Since its June 5 trading debut, stablecoin issuer Circle’s (CRCL) stock has climbed more than 500%.
The rising provider has issued over $61 billion worth of its stablecoin USD Coin (USDC-USD), making it the world’s second largest in today’s $253 billion stablecoin market.
On June 30, Circle announced that it had applied to establish a national trust bank charter called First National Digital Currency Bank. If approved, it would be another step toward integrating stablecoins into traditional banking and financial markets.
Here’s a look at how stablecoins work and how they’ve risen to prominence today.
Stablecoins are a type of cryptocurrency whose value aims to mirror that of another asset.
For example, someone buying a stablecoin pegged to the US dollar would expect the value of that stablecoin to remain at a dollar, with some referring to the coins as “digital dollars.” This sets stablecoins apart from other cryptocurrencies, which can change in value significantly.
Stablecoins are a popular payment option for other cryptocurrencies due to their price stability and facilitation of easier and quicker online transactions than traditional funds. Some believe these qualities could bring stablecoins into broader use.
“Over the long term, we expect stablecoins to evolve from money-rail of crypto markets to money-rail of the internet,” Bernstein analyst Gautam Chhugani wrote when initiating coverage of Circle. “We believe total industry stablecoin supply will reach ~$4Tn over the next decade.”
There are two types of stablecoins: collateralized and algorithmic.
Issuers keep collateralized coin prices stable with reserves. For example, many providers issuing stablecoins pegged to the dollar keep reserves of at least $1 (or equivalent holdings) for each coin they issue.
With these reserves, users expect to be able to exchange their stablecoins for dollars or other backing assets at any time. Stablecoins can be backed by fiat currency such as the dollar, commodities like gold or oil, and even other cryptocurrencies.
Currently, the majority of value in the stablecoin market is held by US dollar- or cash equivalent-backed stablecoins. However, Circle CEO and co-founder Jeremy Allaire told Yahoo Finance earlier this year that the US shouldn’t take that for granted.
“There is a digital currency space race, and the US needs to put laws in place that allow for digital dollars to thrive,” Allaire said. “[On] the question of whether a commodity money like gold or a digital commodity like bitcoin could play a larger role as a store of value or a reserve asset, I’m open-minded about that. … I think that could grow over time.”
Stablecoins got their start roughly a decade ago when the world’s largest, the fiat-based Tether (USDT-USD), launched in 2014. It remains the largest stablecoin by market capitalization today, with $159 billion in circulation. Tether is followed by fiat-backed USD Coin and crypto-backed Dai (DAI-USD).
Dai is an example of a “decentralized” coin, where backing is held in “smart contracts” instead of more centralized reserves. Each time someone creates a Dai token, they lock a specified amount of its backing cryptocurrency into a contract, which is only retrievable by “burning” the Dai, or destroying it. Doing this ensures there’s backing for each coin without a single reserve held by a provider.
Algorithmic coins, on the other hand, keep prices stable by using an algorithm to control supply, which then impacts price. For example, if the price of an algorithmic stablecoin increases, the algorithm might determine that more coins need to be minted to increase supply and drive the price back down.
A significant draw of stablecoins is their ability to facilitate easier and quicker online transactions.
With stablecoins already on the “blockchain,” the digital ledger that enables cryptocurrency transactions, transfers can resolve in minutes or seconds compared to the hours or days of bank transfers.
Without the many intermediaries that facilitate other payment methods, stablecoins can be exchanged 24/7 and across international borders. For transactions that typically come with high fees, such as cross-border transfers and microtransactions, stablecoins can offer a more practical alternative.
Federal Reserve Chair Jerome Powell testifies before the Senate Banking Committee hearing on March 3, 2022, on Capitol Hill in Washington. (Tom Williams, Pool via AP, File) ·ASSOCIATED PRESS
According to Zach Pandl, head of research at the crypto-focused asset manager Grayscale, reducing the cost and friction of global payments with stablecoins is a significant step forward.
“The G20 has an explicit goal to try and reduce the costs and improve the experience of cross-border payments, and there’s all kinds of committees and working groups tackling this topic,” Pandl told Yahoo Finance. “Stablecoins are the [solution] that in the real world is being adopted by consumers.”
Between payments, users feel secure keeping their funds on the blockchain compared to other cryptocurrencies since the price is stable. In fact, this stability has led to growing popularity in countries with high inflation, such as Argentina.
In addition, since stablecoins are on the blockchain, transactions are kept in public records, offering a level of transparency and security.
“Not only will you be confident that your payment will get through, but you can watch it every step of the way,” Pandl said. “Users are in full care of their funds.”
Stablecoins can also be used to generate interest through lending. This specific use case has got a lot of debate over the last year.
Stablecoins come with their own set of risks. With collateralized stablecoins, users rely on providers to properly manage reserves to back issued coins, and any kind of error can have major consequences.
For example, in April 2019, New York Attorney General Letitia James sued Tether and cryptocurrency exchange Bitfinex, alleging that Tether reserves were loaned to Bitfinex to cover a loss, leaving Tether not fully backed. Tether lawyers revealed that for a time, the cryptocurrency was only 74% backed by cash and cash equivalents.
In 2021, Tether and Bitfinex reached a settlement with New York’s Office of the Attorney General for $18.5 million. For two years after the settlement, both companies released reports regarding the makeup of their reserves. Along with these efforts toward transparency, Tether would later shift the majority of its reserves from commercial paper to Treasury bills.
Another concern is the risk of “depegging,” which is when a stablecoin’s value drops below the asset it’s pegged to. This includes both temporary price drops and more significant crashes.
In 2022, the algorithmic stablecoin Terra (UST-USD) and its sister coin Luna (LUNA1-USD) plummeted, erasing $60 billion in value. Terra’s value was previously maintained through market mechanics, where its connection with Luna was used to push the price higher or lower.
“Algorithmic stablecoins are based on confidence and trust in the economic incentives of the stablecoin issuer’s underlying ecosystem,” Ryan Clemens, an assistant professor of business law and regulation at the University of Calgary, told Yahoo Finance at the time. “Once that trust and investor demand evaporates, they quickly fail in a death spiral.”
It all began with a drop in price when $150 million in UST was moved off an exchange and $84 million in UST was sold by an unknown party. The drop sparked a sell-off, and while this coin’s algorithm attempted to correct for the fall, the run drove Terra from $1 to $0.05 in less than two weeks.
“We see run risks which could threaten financial stability … risks associated with the payment system and its integrity and risks associated with increased concentration if stablecoins are issued by firms that already have substantial market power,” US Treasury Secretary Janet Yellen said in a US Senate panel during the crash. “We definitely see significant risks here.”
There are also concerns about stablecoin’s role in illegal activity as it becomes more widespread, particularly if individuals use coins to make untracked payments for illicit purposes.
According to a report by the Financial Action Task Force, an international body created to combat global money laundering and terrorist financing, broader usage of stablecoins or virtual assets could “amplify illicit finance risks.”
“There was approximately $51 billion in illicit on-chain activity relating to fraud and scams in 2024,” the report detailed. “The use of stablecoins by illicit actors, including [Democratic People’s Republic of Korea] actors and terrorist financiers, has risen, with most on-chain illicit activity now involving stablecoins.”
Over the past few years, major corporations have been increasingly involved in the cryptocurrency sphere. For instance, Visa (V) started to settle USDC transactions in 2021, and PayPal (PYPL) launched its own stablecoin.
With this growing adoption of stablecoins, officials in the Biden administration released a report in 2021 recommending that issuers be regulated as banks.
“We’re supportive of that recommendation,” Circle’s Allaire told Yahoo Finance at the time. “We think [this] represents significant progress in the growth of this industry. There’s a real recognition that as these payment stablecoins grow, they could grow at internet scale relatively quickly.”
In 2023, the EU introduced new regulations for cryptocurrency, including stablecoins. The Markets in Crypto-Assets (MiCA) regulation laid out rules, including reserve requirements and transaction limits, that providers and exchanges would have to comply with in order to be made available in the EU.
Excitement for the future of stablecoins in the US was especially high after the passage of the GENIUS Act through the US Senate on June 17. Creators of the bill set out to create a federal framework for dollar-backed stablecoins to be issued and used while ensuring protections for consumers.
“Millions of people around the world are doing billions of dollars of transactions with these products already … but I think [regulations] will provide a degree of comfort for both consumers and businesses that want to use these products and deeply integrate them,” Grayscale’s Pandl said. “Users should have an expectation that they will have the same safety and compliance with appropriate laws as all other financial services technology.”
The bill’s regulations include 100% reserve backing requirements, as well as auditing for stablecoin issuers with market caps over $50 billion. As the act moves forward to the House, eyes will also be on the progress of its companion bill, the STABLE Act, as well as the Clarity Act, a broader crypto market bill.
David Hollerith contributed to this post.
Nina Moothedath is a data reporter intern for Yahoo Finance.
