Stablecoins, Part 2

Hey you!

Welcome back to "that's what she said", the newsletter which is like your web3 friend bringing knowledge and news biweekly. In the previous article, we covered the basics of stablecoins: what they are, why they exist, how the peg is maintained, and who issues them. If you missed it, go read it as it sets the stage for everything we're getting into today.

We're talking about what makes stablecoins different from every other type of digital money out there. We're breaking down every type of stablecoin in detail, with real examples.

Get comfortable and let's start!

⚖️ Stablecoins VS Other Cryptocurrencies

Stablecoins don't exist in a vacuum. They live inside an ecosystem of digital assets that all claim to be "money" in some sense, but operate very differently.

Stablecoins VS Bitcoin & Ethereum

Bitcoin was designed to be scarce, there will only ever be 21 million of them. That scarcity, combined with growing demand, is what drives its price up over time (in theory). Ethereum has a different value proposition: it's programmable infrastructure, and its token ETH is used to pay for computation on the network. Both are volatile by design, or at least by consequence. That volatility is exciting if you're investing. It's a disaster if you're trying to use the asset as actual money.

Stablecoins solve this. They're not trying to appreciate. They're not stores of value in the Bitcoin sense. Their entire job is to stay exactly where they are.

There's also an important structural difference. Bitcoin and Ethereum are decentralised — no single entity controls them. Most major stablecoins, particularly fiat-backed ones, involve a company standing behind the peg, managing reserves, and making promises about redemption. That introduces a layer of trust and counterparty risk that doesn't exist with BTC or ETH.

Stablecoins VS CBDCs

A CBDC (Central Bank Digital Currency) is digital money issued directly by a government. Think of it as the digital equivalent of the cash in your wallet — same issuer, same legal backing, just a different format. On the surface, it sounds nearly identical to a fiat-backed stablecoin. Both are digital. Both are pegged to a national currency. Both aim for price stability.

The key difference is who's in charge. CBDCs are state-issued, state-controlled, and tied to traditional monetary policy. Stablecoins are (mostly) issued by private companies or decentralised protocols, and they live natively on blockchains.

They share the goal of price stability, but they're built on fundamentally different trust models: one relies on government authority, the other on code, reserves, and market mechanics. Both are trying to be "digital money that doesn't lose value overnight", they just arrive there from very different directions.

So, CBDCs and stablecoins are converging on the same goal — stable digital money — but arriving from completely different directions. One is state infrastructure. The other is private market infrastructure.

Below is the comparison table:

💡 Types of Stablecoins

Not all stablecoins are built the same. The mechanism behind each one determines how reliable or risky it is as an asset. The type of collateral (or the absence of it) shapes everything: how stable the peg is, how transparent the system is, and what happens when things go wrong.

There are four main categories. Here's each one in detail.

💵 Fiat-Backed Stablecoins

The simplest and most widely used model. For every coin in circulation, the issuer holds the equivalent amount of real currency in reserve — usually US dollars, sometimes euros or other fiat. That reserve typically sits in a bank or is invested in short-term government bonds, which are considered the safest assets in traditional finance. The promise is straightforward: hand back the coin, get your dollar back.

This model works well as long as three things hold true: the reserves are real and liquid, the issuer publishes transparent proof of those reserves, and users believe they can redeem at any time without friction. When any of those conditions is in doubt, the peg becomes fragile fast.

Pros: Stable, simple, proven at scale. Holds the peg reliably under normal market conditions.
Cons: Centralised. Requires independent audits to verify that reserves actually exist. The issuer is a counterparty risk you can't fully remove.

Key examples:

• USDT (Tether) — the oldest and largest stablecoin, launched in 2014 by Tether Limited. It's the dominant trading stablecoin worldwide, though it has faced repeated questions about the quality of its reserves.
• USDC (Circle) — issued by the American fintech company Circle. Considered the more transparent, regulation-friendly option. Publishes regular reserve attestations and is deeply embedded in DeFi and institutional use.
• PYUSD (PayPal) — launched in 2023 in partnership with Paxos, this is traditional finance's clearest move yet into stablecoin territory. Backed 1:1 by dollar deposits and US Treasuries, PYUSD is available directly through the PayPal app to hundreds of millions of existing users. It's not a DeFi-native product.

🔗 Crypto-Backed Stablecoins

These use other cryptocurrencies as collateral instead of fiat. At first glance, this sounds counterproductive — if crypto is volatile, how can you build a stable asset on top of it? The answer is over-collateralisation.

Here's how it works: you lock up more value in crypto than you receive in stablecoins. If you want $100 worth of stablecoins, you might need to deposit $150 or even $200 worth of ETH. The excess collateral acts as a buffer — even if ETH's price drops significantly, the system is still solvent. If the collateral value falls below a certain threshold, the smart contract automatically liquidates it to cover the stablecoin's value before the system goes underwater.

This all happens on-chain, transparently, without banks or custodians. Anyone can verify the collateral ratios in real time. The trade-off is complexity: these systems require active monitoring and come with liquidation risk for the people depositing collateral.

Pros: Transparent, decentralised, no need for banks or third-party custodians. Assets are on-chain and verifiable by anyone.
Cons: More complex to use. Less stable than fiat-backed under extreme market conditions. If collateral drops too fast, the system can face cascading liquidations.

Key examples:

• DAI (MakerDAO, now Sky) — the OG decentralised stablecoin, launched in 2017 and still one of the most important assets in DeFi. Users lock crypto collateral (primarily ETH, but also other approved assets) into smart contracts called Vaults, which mint DAI as over-collateralised debt. The collateralisation ratio is dynamic, monitored in real time, and enforced by automatic liquidation. MakerDAO rebranded to Sky in 2024 and introduced a successor token called USDS, though DAI remains widely used.
• USDS — MakerDAO's newer stablecoin, introduced as part of the rebranded Sky ecosystem. Built on the same over-collateralised model as DAI but with updated governance and tokenomics. Positioned as a more scalable, accessible version of the original.
• Ethena USDe — a newer and more experimental entry. Rather than traditional over-collateralisation, Ethena uses a delta-neutral hedging strategy: it holds crypto assets while simultaneously taking short positions in perpetual futures markets to offset price exposure. The result is a synthetic dollar position that doesn't rely on being backed by traditional reserves.

🏅 Commodity-Backed Stablecoins

Instead of fiat or crypto, these stablecoins are pegged to physical assets — most commonly gold, though oil and other commodities are theoretically possible. They allow you to hold tokenised exposure to a real-world asset, with the speed and accessibility of blockchain infrastructure.

The key nuance here: commodity-backed stablecoins are "stable" in the sense that they track a specific asset consistently, not that they hold a fixed price. Gold moves. So will these tokens, just without the wild swings of regular crypto. You're getting commodity exposure in digital form, not a fixed $1 peg.

This category sits at the intersection of stablecoins and what's increasingly called real-world asset (RWA) tokenisation — putting ownership of physical things onto blockchains. It's a small category right now, but one that's growing as institutional interest in on-chain assets increases.

Pros: Protected from crypto volatility. Provides on-chain exposure to real-world assets with genuine utility as an inflation hedge or store of value.
Cons: Centralised — you're trusting the token issuer and the custodian holding the physical asset. Not a true price-fixed stablecoin, since commodity prices move.

Key examples:

• Tether Gold (XAUt) — issued by Tether (yes, the same company behind USDT), each XAUt token represents ownership of one troy ounce of gold, reportedly held by a custodian in Switzerland. Holders can elect to receive physical delivery of the underlying gold bar under specific conditions. It brings gold into the crypto ecosystem without you needing a vault.
• PAX Gold (PAXG) — issued by Paxos (the same company that issues PYUSD), each token is backed 1:1 by one fine troy ounce of gold stored in Brink's vaults in London. Paxos is a regulated trust company, which adds an additional layer of compliance and credibility compared to some competitors.

🤖 Algorithmic Stablecoins

No reserves. No collateral. Just code. Algorithmic stablecoins use programmed supply mechanics to maintain their peg. If the price drops below $1, the algorithm reduces the number of tokens in circulation to create scarcity and push the price back up. If it rises above $1, it mints more tokens to increase supply and bring the price down.

Some designs use a dual-token model: one token is the stablecoin itself, the other is a "volatility absorber" token that takes the hit when the market moves. When the stablecoin needs to contract supply, the protocol offers incentives for people to burn stablecoins in exchange for the secondary token.

The fundamental problem is that algorithmic stablecoins are built entirely on confidence. There are no hard assets to fall back on. If enough users simultaneously decide the system won't work, the algorithm can't print its way out of the panic, it just makes things worse. This is sometimes called a death spiral: falling confidence leads to selling, which triggers supply reduction, which reduces confidence further, which leads to more selling.

Pros: No collateral needed. Fully decentralised in theory. Doesn't rely on banks, custodians, or reserve managers.
Cons: Entirely dependent on user confidence. No safety net when that confidence breaks.

Key examples:

• TerraUSD (UST) — the most important cautionary tale in stablecoin history. UST was pegged to the dollar via a dual-token mechanism with LUNA, its sister token. In May 2022, a large coordinated sell-off triggered a classic death spiral: UST lost its peg, confidence evaporated, LUNA was minted in massive quantities to defend the peg, hyperinflating its supply and destroying its value, which further eroded confidence in UST. Within days, LUNA had dropped over 99% and UST was trading at fractions of a cent. An estimated $40–60 billion in value was wiped out. It remains the defining case study in algorithmic stablecoin risk, and the event that triggered the global regulatory response we're now seeing.
• AMPL (Ampleforth) — an earlier and more unusual experiment. AMPL doesn't maintain a fixed $1 peg in the traditional sense. Instead, it uses "rebasing" — the number of tokens in your wallet automatically adjusts daily based on whether AMPL is above or below its target price. Your share of the total supply stays constant, but the absolute number of tokens changes. It's more of a monetary experiment than a practical stablecoin, and it has never achieved mainstream adoption.
• USDX — a newer algorithmic entrant still in early stages. Still being tested at scale and without the track record to assess its resilience under stress conditions.

⚠️ Risks

Stablecoins sound boring by design, and that's the point. But "boring" doesn't mean "risk-free". Here's what can go wrong.

• Loss of value/bank runs. If enough users panic and rush to redeem at once, the issuer may not be able to honour all redemptions immediately. This "run" dynamic — the same one that crashes traditional banks — can hit stablecoins too. Reserve assets might lose value, become illiquid, or be revealed as insufficient. Once confidence cracks, it can spread fast: a run on one stablecoin can contagiously trigger fear about others.
• Payment system risks. Stablecoins face the same operational risks as traditional payment rails — credit risk, liquidity risk, settlement risk — but with fewer safeguards. Decentralised stablecoins add another layer: no single entity is responsible for risk management, so when smart contracts break or blockchains congest, there's no helpdesk to call.
• Risks of scale. The bigger a stablecoin gets, the bigger the systemic consequences if it fails. Large issuers or custodial wallet providers become systemically important — a single point of failure for enormous amounts of value. And if a stablecoin becomes dominant enough, switching to alternatives gets expensive and difficult for users.
• Market integrity. Stablecoin markets aren't immune to manipulation, insider trading, or lack of transparency. The infrastructure around them — exchanges, custodians, trading platforms — introduces risks that regulators are only beginning to address.
• Illicit finance. The speed and borderless nature of stablecoins that makes them useful for payments also makes them attractive for money laundering and sanctions evasion. AML/CFT compliance is a growing area of regulatory focus.
• DeFi-specific risks. If a widely-used stablecoin suddenly loses its peg, it can cascade through every DeFi protocol that uses it as collateral, triggering mass liquidations across lending platforms, draining liquidity pools, and creating knock-on failures in protocols that weren't directly exposed to the stablecoin itself. The 2022 Terra collapse demonstrated this in real time — protocols that hadn't even touched UST directly were affected by the broader market panic and liquidity crunch it caused. Smart contract vulnerabilities add another layer. The code governing how stablecoins interact with DeFi protocols has been exploited repeatedly for hundreds of millions of dollars.

🏛️ Regulatory Trends

For years, stablecoins operated in a regulatory grey zone. That era is officially over. The wake-up call came in May 2022, when TerraUSD collapsed and wiped out tens of billions overnight. US Treasury Secretary Janet Yellen told the Senate Banking Committee that the risks were "not hypothetical — they are playing out in real time". Legislators started paying attention.

🇺🇸 United States — The GENIUS Act

On July 18, 2025, the US signed its first comprehensive stablecoin legislation into law. The GENIUS Act requires all issuers to back tokens 1:1 with high-quality liquid assets, mandates monthly reserve attestations and independent audits, and restricts issuance to federally or state-approved entities only. Compliant stablecoins are explicitly classified as neither securities nor commodities. Circle's USDC was essentially built for this moment. Tether, however, would need a US banking licence or partnership to legally serve American users.

🇪🇺 European Union — MiCA

Europe moved earlier and wider. MiCA took full effect at the start of 2025, creating a unified rulebook across all EU member states. The hard compliance deadline is July 1, 2026, after which non-authorised issuers face delisting. The market is already reshaping: Binance removed USDT and eight other non-compliant stablecoins from EEA spot trading in March 2025, while USDC volume in Europe jumped 337% in H1 2025 as compliant alternatives filled the gap.

🌏 The Rest of the World

Hong Kong's Stablecoin Ordinance, passed in May 2025, requires all issuers to obtain a licence from the Hong Kong Monetary Authority and maintain reserves at par value. Japan, Singapore, and the UAE all have their own frameworks in motion.

The direction is clear everywhere: licensed issuance, transparent reserves, enforceable redemption rights. The "build it and figure out the rules later" era is closing.

Key Takeaways

• Stablecoins and CBDCs share the goal of price stability, but operate on fundamentally different trust models — one backed by government authority, the other by code, reserves, and market mechanics.
• There are four main types of stablecoins: fiat-backed, crypto-backed, commodity-backed, and algorithmic — each with different risk and stability profiles.
• The peg is maintained through three forces working simultaneously: redemption, arbitrage, and trust. Remove any one of them and things get wobbly fast.
• Stablecoins carry real risks — bank runs, payment system failures, scaling issues, and illicit finance concerns. The 2022 TerraUSD collapse was the clearest proof of concept for what happens when algorithmic confidence evaporates.
• Regulation has officially arrived: the US GENIUS Act, EU MiCA, and frameworks across Asia are reshaping who can issue stablecoins and how.

Final Thought

Stablecoins were built to solve a boring problem: make crypto actually usable as money. And somewhere along the way, while Bitcoin was getting the headlines and Ethereum was getting the philosophers, stablecoins quietly became the infrastructure everything else runs on.

The era of the regulatory grey zone is ending. What comes next will determine whether stablecoins grow into a global payment standard or fragment into a patchwork of regional instruments. Either way, it's going to be interesting.

If you learnt something new today, pass it on. Share it with your community. Let's spread the knowledge and level up together.

That's a wrap, normies. Next time, we're going deeper into the types of digital assets. Get ready!

Cookies She Left Behind

If you'd love to dig deeper into the topic, I'd also recommend reviewing the following:

• Types of Stablecoins Explained by CoinGecko
• What are EU Mica Regulations? by Chris Finance
• Stablecoins Overview by Electric Capital