Types of stablecoins and how these stable cryptocurrencies work

As we explained in our article on what stablecoins are, stablecoins are cryptocurrencies designed primarily to maintain a stable value and enable their use as money in the real economy.

In practice, stablecoins function as digital money on blockchain networks. They combine classic financial concepts—such as price, liquidity, market capitalization, and market demand—with blockchain-based technology powered by smart contracts.

Their goal is not to replace currencies like the U.S. dollar or the euro, but to offer a more efficient way to use them for payments, commerce, remittances, and digital payment systems in a global environment.

Below, we review the main types of stablecoins, explaining how they work, what risks they carry, and why their design directly impacts global adoption.

The four main types of stablecoins by backing model

Fiat-backed stablecoins

This is the most common type of stablecoin and the one with the largest market capitalization. The model is simple: for every token issued, there is an equivalent unit of fiat currency held in reserve—usually U.S. dollars or euros.

Stablecoins like USDC or USDT digitally replicate the behavior of fiat money, but as programmable blockchain assets. Their reserves are typically held in highly liquid assets and managed by a centralized issuer.

This structure allows easy integration with banks, exchanges, and traditional payment systems, making them suitable for everyday use. The trade-off is centralization: issuers can freeze funds or block addresses to comply with regulations.

Crypto-backed stablecoins

These stablecoins aim to decentralize stable money issuance. Instead of fiat reserves, they are backed by crypto assets locked in smart contracts.

To offset volatility, these systems require overcollateralization. If collateral value falls below defined thresholds, automatic liquidations occur to maintain stability.

The best-known example is DAI. Crypto-backed stablecoins offer transparency and censorship resistance, but they are less capital-efficient and more exposed to technical risks, oracle failures, and governance issues.

Commodity-backed stablecoins

Commodity-backed stablecoins are pegged to physical assets, most commonly gold. Each token represents a specific quantity of the commodity held in custody by the issuer.

Examples like PAX Gold (PAXG) or Tether Gold (XAUT) resemble a digital version of the gold standard. These stablecoins are useful for diversification and value storage, but they are not stable relative to fiat currencies, limiting their use for payments.

Algorithmic stablecoins

Algorithmic stablecoins attempt to maintain price stability without direct collateral, using algorithms that adjust token supply and demand.

When market confidence holds, these systems may function. When it breaks, they can collapse rapidly—as seen with TerraUSD (UST). To date, algorithmic stablecoins have not demonstrated long-term stability and are viewed cautiously by regulators and market participants.

Other types of stablecoins

Yield-bearing stablecoins (LST-backed)

These stablecoins are backed by liquid staking tokens (LSTs), allowing collateral to generate yield. That yield may be distributed to users, creating so-called “productive stablecoins.”

Examples like eUSD combine stability with passive income, but introduce added technical complexity and staking-related risks.

Hybrid models

Hybrid models combine real collateral with algorithmic components. A well-known example is FRAX, which gradually transitioned toward full collateralization after exposing the limits of mixed designs.

Stablecoins by regulatory classification

Beyond technology, regulation is shaping stablecoins.

In Europe, the MiCA framework distinguishes between:

• Electronic Money Tokens (EMTs), backed by a single fiat currency
• Asset-Referenced Tokens (ARTs), linked to other assets or crypto

In the United States, payment stablecoins must be fully backed and issued by regulated entities, with restrictions on paying interest to end users.

The trend is clear: stablecoins intended for mass adoption must combine technical robustness with regulatory compliance, positioning themselves as global financial infrastructure.

Learn more about stablecoins on Kontigo and start using stable digital currency today.