Stablecoins Explained: How Digital Dollars Work

Stablecoins are one of the most important pieces of infrastructure connecting traditional money with blockchain networks.

At first glance, the concept appears simple: create a digital token worth one U.S. dollar.

But maintaining that value reliably — across billions of dollars of transactions, multiple blockchains, exchanges and market conditions — requires far more than attaching “USD” to a token.

A stablecoin is ultimately a monetary structure.

Understanding who issues it, what backs it, how redemption works and what legal claim the holder has is essential to understanding the asset itself.

What is a stablecoin?

A stablecoin is a digital token designed to maintain a relatively stable value against a reference asset.

The reference is most commonly a fiat currency such as the U.S. dollar, although stablecoins can theoretically reference other currencies or assets.

The defining characteristic is not the blockchain on which the token exists. It is the mechanism intended to keep the token close to its reference value.

Different stablecoins use very different mechanisms to achieve that goal.

Why do stablecoins exist?

Public blockchain networks can move digital assets continuously, but traditional bank money does not natively operate inside those networks.

Stablecoins bridge that gap.

Instead of requiring a bank transfer every time users move between crypto assets and fiat-referenced value, stablecoins allow dollar-like units to circulate directly on blockchain infrastructure.

This made them useful for:

• trading;
• payments;
• cross-border transfers;
• decentralized finance;
• collateral;
• treasury management; and
• settlement between digital assets.

Their role has since expanded beyond crypto trading.

Stablecoins are increasingly being discussed as part of broader payment and tokenized-finance infrastructure.

How fiat-backed stablecoins work

Consider a simplified fiat-backed stablecoin.

1. A user provides funds to the issuer or an authorized intermediary.

2. The issuer creates the corresponding stablecoins.

3. Reserve assets are held according to the product’s structure.

4. The tokens circulate on supported blockchain networks.

5. Eligible holders can redeem according to the issuer’s terms.

6. Redeemed tokens are removed from circulation.

In principle, issuance and redemption help keep the market price close to the reference currency.

If a stablecoin trades meaningfully above one dollar, market participants may have an incentive to create new tokens at par and sell them.

If it trades below one dollar and reliable redemption remains available, eligible participants may buy discounted tokens and redeem them.

This arbitrage mechanism depends heavily on confidence in redemption.

What backs a stablecoin?

The answer depends on the product.

Fiat-backed stablecoin reserves can include assets such as:

• cash;
• bank deposits;
• short-term government securities;
• repurchase agreements; and
• other high-quality liquid assets permitted by the relevant structure.

Reserve quality matters because holders expect the issuer to meet redemption requests.

A stablecoin backed by liquid, transparent assets presents a different risk profile from one dependent on volatile collateral or opaque investments.

The word “backed” should therefore lead to several follow-up questions:

Backed by what?

Held by whom?

For whose benefit?

How quickly can the reserves become cash?

What happens if the issuer fails?

Stablecoin reserves vs tokenized Treasuries

Stablecoin reserves and tokenized Treasury products can both involve U.S. government securities, but they serve different purposes.

A stablecoin issuer may hold Treasury securities as reserve assets supporting a payment-oriented token.

A tokenized Treasury product gives investors an investment exposure or legal interest connected to government securities or a vehicle holding them.

The holder of a stablecoin does not automatically own the Treasury securities in the issuer’s reserve portfolio.

That distinction matters when assessing ownership, yield and risk.

Read Tokenized Treasuries Explained for the asset side of this relationship.

Do stablecoin holders receive the reserve yield?

Not necessarily.

If an issuer holds interest-bearing government securities in its reserve portfolio, those assets can generate income.

Whether holders receive any of that economic benefit depends entirely on the stablecoin’s structure.

Many payment-oriented stablecoins are designed to remain worth approximately one unit of currency rather than pass reserve income directly to token holders.

This creates a major difference between holding a stablecoin and holding a tokenized money-market or Treasury product.

Types of stablecoins

“Stablecoin” is an umbrella term covering several designs.

Fiat-backed stablecoins

These rely on an issuer and reserve assets intended to support redemption at or near par.

This is the model most directly connected to traditional financial infrastructure.

Crypto-collateralized stablecoins

These use crypto assets or tokenized assets as collateral, often with overcollateralization and automated liquidation mechanisms.

Their stability depends on collateral value, protocol design and market liquidity.

Algorithmic designs

Some systems attempt to maintain a target price through incentives, supply adjustments or linked tokens rather than fully liquid reserve assets.

History has shown that these mechanisms can fail dramatically when confidence and market incentives break down.

The label “stablecoin” therefore does not imply equal stability across designs.

Why redemption matters

A stablecoin’s market price can be influenced by exchanges and secondary-market liquidity, but the ability to redeem is fundamental to many fiat-backed models.

Redemption creates a connection between the blockchain token and the offchain financial system.

If market participants trust that eligible tokens can be converted into the reference currency at par, deviations from the target price can attract arbitrage.

If redemption becomes uncertain, that anchor weakens.

This is why issuer solvency, reserve liquidity, banking access and operational resilience can matter even when the token itself continues functioning normally onchain.

Why stablecoins can lose their peg

A stablecoin can deviate from its target for several reasons.

Reserve concerns: Markets may question whether sufficient high-quality assets exist.

Issuer or banking problems: Access to reserve assets or payment infrastructure can become uncertain.

Liquidity stress: Heavy selling can overwhelm available market liquidity.

Smart-contract or protocol failures: Technical problems can damage confidence or impair functionality.

Collateral declines: Crypto-backed structures can become undercollateralized.

Regulatory action: Restrictions can affect issuance, redemption or market access.

Loss of confidence: Stablecoins are monetary instruments; confidence in convertibility matters.

A temporary market-price deviation does not always mean the structure has failed, but it signals that the mechanism maintaining parity is under pressure.

Stablecoins vs bank deposits

A stablecoin is not automatically a bank deposit.

A conventional commercial-bank deposit is a liability of the bank to its customer.

A stablecoin is a claim or digital instrument governed by the stablecoin issuer’s legal and reserve structure.

This distinction affects regulation, redemption, insolvency treatment and potential protections.

Banks are also developing tokenized deposits, which use programmable infrastructure while retaining the underlying commercial-bank liability.

Read Stablecoins vs Tokenized Deposits for the full comparison.

Stablecoins vs CBDCs

A central bank digital currency is a liability of a central bank.

A privately issued stablecoin is not.

That difference matters because the credit standing, legal framework and role in the monetary system are different.

Wholesale central-bank digital money can be especially relevant to institutional settlement, while stablecoins have generally developed through private digital markets.

The two can use similar technologies without being the same form of money.

See CBDCs vs Stablecoins for the deeper distinction.

Stablecoins as settlement infrastructure

Stablecoins become particularly important when we stop thinking about them only as assets and start thinking about them as transaction infrastructure.

A tokenized financial system needs a way to pay for tokenized assets.

If a bond, fund share or other security can move on a blockchain but the cash side remains trapped in a separate banking process, the transaction still depends on disconnected systems.

Stablecoins can provide an onchain cash leg.

This allows programmable transactions in which digital money interacts directly with digital assets.

The concept is closely related to delivery versus payment (DvP), where asset delivery and payment are coordinated.

Our guide What Is Onchain Settlement? explains why the cash leg is one of the most important parts of institutional tokenization.

Why stablecoins matter beyond crypto

Stablecoins can move continuously across compatible blockchain networks and digital applications.

That creates potential uses in:

• international payments;
• remittances;
• merchant settlement;
• institutional treasury operations;
• digital securities;
• machine-to-machine payments; and
• programmable financial transactions.

But blockchain availability does not mean the entire system operates without traditional finance.

Stablecoin issuers still interact with banks, custodians, government securities markets and regulatory frameworks.

The product is onchain. Much of the infrastructure supporting it remains connected to the conventional financial system.

The regulatory direction

Stablecoin regulation is increasingly focused on the same questions that matter economically:

• Who may issue them?
• Which reserve assets are permitted?
• How are reserves safeguarded?
• What redemption rights do holders have?
• What disclosures are required?
• How are operational and financial risks managed?

Different jurisdictions are taking different approaches.

The European Union’s Markets in Crypto-Assets framework created specific categories and requirements for asset-referenced and e-money tokens.

In the United States, the GENIUS Act established a federal framework for payment stablecoins in 2025, including requirements around permitted issuers, reserves and redemption.

The regulatory details matter because stablecoins increasingly sit between crypto infrastructure and the regulated monetary system.

Stablecoins and the “singleness of money”

One concern raised by central banks is whether different privately issued forms of digital money can reliably exchange at par.

In the traditional monetary system, users generally expect a dollar in one commercial bank to be worth the same as a dollar in another bank.

This property is sometimes described as the singleness of money.

A fragmented digital ecosystem containing many issuers, networks and redemption structures can challenge that expectation if instruments trade at different values or cannot move easily between systems.

Interoperability and credible redemption therefore matter not only for convenience but for the monetary architecture itself.

Are stablecoins risk-free digital dollars?

No.

Even a stablecoin that has maintained its peg for years can carry several forms of risk.

Issuer risk — the entity responsible for the token can fail operationally or financially.

Reserve risk — assets supporting redemption can lose value or become inaccessible.

Custody risk — reserve assets depend on banks, custodians and other intermediaries.

Liquidity risk — market liquidity can disappear during stress.

Redemption risk — holders may face restrictions, delays or eligibility requirements.

Technology risk — smart contracts, blockchains, bridges and wallets can fail or be compromised.

Regulatory risk — laws can alter how the token is issued, distributed or redeemed.

Network risk — congestion, outages or governance problems can affect transfers.

Stable value is a design objective, not a guarantee of zero risk.

Stablecoins in the RWA stack

Stablecoins occupy an unusual position in tokenized finance.

They can be considered real-world-connected digital assets because their value depends on offchain money and reserves.

But their more important role may be as the money layer that allows other tokenized assets to transact.

This creates a stack such as:

Tokenized asset
↓
Trading / transaction logic
↓
Stablecoin or other digital money
↓
Settlement
↓
Traditional banking and reserve infrastructure

That relationship explains why stablecoins, tokenized deposits, central-bank money and tokenized securities increasingly appear in the same institutional discussions.

The bigger picture

Stablecoins began as a practical solution for moving fiat-referenced value around crypto markets.

They are becoming something larger.

As securities, funds, deposits and other assets move onto programmable infrastructure, the financial system needs forms of money capable of moving with them.

Stablecoins are one answer.

Tokenized bank deposits are another.

Central-bank settlement infrastructure is a third.

The long-term question is not simply whether stablecoins grow.

It is how different forms of digital money connect to each other and to tokenized financial assets while preserving redemption, legal certainty and monetary stability.

That is why stablecoins are no longer just a crypto-market story.

They are becoming part of the infrastructure debate around the tokenized economy.

Sources

• Bank for International Settlements — research on stablecoins, tokenisation and next-generation monetary systems
• European Central Bank — analysis of stablecoins, tokenised finance and digital money
• European Union — Markets in Crypto-Assets Regulation (MiCA)
• U.S. Congress / federal law — GENIUS Act payment-stablecoin framework, 2025