One of the biggest challenges in cryptocurrency markets is high volatility. Assets like Bitcoin and Ethereum can experience significant price swings in short periods of time. Stablecoins were created as a solution to this problem: cryptocurrencies whose value is typically pegged to 1 US dollar (or another fiat currency or asset).

But how do stablecoins manage to keep their value stable?

In this article, we examine the main types of stablecoins and the mechanisms they use to maintain their peg, in a clear and straightforward way.

Fiat-Collateralized Stablecoins

This is the most common type of stablecoin, and the logic is relatively simple:

• Each 1 stablecoin in circulation is backed by 1 US dollar (or equivalent) held in reserve.
• Users can redeem the stablecoin and receive 1 dollar in return.

How do they stay stable?

• If the stablecoin’s price falls below $1, traders buy it cheaply and redeem it for $1.
• If the price rises above $1, new stablecoins are minted and supplied to the market.

This arbitrage mechanism helps keep the price close to the peg.

Examples: USDT (Tether), USDC

Advantage; Simple and relatively stable

Disadvantage; Centralization and reliance on trust in reserve transparency

Crypto-Collateralized Stablecoins

In this model, stablecoins are backed not by fiat currency, but by other cryptocurrencies.

• These systems typically require over-collateralization.
• For example, to mint $100 worth of stablecoins, $150 worth of ETH may be locked as collateral.

How do they stay stable?

• Smart contracts continuously monitor collateral ratios.
• If the value of collateral drops too much, automatic liquidations occur.

Example: DAI, USDe, USDS

Advantage; Decentralized structure

Disadvantage; More fragile during sharp crypto market downturns

Algorithmic Stablecoins

Algorithmic stablecoins are not directly backed by collateral. Instead, they rely on algorithms and token supply adjustments to maintain price stability.

How do they work?

• If the price rises above $1: new tokens are minted → supply increases → price falls
• If the price falls below $1: tokens are burned → supply decreases → price rises

This mechanism is conceptually similar to how central banks manage money supply.

Examples: FRAX (hybrid model)

Advantage; Theoretical full decentralization

Disadvantage;Risk of collapse during loss of market confidence ("death spiral")

Commodity-Collateralized Stablecoins

Some stablecoins are pegged to physical commodities, such as gold.

• Each token represents ownership of a specific amount of the underlying commodity.

Example: PAX Gold (PAXG)

These stablecoins are often used as a store of value rather than a medium of exchange.

My Last Words; Stablecoins play a critical role in the crypto ecosystem as bridge assets. They are widely used in trading, DeFi applications, payments, and risk management (hedging).

However, not all stablecoins are equally safe. Their ability to maintain a stable value depends on factors such as:

• The stabilization model used
• The structure and transparency of reserves
• Market conditions and historical performance

Before using a stablecoin, it is essential to evaluate:

• How it maintains its peg ... ?
• The quality of its collateral or reserves ... ?
• Whether it has previously lost its peg ... ?

"As I always say, “Listen to everyone, decide for yourself…” Good luck!