Definition
A stablecoin aims to maintain a reference value, often one unit of a fiat currency such as the US dollar. Other designs reference commodities or different assets. The word stable describes an objective, not a guarantee. Holding a dollar-linked token also differs from holding money directly in a bank account.
How It Works
Reserve-backed issuers may hold cash or other assets and offer redemption under stated conditions. Crypto-collateralized systems use on-chain collateral and liquidation rules, while algorithmic designs rely more heavily on incentives and supply adjustments. These mechanisms have different dependencies. Arbitrage may help align a market price with the target when traders can reliably mint or redeem the asset.
Uses and Limitations
Stablecoins are used for transfers, trading and decentralized applications. Evaluating one requires checking its backing, redemption eligibility, reserve disclosures and contract controls. A peg can fail if confidence, liquidity or collateral deteriorates. Even when the target is maintained, users face the purchasing-power changes of the reference currency, as well as custody and network risks.