Stablecoins are set to dominate cross-border payments. Here’s what you need to know about this new currency, its stability and its risks
What is Stablecoin Backing?
Stablecoin backing is the pool of reserve assets, usually cash, treasuries or other highly liquid holdings, kept to anchor each digital token to a reference asset at a 1:1 ratio. With fiat-collateralised coins like USDT (Tether) or USDC, each new token appears only after the issuer sets aside equivalent US dollars in a separate account.
This reserve structure helps maintain the token’s trading value exactly at its face value. Beyond price stability, the underlying reserve composition determines how quickly you can convert stablecoins back to fiat currency during market stress, though stablecoin transfers themselves settle instantly.
Cash-heavy reserves redeem within hours while a portfolio full of long-dated securities or opaque instruments might lock you out when you need your money most.
Why Stablecoin Backing Matters: From MiCA to the GENIUS Act
Regulators now focus directly on how reserves are managed and reported. Europe’s Markets in Crypto-Assets Regulation (MiCA) divides issuers into Asset-Referenced Tokens (ARTs) and E-Money Tokens (EMTs).
Both require fully backed, low-risk reserves, separation from corporate funds and frequent audit reports.
“Significant” tokens—more than 10 million users or €5 billion in circulation—fall under European Banking Authority supervision with daily liquidity monitoring and an ECB veto if systemic risks emerge.
In the US, the GENIUS Act mirrors several MiCA features: federal licensing, 1:1 cash-and-Treasury reserves, public monthly disclosures and an 18-month transition period.
Both frameworks guarantee redemption rights, prohibit stablecoin issuers from paying interest directly to holders, though third-party platforms like Coinbase and PayPal can still offer yield programs on stablecoin deposits through revenue-sharing arrangements
Coins that meet these rules are more likely to maintain bank relationships, pass audits and keep redemption channels open when markets get volatile.
Peg strength also determines conversion reliability. A coin that holds its peg tightly converts to fiat more predictably during volatile periods, reducing FX slippage when exchanging back to traditional currency for cross-border payouts.
What is a Stablecoin Peg and How They Work
A stablecoin peg is the set of economic incentives that keeps a stablecoin’s market price tied to its reference asset. With fiat-backed tokens, the process is straightforward: if the coin trades above $1, arbitrageurs deposit dollars, mint new tokens and sell them, pushing the price back down.
When the price falls below $1, they buy discounted tokens and redeem them for pounds at par, keeping the difference. This mint-and-redeem cycle maintains stability without a central bank.
Soft pegs use market incentives; hard pegs add an explicit redemption promise. The tighter the peg, the more predictable your settlement timings and the fewer FX reconciliation headaches you’ll face.
These stability mechanisms matter because they directly influence which of the four main backing approaches works best for different business needs.
The Four Stablecoin Backing Models
When most people think of stablecoins, they’re looking for the flexibility and speed of digital tokens with the stability and reliability of stable currencies like the US Dollar. However, 1:1-backed coins are only one type of stablecoin.
Understanding the different types can help you identify and avoid riskier digital assets that merely call themselves ‘stable’ without proper backing.
1. Fiat-Collateralised Stablecoins
A fiat-backed coin keeps one foot firmly in the traditional banking system. For every USDC, USDT or EURC you hold, the issuer keeps an equivalent amount of cash or short-dated government securities in a regulated account.
Arbitrage quickly closes price gaps: when the market price rises above $1, you mint new tokens with dollars, sell them and bring the price back down. If it drops below, you buy discounted tokens and redeem them for the underlying fiat.
Market share numbers show why they’re popular. Tether and Circle control the majority of the market, giving you deep liquidity and reliable on and off-ramps. This clarity makes redemptions predictable—essential when you’re paying gig workers or making supplier payments.
The downside is centralisation. You depend on the issuer’s governance, banking partners and compliance track record. An unexpected account freeze or new regulation can create instability, so you need backup plans despite the stable peg.
2. Commodity-Backed Stablecoins
Think of Pax Gold (PAXG) or Tether Gold (XAUT) as digital warehouse receipts. Each token represents a specific amount of gold stored in a vault and checked by third parties.
Since gold prices have historically changed more slowly than crypto, these coins offer protection against inflation with greater liquidity than physical gold..
In practice, redemption is more complicated than with cash. Minimum withdrawal amounts and delivery fees apply and vault storage costs are built into annual token fees. Trading volumes are lower than with fiat coins which means wider spreads during market stress.
If you need to diversify treasury reserves or settle trades in a metal-linked unit, a commodity coin gives you that exposure without physical handling. Just check audit schedules and insurance coverage before committing.
3. Crypto-Collateralised Stablecoins
Crypto-backed models replace bank accounts with smart contracts. For instance, you lock $150 worth of Ethereum (ETH) to mint about $100 of DAI stablecoin, keeping a 150% buffer against volatility. If prices crash and collateral falls below the threshold, on-chain auctions liquidate positions to maintain the peg.
The trade-off is efficiency. You must lock up significantly more crypto value than the stablecoin you receive and technical errors in the automated systems can cause losses even when markets are stable.
4. Algorithmic & Hybrid Models
Algorithmic coins attempt to maintain stability through automated supply adjustments without traditional backing—expanding token supply when prices rise above $1 and contracting when they fall below.
The GENIUS Act essentially prohibits this business model by requiring all payment stablecoins to be fully backed by 1:1 reserves of cash or short-term Treasuries, making algorithmic models that rely on code rather than assets illegal for regulated stablecoin issuers.
The risks became clear in May 2022 when TerraUSD, the largest algorithmic stablecoin with an $18 billion market cap, collapsed within a week. The failure triggered a ‘death spiral’ where falling confidence led to mass redemptions, forcing the creation of trillions of new LUNA tokens that drove both UST and LUNA to near-zero values.
The collapse wiped out nearly $60 billion and demonstrated why algorithmic models remain highly experimental.
Understanding these distinctions matters because not all tokens calling themselves ‘stablecoins’ offer the same stability. Companies need proper due diligence to verify that coins are genuinely backed by currency reserves rather than relying on untested algorithms.
How Payment Teams Can Evaluate Stablecoin Backing Quality
Understanding the four backing models is important but payment teams need practical criteria for choosing between them. This structured review framework helps you select tokens that match your risk appetite and redemption needs.
Verify True 1:1 Backing and Regulatory Compliance
A ‘1:1 backed’ stablecoin doesn’t necessarily mean there’s a US dollar for every token. Many issuers hold short-term, low-risk assets like Treasury bills instead of cash. While these assets are generally safe, sudden interest rate changes could cause backing assets to lose value, creating gaps in coverage.
Look for monthly attestation reports that detail exactly what backs each token. MiCA regulations require issuers to segregate reserve assets from their corporate funds and maintain daily liquidity monitoring for tokens with significant circulation. This provides greater confidence in redemption reliability.
Check redemption terms carefully. How quickly can you convert tokens back to fiat? What are the minimum amounts and fees? Some issuers process redemptions within hours while others may take several business days during high-demand periods.
Regulatory compliance under frameworks like the GENIUS Act requires monthly reporting of total outstanding tokens and reserve composition, along with regular audits by registered accounting firms. Missing attestations, vague asset descriptions or delayed reporting suggest potential compliance issues that could lock your funds during regulatory reviews.”
Verify Regulatory Compliance and Oversight Standards
A licence indicates that regulators have tested an issuer’s governance, capital planning and disclosure. In the European Economic Area, look for an issuer classified as an E-Money Token or Asset-Referenced Token under MiCA with authorisation from a national authority and ongoing supervision by the European Banking Authority for “significant” coins.
Request the latest white paper filed with regulators and check redemption rights: MiCA prohibits interest payments but requires par-value redemption on demand.
In the US, the GENIUS Act mirrors these requirements with federal licensing and monthly reserve disclosures. Check state money-transmitter approvals too, given the overlapping regulations.
Independent audits are crucial: a global accounting firm that examines underlying assets provides much more assurance than a limited-scope attestation. Also, review the issuer’s AML and sanctions controls—weak screening can lead to wallet blacklisting, freezing your settlement funds without warning.
Monitor Operational Performance and Stability Metrics
Numbers reveal how a peg behaves under pressure. Track the biggest deviation from the target value over the past year and recovery time. During the 2023 banking crisis, several fiat-backed coins dropped below 0.98 dollars before returning to par within two days; that recovery speed offers a useful benchmark.
Daily trading volume and exchange coverage show whether you can sell large positions without affecting the market.
Technical infrastructure matters too. Check block finality times, typical transaction fees and any recorded network outages. If the coin operates across multiple chains, verify bridge security audits and past incident reports.
Redemption mechanics deserve equal attention: minimum amounts, processing deadlines and fees all affect cash forecasting.
Finally, ask for the issuer’s business continuity plan—especially their protocol for bank holidays, custodian failures or cyber-incidents—because your ability to pay overseas staff shouldn’t depend on a single server staying online.