Stablecoins Explained: How They Work, What Backs Them and the Risks
Stablecoins are crypto tokens designed to hold a steady value, usually one US dollar. This guide explains how fiat-backed, crypto-backed and algorithmic stablecoins work, what the federal GENIUS Act changed, how they differ from bank deposits and money market funds, and the risks that remain.
A stablecoin is a crypto token built to hold a steady price, almost always one US dollar. It moves on a blockchain like bitcoin or ether, so it can be sent anywhere in minutes at any hour, but it is designed to avoid the price swings that make most crypto assets impractical for payments or parking cash. Stablecoins have become the plumbing of the crypto market: much of the trading on crypto platforms is priced in them, and they are increasingly used for payments and cross-border transfers.
Whether a stablecoin actually stays stable depends on what sits behind it. That is the part worth understanding.
How a stablecoin keeps its value
The basic promise is simple: one token is worth one dollar, and someone stands ready to make that true. There are three main ways issuers try to keep that promise.
Fiat-backed stablecoins. A company issues tokens and holds reserves (cash, bank deposits, short-term US Treasury bills and similar assets) meant to equal or exceed the tokens outstanding. Approved customers can send dollars to receive new tokens, or return tokens to get dollars back. That redemption mechanism anchors the price: if the token trades at 99 cents, traders can buy it cheaply and redeem it for a dollar, pushing the price back up. The largest dollar stablecoins, Tether's USDT and Circle's USDC, work this way.
Crypto-collateralized stablecoins. Users lock up other crypto assets in smart contracts, usually worth considerably more than the stablecoins they create, to absorb price drops. If the collateral falls too far, it is automatically sold. DAI is the best-known example. These avoid relying on a single company but add exposure to crypto market crashes and to software bugs.
Algorithmic stablecoins. These try to hold the peg with code and incentives rather than full reserves, often by minting and burning a companion token. The most famous example, TerraUSD, collapsed in May 2022 when confidence broke and the mechanism spiraled, wiping out billions of dollars of value. The episode is the main reason regulators distinguish sharply between reserve-backed and algorithmic designs.
A small group of tokens is also backed by commodities such as gold, but these are a niche next to dollar coins.
Stablecoins compared with where cash usually sits
| Feature | Dollar stablecoin | Bank deposit | Money market fund |
|---|---|---|---|
| Government insurance | None | FDIC insurance up to the legal limit | None (SIPC covers custody failures at a broker, not losses) |
| Pays interest to holder | Issuers generally do not pay holders directly | Often, depending on account | Yes, passes through fund yield |
| Availability | Around the clock, on a blockchain | Bank hours and payment rails | Trades or redeems on business days |
| Main risks | Reserve quality, issuer failure, depegging, hacks, platform failure | Bank failure above insured limits | Rare losses below $1 per share in stress |
| Primary US oversight | Federal and state stablecoin rules under the GENIUS Act | Bank regulators | SEC |
For a closer look at the traditional options in the right-hand columns, see our comparison of money market funds, high-yield savings and CDs.
What the GENIUS Act changed
For years, US stablecoins operated under a patchwork of state money-transmitter licenses and debates over which federal agency was in charge. (For the wider picture, see who regulates crypto in the US.) In July 2025, Congress passed and the president signed the GENIUS Act, the first federal framework specifically for "payment stablecoins."
In broad terms, the law:
- Limits who can issue. Payment stablecoins offered in the US are meant to come from approved issuers, such as subsidiaries of insured banks, federally qualified nonbank issuers or state-regulated issuers that meet federal standards.
- Requires full reserves. Issuers must back tokens at least one-to-one with high-quality, liquid assets such as US dollars, insured deposits and short-term Treasuries.
- Requires transparency. Issuers must publish the composition of their reserves regularly, with the figures examined by outside accountants.
- Clarifies status. Qualifying payment stablecoins are not treated as securities, and issuers are not allowed to pay holders interest or yield.
- Prioritizes holders in a failure. If an issuer goes bankrupt, stablecoin holders are meant to have a priority claim on the reserves.
Regulators have been writing the detailed rules that put the law into practice, and parts of it phase in over time. The bill text and its status are on Congress.gov; agencies including the Treasury Department and the bank regulators publish implementing rules as they are finalized.
The risks that remain
Federal rules reduce some risks but do not remove them all.
- Depegging. A stablecoin can trade below $1 in the market, even briefly. In March 2023, USDC slipped well below its peg for a few days after it disclosed that part of its reserves sat at Silicon Valley Bank when that bank failed. It recovered once access to the deposits was assured, but holders who sold in a panic locked in losses.
- Reserve and issuer risk. A token is only as good as the assets behind it and the company managing them. Stablecoins issued outside the US, or tokens that do not qualify under US rules, may not follow the same reserve and disclosure standards.
- Redemption access. Direct redemption at $1 is often available only to verified customers who meet minimums. Most individuals buy and sell through exchanges or apps, where the price depends on the market and the platform's own health.
- Platform risk. If the exchange or app holding your stablecoins fails, freezes withdrawals or is hacked, the token's backing does not help you get your coins out. How you hold them, on a platform or in a wallet you control, matters as much as which coin you choose.
- Scams and mistaken transfers. Blockchain transfers are generally irreversible. Fake tokens using familiar names, phishing links and "investment" schemes promising high returns on stablecoins are common. The FTC and FBI both warn about crypto payment scams.
- Yield products. Because issuers cannot pay interest directly, some platforms offer "rewards" on stablecoin balances funded by lending or other activities. Those returns come with the platform's risks, not the stablecoin's.
How stablecoins are taxed
The IRS treats digital assets, including stablecoins, as property. Converting dollars into a stablecoin is not taxable by itself. Selling, spending or swapping a stablecoin is a disposal, and if the price differs slightly from what you paid, a small gain or loss results. The bigger tax events usually come from trading other crypto into stablecoins, which realizes the gain or loss on the asset you sold. Brokers now report digital asset transactions on Form 1099-DA; the IRS digital assets page explains current rules.
Where this leaves stablecoins
Stablecoins sit in an unusual spot: crypto technology carrying an old-fashioned promise of a dollar for a dollar. Reserve-backed coins issued under the new federal regime are designed to be far more transparent than the industry's early years, while algorithmic designs remain a cautionary tale. Two questions settle most of the comparison: what backs the coin, and where is it held? The answers determine whether a stablecoin behaves like digital cash or like another speculative token.
Frequently asked questions
Are stablecoins insured by the FDIC?
No. Stablecoins are not bank deposits and are not covered by FDIC insurance, even when the issuer keeps some reserves at an insured bank. Holding stablecoins on a brokerage or crypto platform also does not bring SIPC protection in the way securities in a brokerage account generally have.
Do I owe taxes when I use a stablecoin?
The IRS treats digital assets, including stablecoins, as property. Buying a stablecoin with dollars is not taxable by itself, but selling, exchanging or spending one is a disposal that must be reported, and trading another crypto asset for a stablecoin can trigger a gain or loss on that other asset. Small differences from $1 can also create small gains or losses.
Can a dollar stablecoin lose its peg?
Yes. A stablecoin can trade below $1 if markets doubt its reserves, if redemptions are paused or if a bank holding its reserves runs into trouble. Some coins have recovered quickly after brief depegs, while algorithmic designs have collapsed entirely.
