Stablecoins 101: mechanics, types, and value propositions

1) Executive overview: what stablecoins are (and aren’t) in 2025

Stablecoins are digital tokens designed to maintain a stable value—typically pegged to a fiat currency (most frequently the U.S. dollar)—and used as a medium of exchange, unit of account or store of value within blockchain-based systems. However, they are not identical to central bank money or bank deposits: their design, regulation, and risk profile differ.

As of mid-2025, the market for stablecoins reached an approximate total market capitalisation of US $250 billion to $256 billion, depending on data source. For example, Reuters reported a market cap of about US $256 billion in June 2025. (Reuters)

Stablecoins matter because they bridge crypto-ecosystems and traditional financial systems. The Bank for International Settlements (BIS) in its Annual Economic Report 2025 described tokenisation—including stablecoins—as “a transformative innovation” that may underpin the next-generation monetary and financial system when built on central-bank reserves, commercial-bank money and government bonds. (Bank for International Settlements)

At the same time, while stablecoins offer new infrastructure possibilities (instant settlement, digital programmability, cross-border rails), leading regulatory bodies note that they do not yet function as fully mature substitutes for fiat money. For example, the BIS Bulletin 108 (2025) found stablecoins “perform poorly when assessed against three tests for serving as the mainstay of the monetary system.” (ICBA)

2) Mechanics 101: how a stablecoin actually works

Mint and redemption process

A typical fiat-backed stablecoin involves an issuer that receives fiat (or eligible liquid assets) from an authorised participant, then mints tokens on-chain representing that deposit or asset. Token holders can redeem tokens for fiat (or equivalent) through the issuer or authorise transfer agents. This mint-redeem loop helps underpin the peg.

Peg maintenance and arbitrage

The mechanism of maintaining peg involves arbitrage: if the token trades above the fiat value, authorised participants redeem tokens for fiat, reducing supply; if it trades below, they buy tokens in the market and redeem, increasing supply. The stability of this mechanism depends on the transparency of backing assets, redemption speed, and market confidence. A recent analysis (Goel et al., 2025) show reserve transparency and redemption access are key to reducing run-risk. (SSRN)

On-chain operations, settlement, and transfer

Once minted, tokens exist on blockchain ledgers. Transfers between wallets are near-instant (subject to network confirmation). Tokens may serve as settlement units in DeFi/crypto markets, global payments, or treasury functions. Under the hood, stablecoin protocols must manage custody of reserves, smart-contract logic (sometimes for pausing/freeze), and reconciliation between on-chain state and off-chain fund records. According to a JPMorgan review (Oct 2025), a stablecoin’s peg “works only if reserve, governance, redemption and blockchain settlement integrate seamlessly.” (J.P. Morgan Private Bank)

What can break the peg

Several factors threaten peg stability: large redemption shocks, reserve illiquidity or opacity, operational glitches (mis-minting or hacking), or regulatory/legal risk. BIS research underlines that stablecoins may face fire-sale risk of underlying assets in stress scenarios, especially when reserves are invested in short-term government or other instruments without clear liquidity ladders. (Bank for International Settlements)

3) Taxonomy: the main stablecoin designs (with real examples)

Fiat-backed or cash-equivalent backed

These stablecoins are backed 1:1 (or near-1:1) by cash, short-term government securities, or highly liquid assets. Example: Tether (USDT) and USD Coin (USDC). As of mid-2025, USDT alone accounted for a market capitalization exceeding US $150 billion, representing roughly 60-65 % of the total stablecoin market. (CoinDesk)

Asset-referenced tokens (ARTs)

These are backed by a basket of assets (multiple fiats, commodities, or other securities) rather than a single fiat. Under the EU’s Markets in Crypto-Assets (MiCA) regulation, asset-referenced tokens face stricter reserve and governance requirements.

Crypto-collateralised over-collateralised stablecoins

These stablecoins are backed by other crypto-assets—ETH, other tokens—often over-collateralised because of volatility. Example: Dai. While offering decentralised backing, these designs carry higher risk due to collateral volatility and liquidation mechanics. Research by De Sclavis et al. (2024) notes that algorithmic/crypto-collateral models must embed strong liquidation and governance structures to maintain peg. (arXiv)

Algorithmic or synthetic stablecoins

These rely on algorithmic protocols or seigniorage mechanisms rather than full collateralisation. Post-2022, many such designs have decoupled or failed; regulators generally treat them with caution due to run-risk and governance fragility.

Yield-bearing “stablecoins” or tokenised fund shares

Some tokens represent stable-value assets but offer yield (from T-bills, MMFs, etc.). While they may superficially appear as stablecoins, legally they may be tokenised fund shares rather than payment-stablecoins. Differentiating design and regulatory status is critical.

Summary of major designs (with examples):

• Fiat-backed: USDT, USDC

• Asset-referenced: (emerging)

• Crypto-collateralised: Dai, LUSD

• Algorithmic: earlier models (e.g., Terra UST, now inactive)

• Tokenised fund shares: MMF share tokens

  
  

Each design implies different risk, transparency, redemption, reserve management, and operational mechanics.

4) Reserve design & transparency: what’s inside the box

Eligible assets and liquidity ladders. For fiat-redeemable stablecoins, reserves typically comprise bank deposits, U.S. Treasury bills/notes, reverse repos backed by Treasuries, and government money-market funds. The BIS highlights that, at scale, redemptions can force issuers to sell large volumes of “safe assets,” creating a fire-sale externality—hence the emphasis on short-duration ladders and high-liquidity collateral in supervisory discussions. (Bank for International Settlements)

Issuer disclosures (examples).

• Tether (USDT): Q2 2025 attestation reported > $127 billion exposure to U.S. Treasuries (direct + indirect), underscoring the sector’s reliance on sovereign bills/notes as reserve assets. (Tether)

• Circle (USDC): publishes monthly reserve attestations and maintains a public “transparency” portal detailing reserve composition and reconciliation between supply and backing assets. (Circle)

  
  

Regulatory templates. In the EU, the MiCA regime distinguishes e-money tokens (EMTs) (fiat-referenced, par-redeemable) from asset-referenced tokens (ARTs) (baskets), with authorization, reserve, governance, and disclosure requirements overseen by the EBA/ESMA. ESMA’s 2025 statement also clarified transition/sell-only arrangements for non-compliant tokens during early implementation. (European Banking Authority)

Why this matters. Reserve eligibility, concentration, tenor, and disclosure cadence (daily/weekly holdings; monthly attestations; annual audits) drive redemption confidence and peg integrity. The macro-prudential takeaway from BIS work is straightforward: greater scale → greater need for liquidity risk management and transparent, high-frequency reporting. (Bank for International Settlements)

5) Market structure & concentration in 2025

Dominance of USD-pegged supply. Most circulating stablecoins are USD-denominated; the IMF’s Crypto Assets Monitor (Oct 2025) notes U.S.-dollar tokens remain the sector’s core settlement rail. (IMF Connect)

Concentration among a few issuers. Multiple data series show USDT + USDC comprise the clear majority of fiat-redeemable supply (roughly ~80% in mid-/late-2025 snapshots), with USDT alone exceeding $150 billion market cap per industry trackers and financial press. This level of concentration has strategic implications for liquidity, market microstructure, and policy oversight. (Fn London)

Scale and velocity indicators. Beyond market cap, the World Economic Forum highlighted rapid growth in transfer volumes—estimating $27.6 trillion stablecoin transfer value in 2024 (methodologies vary), reflecting their role as on-chain transaction money and settlement asset. While methodologies differ, the directional signal—high transactional velocity—is consistent across reputable analyses. (World Economic Forum)

Supervisory lens. The New York Fed’s Liberty Street Economics frames tokenized funds and cash-equivalents as early, credible production use-cases, but stresses that tokenization does not erase the need for robust accounting, transfer-agent sync, and risk controls—an interpretation that also applies to fiat-redeemable stablecoins when treated as money-like instruments. (Liberty Street Economics)

6) Value propositions (and limits)

Users & merchants. Stablecoins enable 24/7 finality, programmable disbursements, and efficient cross-border value transfer, especially where access to USD rails is constrained. However, on/off-ramp frictions, travel-rule/KYC requirements, and variability in consumer protections limit mass-market substitution for traditional payment instruments. IMF and BIS assessments emphasize these frictions even as usage expands. (IMF)

Market infrastructure. In crypto/DeFi, stablecoins function as base collateral and settlement cash, providing inventory for market-making, arbitrage, and margining. Their linkage to short-term sovereign assets (for fiat-redeemable designs) also aligns incentives for operational stability, while elevating liquidity-management and disclosure as core disciplines. (Bank for International Settlements)

Institutions & treasurers. For regulated treasurers seeking explicit fiduciary wrappers, tokenized money-market funds and T-bill funds often serve the same operational objective (programmable, fast-settling cash) with clearer fund law protections—hence the parallel growth in tokenized MMFs alongside fiat-redeemable stablecoins. The Liberty Street Economics series and BIS reports both situate these products within a broader tokenized market-infrastructure trajectory. (Liberty Street Economics)

Limits & risk. Policy bodies caution that stablecoins are not central-bank money; at scale they may transmit shocks (e.g., via reserve fire sales) or fragment liquidity if poorly designed. The prudent reading of 2025 research: stablecoins are useful settlement media within defined perimeters, but durable public-interest outcomes depend on reserves, redemption, governance, and supervision that meet banking-grade expectations. (Bank for International Settlements)

7) Regulation & policy: where rules stand now (2025)

European Union (MiCA/MiCAR). MiCA’s stablecoin regimes—ARTs (asset-referenced tokens) and EMTs (e-money tokens)—have applied since 30 June 2024. In January 2025, ESMA directed EU crypto-asset service providers to cease offering non-compliant stablecoins (with limited “sell-only” transitions) and urged firms to accelerate MiCA conformance; EBA/ESMA continue to roll out Level-2/3 measures and supervision expectations. (ESMA)

United States (federal framework). On 18 July 2025, the GENIUS Act became law, establishing a federal perimeter for payment stablecoin issuance, subjecting issuers to BSA/AML obligations, and limiting who may issue payment stablecoins; Treasury and agencies are now implementing rulemaking. (Politico)

United Kingdom (systemic stablecoins). The Bank of England’s 2025 communications outline a regime under which the BoE would supervise systemic sterling stablecoins, with potential caps until risks are demonstrably contained; the FCA would oversee non-systemic issuers. A consultation on limits and a resolution framework is expected as the rulebook is finalized. (Reuters)

Global standard-setting. The BIS (Annual Economic Report 2025; Bulletin 108) frames stablecoins within tokenized market infrastructure and highlights run and fire-sale risks, calling for liquidity ladders, robust redemption mechanics, and high-frequency disclosure. (Bank for International Settlements)

Bottom line. Across major jurisdictions, the policy arc is clear: authorization, reserve quality, redemption at par, financial-integrity controls, and disclosure cadence—with systemic oversight if scale grows.

8) Comparing stablecoins with near-neighbors

CBDCs vs. stablecoins.

• CBDCs are direct central-bank liabilities (retail or wholesale), designed for public money use cases. Stablecoins are private liabilities with reserve risk and issuer governance. BIS surveys (2025) emphasize that wholesale CBDCs aim to be settlement assets between banks; retail CBDCs would be accessible to the public—distinct from stablecoins in legal nature and risk. (Bank for International Settlements)

  
  

Tokenized deposits (bank money) vs. stablecoins.

• Tokenized deposits are on-chain representations of commercial-bank deposits—they inherit deposit insurance, bank supervision, and existing payment law. Stablecoins are issued by non-bank or bank entities under bespoke regimes (e.g., EMT/payment-stablecoin rules) and may not carry deposit protections. BIS/BoE policy speeches highlight this legal distinction when discussing systemic usage. (Bank of England)

  
  

Tokenized MMFs vs. “yielding stablecoins.”

• Tokenized MMF shares are fund securities with prospectuses, daily NAV, transfer-agent records, and issuer redemptions (e.g., LiquidityDirect ↔ GS DAP). Some “yielding stable” tokens are effectively tokenized cash-equivalent funds, not payment stablecoins; their risk, disclosure, and investor-eligibility frameworks therefore follow fund law, not “stablecoin” law. (Liberty Street Economics)

  
  

Takeaway. Treat these as separate instruments: CBDCs (public money), tokenized deposits (bank money), payment stablecoins (private liabilities under EMT/payment-stablecoin rules), and tokenized MMF shares (fund securities).

9) Risk checklist & buyer’s guide (practical due diligence)

Use this issuer-agnostic checklist before holding or integrating a stablecoin:

1. Legal status & perimeter

   • Is it an EMT/ART under MiCA or a payment stablecoin under the GENIUS Act (U.S.)? Who supervises the issuer? Are there geographic restrictions? (ESMA)

2. Reserve eligibility & concentration

   • Composition (cash, T-bills, reverse repo, MMFs); tenor ladder; bank/custodian concentration; rehypothecation policies. BIS warns that scale without ladders raises fire-sale risk. (Bank for International Settlements)

3. Redemption terms & access

   • Who can redeem (all holders vs authorized participants)? Settlement windows (T+0/T+1); fees; blackout conditions; historical fulfillment during stress.

4. Disclosure cadence

   • Daily/weekly holdings? Monthly attestations vs annual audits; machine-readable files (CSV/JSON) that reconcile supply and reserves.

5. Financial-integrity controls

   • BSA/AML, sanctions screening, Travel Rule compliance; incident reporting. (GENIUS Act and EU frameworks require robust programs.) (The White House)

6. Smart-contract & governance

   • Upgrade authority, pause/freeze controls, multi-sig policies, audit history; chain(s) used and bridge policy (if multichain).

7. Market structure & usage

   • Actual transfer volumes and counterparty breadth (e.g., IMF/WEF show stablecoins function as settlement media with high velocity); venue/custody integrations. (IMF Connect)

8. Macro & policy exposure

   • Jurisdictional caps/limits (e.g., prospective UK caps); risk of rule changes; systemic designations. (Reuters)

     
     

Red flags: unaudited or infrequent reserve reporting; unclear redemption agents; offshore, opaque custody; algorithmic stabilization without robust collateral; ambiguous legal wrapper.

10) Outlook 2025–2027: three realistic scenarios

Base case — “Reg-first scaling.”

• EU MiCA and U.S. GENIUS implementation drive authorized stablecoin growth, with stricter reserve, disclosure, and AML standards. USD-denominated coins remain dominant; payment use rises gradually where on/off-ramps strengthen and FX corridors are efficient. IMF Q3-2025 data continue to show USD stablecoins as the sector’s core. (IMF Connect)

  
  

Optimistic — “Payments breakout.”

• PSPs and banks integrate tokenized deposits and payment stablecoins into retail apps; cross-border corridors (remittances, B2B) achieve measurable cost/time gains. Supervisors allow broader distribution under tight guardrails; secondary effects include higher Treasury-bill demand from stablecoin reserves. (Reuters and standard-setting bodies have flagged this channel.) (Bank for International Settlements)

  
  

Downside — “Fragmentation and caps.”

• Divergent rules (e.g., UK caps on holdings; jurisdiction-specific licensing hurdles) fragment liquidity; stress events trigger redemption spikes and forced sales of safe assets, validating BIS fire-sale concerns and pushing some users toward tokenized MMFs or on-ramp CBDC pilots. (Reuters)

  
  

Strategic takeaway. Stablecoins are useful settlement media within defined perimeters. Durable public-interest outcomes hinge on reserve quality, redemption reliability, machine-readable disclosure, and prudent supervision—and on recognizing when the right instrument is a payment stablecoin versus a tokenized fund share or tokenized deposit. (Bank for International Settlements)