With more than $230 billion in circulation and trillions in monthly transaction volume as of April 2025, stablecoins serve as the connective tissue between traditional finance (TradFi) and decentralized finance (DeFi). But look under the hood and you’ll find they’re built in very different ways — with real implications for how you use them. One of the biggest differences between stablecoins is how they stay stable.
Fiat-backed stablecoins are designed to hold their value by being tied to the US dollar, the euro, or another fiat currency. That means fiat-backed stablecoins are backed by fiat currencies (and equivalent assets) held in reserve. Crypto-backed stablecoins are another major type of stablecoin, which are backed by various cryptocurrencies.
In this article, we’ll explain how stablecoins work, break down different types of stablecoins, and point out key considerations when exploring fiat-backed and crypto-backed stablecoins. What are stablecoins used for? How do stablecoins work? Let’s answer your questions while breaking these key stablecoin types down in plain English — no white papers, just plain talk.
Stablecoins: it’s all about the collateral
At their core, stablecoins are digital assets designed to keep a stable value, usually relative to a fiat currency like the US dollar. They’re not like most other volatile digital assets you’ve heard of. You’ve seen it: a token soars one day and plummets the next. In contrast, stablecoins are generally the calm in crypto’s storm — the digital equivalent of sitting out the rollercoaster.
When digital asset markets are volatile, investors often trade into stablecoins that serve as digital versions of dollars, euros, and other fiat alternatives. Stablecoins are used for trading, hedging against volatility, and a variety of investing activities. This includes using them within DeFi tools and platforms.
Beyond that, many stablecoins are increasingly used in everyday commerce — from sending payments to purchasing goods and services. This could include buying clothes or food, selling your art, or paying your freelance employees. They’re good for transferring funds quickly, whether that be across the table, across town, or across international borders. But the way they are designed to maintain their stability is where the key distinction comes in.
How fiat-backed stablecoins work
Fiat-backed stablecoins are the most common and straightforward type of stablecoin in the digital asset market. They operate on a simple financial principle: for every token issued, there should be an equivalent amount of fiat currency or cash-equivalents. This collateral is held in reserve by a centralized entity and should be regularly and independently audited. Circle’s dollar-pegged USDC and its euro-pegged EURC are leading fiat-backed stablecoins designed for trust, transparency, and regulatory compliance1. USDC and EURC reserves are independently verified with regular, third-party attestations that are published monthly by a Big Four accounting firm and made publicly available for anybody to review for themselves.
This setup means that for every USDC in circulation there’s an equivalent amount of highly liquid cash and cash-equivalent USD assets held in reserve, making USDC redeemable 1:1 for US dollars2.
USD-pegged stablecoins are widely used across crypto exchanges, crypto wallets, and DeFi platforms due to their ease of use, strong liquidity, and familiarity. Their direct tie to fiat reserves helps fiat-backed stablecoins maintain a consistent value, which is especially useful in uncertain market conditions. However, you must place a significant amount of trust in the issuing organization to manage the reserves responsibly and remain compliant with financial regulations. Transparency, regular audits, and regulatory oversight are crucial to the long-term stability of these assets. Some issuers, like Circle with USDC, build additional trust with users and institutions by regularly publishing reserve audits (known as “assurances” or “attestations”) and collaborating with regulators.
Like anything in finance, trade-offs exist. Fiat-backed stablecoins are controlled by centralized companies. You have to trust them to manage the money and keep the value steady. If they make a mistake or break the rules, you could lose access to your funds. Fiat-backed stablecoins depend on the company that issues them to safely manage the money that backs each token. This dependency introduces risks that may not sit well with users who prefer more decentralized options that skip the need for a trusted third party.
At Circle, we pride ourselves on our regulation-first, transparent approach to stablecoins — it’s what sets Circle apart in a sea of stablecoin issuers. USDC and EURC are fully backed by highly liquid cash and cash equivalent assets that are held separately from Circle’s operating funds at leading financial institutions. And as part of our strong commitment to transparency, we’ve issued reports on all reserve assets since 2018. Find our latest transparency reports here, and a list of Circle’s licenses here.
Crypto-backed, decentralized stablecoins
Crypto-backed stablecoins take a different approach, offering stability through overcollateralization with volatile digital assets like ether (ETH), wrapped bitcoin (wBTC), and a host of others. Rather than relying on fiat reserves managed by a centralized entity, these stablecoins are governed by decentralized protocols and smart contracts.
To mint (i.e., create) $100 worth of a crypto-backed stablecoin, you might need to deposit $150–200 worth of cryptocurrency as collateral. It’s like putting down a security deposit — extra upfront, but it helps keep things stable. This extra collateral cushion accounts for crypto’s price volatility and helps the stablecoin maintain its intended value. Crypto-backed stablecoins are designed to be overcollateralized so that when price volatility inevitably occurs, they have a better chance of retaining stable value.
If, however, the value of the collateral drops too far, the system can trigger a liquidation process (i.e., selling the underlying digital assets used as collateral in order to protect the stablecoin’s peg). When your collateral dips below the value of your stablecoins, you are technically undercollateralized (i.e., you’ve borrowed more than your backup assets can support). In practice, however, this is unlikely to happen as the protocol will typically liquidate your collateral assets before this occurs. In order to avoid this, you either have to deposit more collateral or redeem your stablecoins for your collateral prior to reaching a potential liquidation event.
The minting process works through automated smart contracts. When a user locks up their collateral, the protocol issues a stablecoin. A popular example is USDS (formerly DAI), issued by Sky (formerly known as MakerDAO). Under its original name, DAI was fully crypto-collateralized. Today, as USDS, it’s backed by a combination of digital assets and real-world assets like US bonds and even other fiat-backed stablecoins like USDC (which is fully fiat-backed).
However, there are alternatives to USDS that are completely crypto-backed. Some of the most popular are GHO, LUSD, and sUSD — all pegged to the US dollar, though backed by digital assets. The thing with minting crypto-backed stablecoins is that you have to overcollateralize your position with wETH, wBTC, or other volatile assets. If not, you risk collateral liquidation. You can avoid this liquidation risk by using fiat-backed stablecoins like USDC as collateral. But some would argue this defeats the purpose of a “decentralized stablecoin.”
The benefits of crypto-backed stablecoins lie in their decentralization, transparency, and resistance to censorship. Some users who value decentralization may prefer crypto-backed stablecoins, which are managed via protocols rather than institutions. However, the model is not without its own challenges.
Digital asset market volatility can make it harder to keep a stablecoin’s value steady. And these systems can be tricky to use if you’re new to blockchain. Plus, because they require extra collateral, they’re less efficient. Minting $100 of a crypto-backed stablecoin may require, for example, $200 in ETH collateral, tying up capital that could otherwise be used elsewhere. More value must be locked up than is actually minted, which leaves capital on the sidelines that could otherwise be deployed for other purposes.
Despite these hurdles, crypto-backed stablecoins remain a vital innovation in the space, offering an alternative path to stable onchain value without depending on traditional financial institutions.
Core differences between fiat-backed and crypto-backed stablecoins
Fiat-backed stablecoins and crypto-backed stablecoins are similar in many ways, but their key differences speak to different underlying values. Do you prioritize simplicity, clear rules, and more integration with the traditional banking system? If that sounds like you, fiat-backed stablecoins are likely the better fit. They are widely accepted across exchanges, easier to understand, and generally offer the reassurance of being backed by real-world currency reserves. They’re a suitable option if you’re a newcomer to the digital asset space and wary of more complex offerings. If you live and breathe decentralization, crypto-backed stablecoins might feel more aligned with your principles. These assets do not rely on centralized custodians and instead function entirely through smart contracts and decentralized governance.
Final thoughts on stablecoin collateral
While stablecoins are designed to maintain stable values (unlike volatile assets like BTC, ETH, SOL, and the rest), their role in the digital economy is arguably just as important, if not more so. They can provide the foundational price stability that allows you to interact with digital asset markets without constantly worrying. Stablecoins, as their name implies, are designed to unlock stable value.
From facilitating quick, low-cost international transfers to facilitating different types of trading in DeFi protocols, stablecoins function as a critical part of a new financial paradigm that runs onchain. Whether you’re using fiat-backed stablecoins like USDC or exploring decentralized stablecoins, the collateral model you choose matters.
As the digital asset space matures, stablecoins may very well be the infrastructure layer that enables wider adoption and integration into everyday financial life. As global demand for faster, cheaper payments grows, stablecoins are poised to serve as the foundation for onchain finance. They may not make headlines with dramatic price swings, but in a landscape built on innovation and disruption, stability might just be the most radical offering of all.
