Stablecoins Explained: How They Work and Who Regulates Them

A stablecoin is a crypto asset designed to hold a steady value, usually one US dollar per token, so that it can be used for payments, settlement and as a parking place between trades. Stablecoins explained in one line: the issuer takes in dollars (or other assets), issues tokens on a blockchain, and promises to redeem each token for a fixed amount of money. Whether that promise is reliable depends on what stands behind the token, who audits it, and which rules govern the issuer. Those questions come up in almost every crypto news digest, because stablecoins sit under most trading activity.

In brief

• Stablecoins try to keep a fixed value through reserves, collateral or algorithms; reserve-backed designs are the most common.
• The peg holds only as long as holders believe they can redeem at par.
• A federal law enacted July 18, 2025, the GENIUS Act, sets a framework for “payment stablecoins” issued in the United States.
• A stablecoin is not a bank deposit and is not issued by the central bank.

What makes a coin “stable”

Most crypto assets float freely, so their prices move with supply and demand. A stablecoin tries to remove that movement by tying its value to an external reference. The reference is typically a national currency, most often the US dollar, though designs exist for other currencies and for commodities such as gold.

The tie is maintained by one of three broad methods:

1. Fiat-reserve backing. The issuer holds cash and short-term assets in an amount meant to match the tokens outstanding. This is the model the GENIUS Act regulates.
2. Crypto-collateralized backing. Smart contracts lock up other crypto assets, usually worth more than the stablecoins issued, so that a drop in collateral value is cushioned. Liquidation rules sell collateral if the cushion shrinks.
3. Algorithmic designs. Software adjusts supply, or links the coin to a companion token, to push the price toward the target without full reserves. These have the weakest record. Several have lost their peg when confidence faded, because nothing of equal value stood behind them.

How a reserve-backed stablecoin works

The cycle is simple.

1. A customer sends dollars to the issuer, directly or through an intermediary such as an exchange.
2. The issuer creates (mints) the same number of tokens on a blockchain and sends them to the customer.
3. The issuer invests the dollars in reserve assets.
4. When a holder wants dollars back, the issuer takes the tokens out of circulation (burns them) and pays out.

The coin trades on exchanges at prices near one dollar. If the market price rises above par, eligible customers can create new tokens at par and sell them. If it falls below par, they can buy tokens cheaply and redeem them for a full dollar. That arbitrage pulls the price back. It works only if redemption is actually open to them, fast and cheap. In practice many holders never redeem directly with the issuer. They rely on exchange prices, so the peg depends on a small group of large, authorized counterparties and on market confidence.

A worked example

Take a hypothetical issuer with 1,000 tokens outstanding and 1,000 dollars of reserves in short-term government debt and cash. Customers want out, and 400 tokens are presented for redemption. The issuer sells or lets mature enough reserves to pay 400 dollars. If the reserves are liquid and fully intact, that is routine. If instead the issuer had put 300 of the reserve dollars into a less liquid asset that cannot be sold at face value on short notice, it may be unable to pay on time, the price slips below par, and more holders rush to redeem. This is the run dynamic, and it is why the quality and liquidity of reserves are the core issue.

What the GENIUS Act requires

On July 18, 2025, Congress enacted Public Law 119-27, the Guiding and Establishing National Innovation for U.S. Stablecoins Act, known as the GENIUS Act. The statute is available on GovInfo. In general terms, it does the following.

Defines a payment stablecoin. A payment stablecoin is a digital asset that is, or is designed to be, used as a means of payment or settlement, and whose issuer is obligated to convert, redeem or repurchase it for a fixed amount of monetary value and represents that it will maintain a stable value relative to that amount. The definition excludes national currency, deposits (including tokenized deposits) and instruments that are securities as defined in the federal securities laws.

Sets reserve standards. A permitted issuer must maintain identifiable reserves backing outstanding tokens on at least a one-to-one basis. Permitted reserve assets include US coins and currency, funds in accounts at a Federal Reserve Bank, demand deposits or insured shares at insured depository institutions, and short-dated Treasury securities, with the statute specifying maturity limits, along with certain repurchase agreements and similar items. The Act also restricts pledging or reusing reserves except for narrow purposes.

Requires disclosure. Issuers must publicly disclose redemption policy and the fees tied to buying or redeeming tokens, and must publish the monthly composition of reserves on the issuer’s website, including the number of tokens outstanding and the amount and composition of reserves.

Bars interest from the issuer. A permitted issuer may not pay a holder interest or yield solely in connection with holding, using or retaining the stablecoin. This provision is why debates about “yield” on stablecoins often focus on what intermediaries such as exchanges may offer, which the statute treats differently from the issuer’s own payments.

Splits oversight. The Act provides for federal qualified issuers, approved by the Office of the Comptroller of the Currency, and for state qualified issuers, with a transition to federal oversight when a state issuer’s outstanding issuance passes a statutory threshold. Banks and their subsidiaries have their own paths.

Limits who may offer tokens in the United States. Beginning three years after enactment, subject to the statute’s exceptions, digital asset service providers may not offer or sell a payment stablecoin to a person in the United States unless it was issued by a permitted issuer. Foreign issuers face conditions, including the ability to comply with lawful orders.

This is a general summary. The statute is lengthy, and agencies are required to write implementing rules. Readers who need precision should read the Act’s text and the regulators’ current releases.

Risks to understand

• Reserve risk. Reserves can be mismanaged or held in assets that lose value or are hard to sell.
• Redemption risk. Some arrangements limit who can redeem, set minimums, charge fees, or reserve the right to delay.
• Counterparty and custody risk. Reserves sit at banks and custodians. A failure at one of them can interrupt access.
• Smart-contract and chain risk. A bug, an exploit or a network outage can affect transfers.
• Regulatory risk. Rules differ across countries, and a token that is permitted in one market may be restricted in another.
• Concentration. A small number of tokens account for most of the market, so a problem at one can spread to exchanges and lenders that use it as collateral.

The SEC’s investor education pages on crypto assets stress that features and risks vary widely by asset, and its custody bulletin explains that wallets hold keys and not the assets themselves. Both points apply to stablecoins, since holders face custody decisions just as they do with other tokens.

Stablecoins versus related products

• Bank deposits. A deposit is a claim on an insured bank, with deposit insurance up to legal limits. The GENIUS Act definition excludes deposits from “payment stablecoin,” so the two are distinct categories.
• Money market funds. These are securities, pooled investments that hold short-term debt, and they are regulated under the investment company laws. A token that is itself a security is outside the Act’s definition.
• Central bank digital currency (CBDC). A CBDC would be a direct liability of a central bank. A stablecoin is a private liability of its issuer.
• Tokenized deposits. These are bank deposits recorded on a ledger, and the Act’s definition treats them as deposits.

Why banks and regulators watch the market

Stablecoin reserves are largely invested in government debt and bank deposits, which links the sector to short-term funding markets. Banking supervisors also look at how regulated banks may engage with crypto activities, including under the Volcker rule, which the Federal Reserve Board describes as generally prohibiting banking entities from proprietary trading and from investing in or sponsoring hedge funds or private equity funds. The GENIUS Act authorizes entities regulated by the primary federal payment stablecoin regulators to engage in payment stablecoin activities, and directs those regulators to review their guidance and clarify the point.

Common misconceptions

“A stablecoin is always worth a dollar.” The target is a dollar. Market prices can fall below it, sometimes sharply, when confidence breaks.

“Reserves mean the coin is risk-free.” Reserves reduce risk only if they are liquid, segregated and reported accurately.

“The government insures stablecoins.” No federal deposit insurance applies to a stablecoin simply because it is pegged to the dollar.

“All stablecoins are the same.” Backing, redemption rights, governance and jurisdiction differ greatly.

FAQ

Is a stablecoin the same as a digital dollar from the Federal Reserve?

No. A central bank digital currency would be issued by the central bank. Stablecoins are issued by private companies and backed by their own reserves.

What happens if a stablecoin issuer fails?

The outcome depends on the legal structure, the reserves and the applicable insolvency regime. Holders may have redemption claims, but timing and recovery are not guaranteed. The GENIUS Act gives the claims of stablecoin holders priority, on a ratable basis and subject to the statute’s terms, in an insolvency proceeding of a permitted issuer. Readers should consult the text for the specifics.

Can an issuer pay me interest for holding its stablecoin?

Under the GENIUS Act, a permitted issuer may not pay interest or yield solely for holding, using or retaining the token. Other firms may offer separate products, with their own terms and risks.

Where can I check an issuer’s reserves?

The Act requires permitted issuers to publish the monthly composition of reserves on their websites. Attestation or audit reports, where an issuer publishes them, give further assurance, and the type of report matters.

Are stablecoins legal to use in the United States?

Using them is generally lawful. The Act regulates who may issue them and who may offer them to US persons. Tax and reporting rules also apply to transactions, and the IRS and Treasury publish current guidance.