Stablecoins are the backbone of the crypto economy, providing a price-stable medium of exchange that bridges traditional finance and decentralised systems. With over $150 billion in circulation, stablecoins facilitate trading, lending, payments, and remittances. Understanding the different stabilisation mechanisms and their technical architectures is essential for anyone building in this space.
Fiat-Backed Stablecoins
Fiat-backed stablecoins like USDC and USDT maintain a 1:1 peg by holding equivalent fiat reserves in bank accounts or short-term treasury instruments. The smart contract is relatively straightforward — an ERC-20 token with mint and burn functions controlled by the issuer. When users deposit fiat, the issuer mints tokens. When users redeem, tokens are burned and fiat is returned. The technical challenge is not the smart contract but the off-chain infrastructure: banking relationships, reserve management, attestation processes, and compliance systems. The contract must include admin functions for blacklisting addresses (required by regulators for sanctions compliance), pausing transfers in emergencies, and upgrading the implementation via proxy patterns. USDC's contract is a well-studied reference implementation.
Crypto-Collateralised Stablecoins
Crypto-collateralised stablecoins are backed by on-chain crypto assets rather than fiat reserves. MakerDAO's DAI is the leading example:
- Overcollateralisation: Users deposit crypto assets worth more than the stablecoins they mint. A 150% collateralisation ratio means depositing $150 of ETH to mint 100 DAI.
- Liquidation: If collateral value falls below the minimum threshold, the position is liquidated — collateral is sold at auction to repay the debt and maintain system solvency.
- Stability mechanisms: Interest rates (stability fees) and the DAI Savings Rate are adjusted through governance to manage supply and demand, keeping the peg stable.
Algorithmic Stablecoins
Algorithmic stablecoins attempt to maintain price stability through automated supply adjustments without direct collateral backing. Mechanisms include seigniorage shares (minting and burning supply based on demand), rebasing (automatically adjusting all holder balances), and fractional-algorithmic hybrids that combine partial collateral with algorithmic stabilisation. The collapse of Terra/UST in 2022, which erased $40 billion in value, demonstrated the fragility of purely algorithmic designs under stress conditions. Undercollateralised algorithmic stablecoins are now widely considered failed experiments, and MiCA explicitly restricts their issuance in the EU. Any project exploring algorithmic mechanisms should ensure robust collateralisation and extensive stress testing.
Regulatory Landscape
Stablecoins are the most heavily regulated segment of crypto. MiCA classifies stablecoins as either Asset-Referenced Tokens (ARTs) or Electronic Money Tokens (EMTs), each with specific reserve requirements, redemption rights, and capital buffers. EMT issuers must be authorised as electronic money institutions. Significant stablecoins — those exceeding certain usage thresholds — face additional requirements including enhanced reserve management and stress testing. In Malta, stablecoin issuance falls under both the VFA framework and MiCA requirements. At Born Digital, we help stablecoin projects architect both the on-chain smart contracts and off-chain compliance infrastructure needed to operate within the European regulatory framework.