Stablecoins Explained: USDC, USDT, and How They Work

Stablecoins are the quiet success story of crypto. Unlike Bitcoin or Ethereum, they are not designed to go up in value — they are designed to be boring. A stablecoin is a token that aims to maintain a 1-to-1 peg with another asset, almost always the US dollar.

By 2026, stablecoins settle hundreds of billions of dollars in transactions every month. They have become the default unit of account in crypto markets, the rails for an increasing share of cross-border payments, and one of the largest non-bank holders of US Treasury bills in the world.

This guide explains how they work, what the major types are, and where the real risks lie.

The three main types of stablecoin

Fiat-backed (centralized)

The most common design. The issuer holds reserves — typically a mix of cash and short-duration US Treasuries — equal to or greater than the number of tokens in circulation. When you deposit a dollar with the issuer, you receive one token. When you redeem one token, you receive a dollar back.

The two largest stablecoins, USDT (Tether) and USDC (Circle), both work this way. Together they account for the vast majority of stablecoin supply. Both publish regular attestations of their reserves, though the rigor of those attestations varies.

Crypto-backed (over-collateralized)

Backed not by dollars in a bank but by crypto assets locked in a smart contract. To mint $100 of these stablecoins, you typically need to lock at least $150 of collateral, with automatic liquidation if the collateral value falls too far. DAI, issued by the MakerDAO protocol, is the largest example.

The trade-off is capital inefficiency: you need more value locked up than the stablecoins you create. The benefit is decentralization and verifiability — anyone can audit the collateral on-chain at any time, with no need to trust an issuer's auditor.

Algorithmic (no full backing)

Tokens that try to maintain their peg through algorithmic mechanisms, often involving a secondary token whose supply expands and contracts. Several high-profile algorithmic stablecoins have collapsed — most catastrophically Terra's UST in May 2022, which destroyed roughly $40 billion in value over a few days. The category has not recovered, and most serious analysts now consider purely algorithmic designs unworkable at scale.

What stablecoins are actually used for

• Trading pairs on exchanges. Most crypto trading is denominated in stablecoins, not in dollars directly.
• Holding "cash" in a self-custody wallet. Stablecoins let crypto users hold dollar-denominated value without a bank account.
• Remittances and cross-border payments. Sending USDC across the world takes seconds and costs cents, where bank wires can take days and cost dollars.
• Earning yield in DeFi. Stablecoins can be deposited into lending protocols to earn interest, often well above bank savings rates.
• Avoiding currency depreciation. In countries with high inflation or capital controls, stablecoins offer a way to hold dollar exposure that local banks may not provide.

How issuers actually back the tokens

Both Circle (USDC) and Tether (USDT) have published quarterly attestations showing their reserves. As of recent reports, both hold the large majority of their backing in short-duration US Treasury bills, with smaller allocations to cash, repurchase agreements, and other liquid instruments.

The gross interest income on these reserves is substantial — at recent Treasury yields, a $100 billion stablecoin issuer can earn several billion dollars a year just from holding government bonds. This is why stablecoin issuance has become a genuinely lucrative business.

The risks

Issuer risk

If the issuer is hacked, becomes insolvent, or has its reserves frozen by authorities, the stablecoin can lose its peg. This is mostly a theoretical concern for the major issuers today, but it remains the central risk of fiat-backed stablecoins.

Reserve quality risk

What is in the reserves matters. A stablecoin backed entirely by overnight reverse repos with the Federal Reserve is much safer than one backed by commercial paper from companies whose financial health is opaque. This was Tether's main controversy for years and is part of why Circle markets USDC as the more transparent alternative.

Banking risk

Stablecoin issuers hold their reserves at banks. When Silicon Valley Bank failed in March 2023, USDC briefly traded as low as $0.87 because Circle had a portion of its reserves there. The peg recovered within days, but the episode showed that even well-managed stablecoins inherit risk from their banking partners.

Smart contract risk

For crypto-backed stablecoins like DAI, a bug in the smart contract that manages collateral could allow attackers to mint stablecoins without backing.

Regulatory risk

Stablecoin regulation has tightened significantly worldwide. The EU's MiCA framework requires stablecoin issuers to be authorized banks or e-money institutions. The United States has multiple competing legislative proposals, and several states already regulate stablecoin issuers directly. New rules can change the economics of issuance and limit which stablecoins are available in which jurisdictions.

How to choose a stablecoin

For most users, the practical considerations are:

• Where you can use it. Different exchanges and protocols support different stablecoins. USDC has the broadest institutional integration; USDT has the deepest liquidity in many trading pairs.
• Issuer transparency. Look for monthly or quarterly attestations from a reputable accounting firm.
• Regulatory standing. A stablecoin issued by a regulated entity in a jurisdiction with clear rules is generally safer than one operating in a regulatory gray area.
• Concentration. If you are holding large amounts, splitting across two or more stablecoins reduces single-issuer risk.

The bottom line

Stablecoins are no longer a niche crypto product. They are a parallel dollar system that handles trillions in annual settlement and holds enough US Treasuries to matter macroeconomically. For users, they are a useful tool — a way to hold dollar exposure on-chain — but they are not literally dollars, and the risks behind the peg are real. Treat them as a financial product with counterparty risk, not as cash, and you will avoid most of the ways people get hurt.