

2. Cross-border payments Sending $1,000 from the US to the Philippines via Western Union: ~$50 fee, 2-3 days. Via USDC on a blockchain: ~$0.10, minutes. This is driving real adoption in remittance corridors. Stellar, Ripple, and direct USDC transfers are used by fintechs like MoneyGram and Bitso.

3. Dollar access in high-inflation economies In Argentina, Turkey, and Venezuela, dollar-denominated savings are in demand but hard to access. USDC on-ramps via local exchanges let citizens hold dollar value without a US bank account.

4. Treasury and yield Corporations increasingly hold stablecoins for working capital, especially in international operations. Some yield-bearing stablecoins (backed by T-bills) are competing with money market funds for short-duration cash management.

The Three Models of Stablecoins

Model 1: Fiat-Backed (Custodial)

The simplest model: for every dollar token in circulation, a dollar (or dollar-equivalent) sits in a bank account.

USDC (Circle Internet Group): Each USDC is backed 1:1 by cash and short-duration US Treasuries held in regulated US financial institutions. Circle publishes monthly attestations from Grant Thornton. USDC is widely considered the most transparent large stablecoin.

USDT (Tether): The largest stablecoin by market cap (~$140B as of 2025). Tether’s reserves have historically been opaque and have included commercial paper and other non-cash assets. Repeated controversy about reserve quality. Despite scrutiny, remains dominant in offshore/emerging market contexts.

Key risk: The custodian risk. If Circle’s banking partner fails (Silicon Valley Bank’s collapse briefly de-pegged USDC in March 2023 when $3.3B in Circle’s reserves were frozen), the peg breaks. USDC recovered fully when the FDIC backstopped SVB, but the event revealed the model’s dependency on traditional banking infrastructure.

Model 2: Crypto-Collateralized (Overcollateralized)

DAI (by MakerDAO, now rebranded as Sky): To mint $100 of DAI, you must lock up > $150 worth of ETH or other approved crypto as collateral. The overcollateralization creates a buffer against crypto’s volatility.

If the collateral value drops below a threshold, the position is auto-liquidated by smart contracts — no human intervention. The system is transparent (all positions are on-chain, auditable by anyone, in real time).

Strength: Truly decentralized, no custodian. Weakness: Capital inefficient (you need $150+ to get $100). Works fine in stable markets, but in severe crashes (March 2020 “Black Thursday”), liquidation cascades briefly broke DAI’s peg.

Model 3: Algorithmic Stablecoins

The attempt to create a stablecoin without collateral, using algorithmic supply expansion/contraction to maintain the peg. The canonical example is Terra/LUNA:

• UST (TerraUSD) maintained its peg through a two-token system: burn $1 of LUNA to mint 1 UST, or burn 1 UST to mint $1 of LUNA
• In May 2022, a large UST sell-off triggered a “death spiral”: UST depegged → LUNA printed at scale to defend the peg → hyperinflation of LUNA → collapse of both to near zero in 72 hours
• ~$40 billion in value was destroyed. The founder Do Kwon was later arrested for fraud.

The Regulatory Landscape

United States:

The GENIUS Act (Guiding and Establishing National Innovation for US Stablecoins) passed the Senate in 2025 and established the first federal stablecoin framework:

• Payment stablecoins must be 1:1 backed by USD cash or T-bills
• Issuers must hold federal or state licenses
• Prohibits algorithmic stablecoins without full backing
• Tether (USDT), as a foreign issuer, must effectively rebuild its structure to comply with US issuance rules — a major competitive moat for US issuers like Circle

Europe:

The EU’s MiCA (Markets in Crypto Assets) regulation took full effect in December 2024. It establishes:

• E-Money Token (EMT) rules for fiat-pegged stablecoins
• Asset-Referenced Token (ART) rules for other pegged instruments
• Mandatory 1:1 reserve requirements, regular audits, and passporting across EU member states

Impact: Several non-compliant stablecoins were delisted from EU exchanges. Compliant issuers (Circle’s EURC, for example) gained a significant regulatory advantage.

Yield-Bearing Stablecoins: The New Money Market Fund?

A growing category: stablecoins that pass through yield from their underlying reserves to holders.

• BlackRock’s BUIDL: A tokenized money market fund on Ethereum. Institutions earn T-bill yields in token form, with real-time settlement.
• Ondo Finance’s USDY: T-bill backed, yield-bearing, available to non-US accredited investors.
• MakerDAO’s sDAI: Earns the “DAI Savings Rate” funded by protocol fees.

CBDCs: The Government Response

Central Bank Digital Currencies (CBDCs) are the government’s answer to private stablecoins. A CBDC is a digital liability of the central bank — equivalent to a digital banknote.

Retail CBDC: Held by consumers directly at the central bank (or licensed intermediaries). The Bahamas’ “Sand Dollar,” China’s Digital Yuan (e-CNY), and India’s Digital Rupee are live examples.

Wholesale CBDC: Used between financial institutions for interbank settlement. More likely to succeed in the near term — it doesn’t require rebuilding consumer banking but improves backbone infrastructure.

Why central banks care: A widely adopted private dollar stablecoin (or foreign CBDC) could displace domestic currency use, undermining monetary policy transmission. The CBDC discussion is as much about sovereignty as it is about innovation.

The US debate: The Federal Reserve has studied CBDCs but Congress has been cautious (some members see retail CBDCs as surveillance tools). The US approach is currently to allow regulated private stablecoins rather than a Fed-issued retail digital dollar.

What Banks Are Doing

1. Issuing proprietary stablecoins: JPMorgan’s JPM Coin for institutional settlement; PayPal’s PYUSD (issued on Ethereum and Solana).
2. Offering custody and rails: Banks are building infrastructure to custody and transfer customer-held stablecoins.
3. On/off ramps: Acting as the fiat gateway between traditional banking and the stablecoin ecosystem.
4. Competitive response: Every treasury product team is now thinking about whether tokenized deposits or yield-bearing stablecoins compete with their cash management offerings.

Key Takeaways

• Stablecoins solve crypto’s volatility problem, enabling real-world payment and DeFi use cases
• Three models: fiat-backed (USDC, Tether — simplest but custodian risk), crypto-collateralized (DAI — decentralized but capital-intensive), algorithmic (Terra/UST — proven to be structurally fragile)
• The market is consolidating around regulated fiat-backed stablecoins following GENIUS Act and MiCA
• Yield-bearing stablecoins are creating direct competition with bank deposits and money market funds
• Financial institutions are simultaneously threatened by stablecoins and building infrastructure on top of them — the classic innovator’s dilemma

Next: DeFi Essentials — how decentralized finance protocols work, and the legitimate use cases vs. the noise