Stablecoins Explained: How They Work, the 2026 Rules, and the Real Risks

Executive Summary

A stablecoin is a cryptocurrency designed to hold a steady value — most often exactly one US dollar — rather than fluctuating the way Bitcoin or Ethereum do. It achieves that stability through one of three mechanisms: holding fiat currency and short-term government debt in reserve, over-collateralizing with other crypto assets, or (historically, with poor results) using an algorithm to expand and contract supply.

Stablecoins have quietly become the plumbing of the entire crypto economy. As of September 2026, the total stablecoin market sits above $300 billion, with Tether's USDT (roughly $180 billion-plus) and Circle's USDC (roughly $74 billion) together accounting for more than 90% of it. They are used to settle trades between exchanges in seconds, to move money across borders at a fraction of legacy remittance costs, and — increasingly — for ordinary business payments.

In July 2025, the United States passed its first federal stablecoin law, the GENIUS Act, which mandates full reserve backing, monthly public disclosures, and a ban on issuers paying interest to holders. Implementation rulemaking has continued through 2026, with the law taking full effect no later than January 2027.

The honest framing, which this article keeps throughout: stablecoins are simultaneously crypto's most useful product and its most systemic risk. They function like money market funds with instant, 24/7 redemption and no deposit insurance — a combination that history suggests is fragile under stress. Both of those things are true at once, and understanding why is the point of this guide.

What Are Stablecoins, Exactly?

At the simplest level, a stablecoin is a token on a blockchain whose issuer promises it can be redeemed for a fixed amount of something else — usually one US dollar. Where a Bitcoin's price floats freely on supply and demand, a stablecoin's price is anchored to a reference asset. That anchor is called the peg, and everything about a stablecoin's risk comes down to how that peg is maintained and how credible the promise behind it is.

There are three broad designs, and they are not equally safe.

1. Fiat-backed stablecoins

The dominant model. An issuer takes in dollars (or euros, or other currency) and mints an equivalent number of tokens. It holds the proceeds in reserve — ideally cash at banks and short-term US Treasury bills — and promises to redeem tokens back for dollars on demand. Tether's USDT (launched 2014) and Circle's USDC (launched 2018) are the two giants. PayPal's PYUSD and a growing list of bank-issued tokens use the same structure. The peg holds because arbitrageurs can always redeem one token for one dollar with the issuer, so any market price below $1 is (in theory) free money that gets bought back up to par.

2. Crypto-backed stablecoins

Instead of dollars in a bank, these hold other cryptocurrencies as collateral — and because crypto collateral is volatile, they require over-collateralization. The best-known example, Sky Dollar (USDS, formerly DAI from MakerDAO), historically required around $1.50 or more of Ether and other assets locked in a smart contract to mint $1 of stablecoin. If the collateral's value drops toward a threshold, the system automatically sells it to protect the peg. This model is transparent — reserves live on-chain where anyone can inspect them — but it is exposed to sharp collateral sell-offs and smart-contract bugs.

3. Algorithmic stablecoins

The third model tries to hold a peg with little or no collateral, using software that mints or burns tokens as demand shifts, often paired with a second, freely floating token that absorbs the volatility. This is the model that produced the largest failure in crypto history: TerraUSD, covered in detail below. After May 2022, purely algorithmic designs are treated by most of the industry — and by regulators — as structurally unsound at scale.

Why Do Stablecoins Exist? The Real Use Cases

Stablecoins were not invented to replace the dollar. They were invented to solve a practical problem inside crypto markets, and the uses have expanded from there.

• Trading settlement. The original use case. Crypto markets run 24/7, but bank wires do not. Traders needed a dollar-denominated asset they could move between exchanges in minutes on a Sunday night. Stablecoins became the quote currency for a large share of all crypto trading volume, and they remain the on-ramp and off-ramp for the whole ecosystem you can browse on our crypto coverage.
• Cross-border payments and remittances. The World Bank has long reported global average remittance costs of around 6% of the amount sent, with settlement taking days. A stablecoin transfer can settle in under a minute for a fraction of a cent on a low-fee network. For workers sending money to family abroad, that difference is meaningful — which is why remittance corridors in Latin America, Africa, and Southeast Asia have been early adoption hotspots.
• Dollar access. In countries with high inflation or capital controls, holding digital dollars is a way to preserve purchasing power when local banking systems are unstable or inaccessible. This is a genuinely humanitarian use case — and, from the perspective of those countries' central banks, a genuine policy problem.
• Business payments and treasury. Payment companies have moved in: Stripe acquired the stablecoin infrastructure firm Bridge for roughly $1.1 billion in 2024, PayPal launched its own token, and Visa has run stablecoin settlement pilots. A supplier in one country can be paid by a buyer in another in minutes, any day of the week.
• On-chain finance collateral. Lending, borrowing, and derivatives protocols on networks like Ethereum overwhelmingly denominate in stablecoins rather than volatile assets.

The GENIUS Act: What the 2025 US Law Changed

On July 18, 2025, the Guiding and Establishing National Innovation for US Stablecoins Act — the GENIUS Act — was signed into law as Public Law 119-27. It was the first major federal crypto statute in US history, and it created a legal category called the permitted payment stablecoin issuer. Its core requirements, in plain English:

• Full reserve backing. Issuers must back tokens at least 1:1 with high-quality liquid assets: US currency, insured bank deposits, short-term Treasury bills, certain overnight repurchase agreements, and similarly safe instruments. Riskier reserve assets are off the table for payment stablecoins.
• Monthly public disclosures. Issuers must publish the composition of their reserves every month, examined by a registered public accounting firm, with executive certifications. Large issuers face full annual financial statement audits.
• No interest to holders. Issuers are prohibited from paying yield or interest on payment stablecoins — a provision with large consequences, discussed in the yield section below.
• No misleading marketing. Issuers may not claim that tokens are backed by the US government or covered by federal deposit insurance.
• Redemption and AML rules. Issuers must honor timely redemption at par and comply with Bank Secrecy Act anti-money-laundering requirements, including the ability to freeze and burn tokens when legally ordered.
• A dual charter. Smaller issuers can operate under qualifying state regimes; larger ones fall under direct federal oversight.

The law takes full effect no later than January 18, 2027, or 120 days after final implementing regulations, whichever comes first. Through 2026, the Treasury and banking regulators have been running the rulemaking process — including an August 2026 proposal defining who counts as issuing or selling a stablecoin in the US. In other words: as of this writing, the framework exists on paper and the detailed rulebook is still being finalized. That transition period matters, because some large issuers' existing reserve mixes (which have historically included assets like secured loans, precious metals, or Bitcoin) do not neatly fit the new permitted list.

Two things the law deliberately did not do: it did not extend FDIC deposit insurance to stablecoins, and it did not make the government a backstop for any issuer. A GENIUS-compliant stablecoin is safer on paper than the pre-law wild west, but it is still a private liability, not a government one.

How Do Tether and Circle Actually Make Money?

The fiat-backed stablecoin business model is one of the simplest — and most lucrative — in modern finance. It works like this:

1. Customers hand the issuer dollars and receive tokens.
2. The issuer parks those dollars in short-term US Treasury bills and cash equivalents.
3. The issuer keeps all of the interest. Holders of the token receive none.

When short-term interest rates sit near zero, this is a thin business. When rates are in the 4–5% range, as they were for much of 2023–2025, it is extraordinary. Tether reported roughly $13 billion in net profit for 2024 — with a headcount of only around one hundred employees, a profit-per-employee figure that rivals anything in the history of finance. Circle's revenue is similarly dominated by interest income on its reserves, though it shares a substantial portion of USDC economics with distribution partner Coinbase. Tether's Treasury bill holdings grew so large that the company ranked among the biggest holders of US government debt in the world, comparable to mid-sized sovereign nations.

Circle, which went public in June 2025, is the more transparent of the two: as a US-listed company it files audited financials you can read on SEC EDGAR, and its reserves sit largely in a dedicated, regulated money market fund and segregated bank accounts. Tether, domiciled offshore, has historically published attestations rather than full audits — though it announced work toward a full audit with a major accounting firm. The GENIUS Act pushes the whole industry toward the Circle end of that spectrum.

When Pegs Break: A Short, Sobering History

A peg is a promise, and promises get tested. The two defining episodes are worth knowing in detail.

TerraUSD, May 2022: the algorithmic collapse

TerraUSD (UST) was an algorithmic stablecoin that held its peg through a mint-and-burn relationship with a sister token, LUNA, propped up further by a lending protocol offering deposit yields near 20%. In May 2022, large withdrawals triggered redemptions; the algorithm minted trillions of new LUNA to absorb them; LUNA's price spiraled toward zero; and UST, with nothing real behind it, lost its peg entirely. Roughly $40 billion or more in combined value evaporated in about a week. The collapse cascaded through the industry, contributing to the failures of Celsius, Three Arrows Capital, and later FTX, and Terra's founder Do Kwon was ultimately convicted of fraud. The lesson: an asset that is stable only while everyone believes in it is not stable at all.

USDC, March 2023: the banking weekend

Even a fully reserved, fiat-backed stablecoin can depeg. When Silicon Valley Bank failed on Friday, March 10, 2023, Circle disclosed that $3.3 billion of its roughly $40 billion in reserves was held there. With US regulators silent over the weekend and redemptions technically dependent on the banking system, USDC traded as low as roughly $0.87–0.88 on secondary markets — an 11–13% discount on an instrument marketed as always worth $1. The peg recovered within days once the FDIC's systemic-risk exception made SVB depositors whole. The lesson: a stablecoin is only as stable as its weakest link, and that link can be an ordinary bank.

Tether has its own history: in 2021 it paid a $41 million fine to the CFTC over past misrepresentations that USDT was fully backed by dollars at all times, and an $18.5 million settlement with the New York Attorney General, which had found periods where reserves fell short. USDT has also traded at temporary discounts during past market panics before recovering.

Why Can't Stablecoins Pay Interest? The Yield Debate

The GENIUS Act's ban on issuers paying interest was not an accident — it was one of the most contested parts of the law. The banking industry lobbied hard for it, warning that if stablecoins could pass Treasury yields directly to holders, trillions of dollars in bank deposits might migrate to them, shrinking the deposit base that funds bank lending. Stablecoin advocates countered that the ban simply protects bank profit margins and denies consumers a better deal.

In practice, the market has been testing the edges. The law restricts issuers, and third parties — exchanges and platforms — have offered "rewards" on stablecoin balances that look economically similar to interest. Whether those arrangements survive further rulemaking and the broader market-structure legislation that Congress continued to debate through 2026 is an open question. For a holder, the practical takeaways are modest: any yield on a stablecoin balance is a platform product, not an issuer obligation; it carries its own counterparty risk; and it sits in a genuinely unsettled legal area. The Federal Reserve and other central banks, meanwhile, continue to study both stablecoins and central bank digital currencies, and their public research is worth reading directly at federalreserve.gov.

Payments vs Trading: Where Does the Volume Really Come From?

Headline stablecoin transfer volumes are enormous — tens of trillions of dollars annually by some on-chain measures — but most of that is not people buying coffee. The majority historically consists of trading: moving between tokens, arbitrage between exchanges, collateral flows, and automated market-making. Raw transfer counts also overstate economic activity, because the same dollars can be shuffled between protocols many times, and analyses that filter out bot and exchange-internal flows arrive at far smaller "real payments" figures.

That said, the payments share is growing from a small base, and the direction is what matters for the long-term thesis. Remittances, B2B settlement, payroll for international contractors, and treasury operations for internet-native businesses are all real and expanding use cases. The fairest current summary: trading built the stablecoin market; payments may determine its ceiling. Investors trying to gauge how much of the crypto economy is speculative versus transactional should keep that distinction in mind when reading adoption headlines on markets pages or anywhere else.

Bank-Run Dynamics and Systemic Risk

Here is the structural issue that earns stablecoins the "systemic risk" label. A fiat-backed stablecoin combines three features:

• Instant, unlimited redemption promises — like a bank checking account.
• No deposit insurance and no central bank backstop — unlike a bank checking account.
• Reserves concentrated in assets that must be sold quickly in a crisis — like a money market fund.

Money market funds with that profile have "broken the buck" in past crises and required government support, which is why they are now heavily regulated. A large stablecoin faces the same dynamic with faster plumbing: redemptions are possible 24/7, blockchain settlement is near-instant, and a rumor on social media can trigger billions in outflows within hours. If an issuer must liquidate Treasury bills rapidly to meet redemptions, the sale itself can stress the very market its reserves depend on — economists call this a fire-sale externality, and Federal Reserve and academic researchers have flagged it specifically for stablecoins at their current scale of Treasury holdings.

On top of that sit the ordinary risks: issuer misconduct or opaque reserves (Tether's 2021 settlements show this is not theoretical), banking-partner concentration (the SVB weekend), smart-contract and bridge exploits for tokens that move across chains, sanctions and freeze powers embedded in the tokens themselves, and plain user error — sending tokens to the wrong address or losing keys has no recourse.