You’ve likely come across the term “stablecoin” while exploring digital assets. Maybe you’ve also heard stablecoins classified as “fiat-backed,” “crypto-backed,” “commodity-backed,” or “algorithmic.” Stablecoin terminology might sound complex, but it’s actually pretty simple once you peel back the jargon. We’re here to help break it down and explain how stablecoins work — especially two of the most talked-about types of stablecoins: fiat-backed and algorithmic.
In general, stablecoins are crypto assets designed to hold a steady value by pegging their value to another asset — most commonly fiat currency (e.g., US dollars, euros, or Japanese yen), commodities (e.g., oil or precious metals), or other crypto assets. For example, USDC is a fiat-backed stablecoin1 pegged to the US dollar and designed to move seamlessly across global blockchains, making it useful for transfers, payments, saving, and trading.
In this article, we’ll compare fiat-backed stablecoins and algorithmic stablecoins.
Fiat-backed stablecoins vs. algorithmic stablecoins: different strategies for maintaining price stability
This section breaks down the design differences between fiat-backed stablecoins and algorithmic stablecoins. Keep in mind, a well-designed stablecoin should maintain a stable price, relative to the fiat currency it represents. Both algorithmic and fiat-backed stablecoins aim to do exactly that, but they go about it in different ways.
If you’re interested in using stablecoins, it’s important to understand the different strategies to keeping a resilient price peg. It’s not just an intellectual exercise for the crypto curious.
Here’s a high-level overview of the design differences between fiat-backed and algorithmic stablecoins:
Fiat-backed stablecoins: backed by collateral
For every fiat-collateralized stablecoin in circulation, there should be real money that’s easily accessible. For every USD-pegged stablecoin, for example, there should be a corresponding dollar (or dollar-equivalent asset like US Treasury bills) held in reserve. In practice, however, not all fiat-backed stablecoins adhere to the same levels of scrutiny when it comes to reserve management, and they might not be fully backed by assets held in reserve. As you can imagine, it’s absolutely crucial for stablecoin price stability that fiat-backed stablecoins are fully backed.
What does it mean for a stablecoin to be fully backed?
Let’s examine what it means to be fully backed using USDC as an example. Let’s say that USDC’s market cap is $60 billion. In that case, Circle would need $60 billion worth of cash or cash-equivalent assets in order for USDC to be considered fully backed. In reality, Circle maintains reserves equal to or greater than the amount of USDC in circulation, held in highly liquid cash and cash-equivalent assets. (Details can be found in our latest reserve attestation.) That means that the value of the reserves is greater than the amount of USDC in circulation.
Let’s say that hypothetical stablecoin XYZ has a market cap of $50 million and only $40 million in collateral backing their stablecoin. In this instance, XYZ would not be fully backed as it lacks an equivalent amount of collateral held in reserve. In this scenario, only $40 million worth of XYZ could be redeemed for USD, leaving a difference of $10 million XYZ that’s not redeemable. This would be an example of an undercollateralized stablecoin, and the risk here is that in times of increased redemptions, market panic could set in.
This example illustrates why it’s important to use a fully collateralized, fiat-backed stablecoin that transparently publishes third-party audits. Circle publishes monthly attestations for both USDC and its euro-pegged EURC using a Big Four accounting firm to provide transparency that’s accessible to anyone.
Pros of fiat-backed stablecoins
Let’s explore the stablecoin pros and cons starting with fiat-backed models. What backs a fiat-backed stablecoin, and why does it matter? Because they’re backed by actual money, their value tends to stick closely to the fiat currency they’re pegged to (in most cases, that’s $1 USD). That said, fiat-backed stablecoins can fluctuate slightly (such as $0.9998–1.0002) based on market conditions.
Fiat-backed stablecoins are designed to work more like regular money. This makes them easier to understand, audit, and regulate. As such, fiat-backed stablecoins have been gaining recognition under regulatory regimes. This can be seen in the following examples:
- In the US, proposed legislation like the GENIUS Act of 2025 aims to bring stablecoin issuers under a clear federal licensing framework, emphasizing oversight by prudential regulators and restricting the use of algorithmic stablecoins for payment purposes.
- The UK has recently advanced its regulatory framework for stablecoins through the Financial Services and Markets Act 2023, complemented by joint proposals in 2025 from the Financial Conduct Authority (FCA) and Bank of England. This updated framework focuses on mandatory FCA authorization, increased transparency requirements for issuers, robust consumer protection, and systemic risk management.
- The EU’s Markets in Crypto-Assets Regulation (MiCA) introduces a comprehensive framework for stablecoins, imposing strict requirements on fiat-referenced and asset-referenced tokens. Algorithmic stablecoins, lacking asset backing, are unlikely to meet these regulatory standards under MiCA.
Cons of fiat-backed stablecoins
The main concern with fiat-backed stablecoins is that you have to trust the company issuing the stablecoin to manage reserves honestly and securely. That’s why independent audits, publicly available reports, and issuer transparency are so important.
Algorithmic stablecoins: high tech and uncollateralized
Let’s take a closer look at how algorithmic stablecoins work — and why most have struggled to maintain their peg at scale. Algorithmic stablecoins typically ditch the concept of reserve backing and let code do the balancing act. Algorithmic stablecoins maintain their value (or try to) without holding fiat collateral, or any collateral at all. Instead, they use smart contracts, incentives, and supply-and-demand dynamics to aim for target price parity. In practice, this approach has not proven to be nearly as reliable as the fully collateralized approach.
Different types of algorithmic stablecoins
There are a few different approaches to algorithmic stablecoins. Some algorithmic stablecoins have no collateral at all. Others use a mix of algorithms and backing.
“Rebalance” algorithmic stablecoins (like Ampleforth’s AMPL) adjust their supply automatically. If the price rises above $1, more coins are created to bring the price back down. If the price drops below $1, the system reduces supply to bring it back up. This system directly impacts the number of AMPL tokens that a user holds — the quantity of AMPL in your wallet can fluctuate, but the value is intended to remain stable.
Other algorithmic stablecoins use a “seigniorage model” which relies on using other tokens (in addition to the stablecoin itself) to keep the value of the stablecoin steady through mint-and-burn mechanisms, stake-and-earn mechanisms, or other methods. These multi-token systems are designed to create a mechanism to increase/decrease the supply/demand for an algorithmic stablecoin.
Take the algorithmic stablecoin Terra USD (UST), for example. UST functioned as part of a two-token system along with its counterpart asset, LUNA. In this scenario, UST was designed to be the stablecoin, and LUNA was designed to have variable value. As described above, LUNA was intended to minimize or absorb price volatility from UST, but ultimately it didn’t work, and UST’s market cap quickly dropped from $18B to less than $1 billion.
Cons of algorithmic stablecoins
The UST example highlights one of the biggest stablecoin risks today: when an algorithmic model fails, it can result in rapid, irreversible value loss. While there are deep dives that explain what happened to UST in detail, the long and short of it is that the mechanism failed, resulting in a rapid loss of value and a lasting loss of trust. At the time of writing, UST trades for around $0.01, not $1. Its collapse led to significant financial losses for users across the blockchain ecosystem.
Prior to its price collapse which began on May 9, 2022, UST had a market cap over $18 billion. Since then, the collective digital asset market has largely veered away from algorithmic stablecoins due to concerns about their ability to sustain stable value at scale.
This is, far and away, the biggest concern about algorithmic stablecoins. When they can’t achieve their primary function (i.e., price stability) they no longer serve the needs of users. That being said, some teams continue to experiment with algorithmic stablecoins, hoping to crack the code for a decentralized, collateral-free stablecoin.
Pros of algorithmic stablecoins
Arguably the only advantage of algorithmic stablecoins is their decentralized nature. While fiat-backed stablecoins rely on a central issuer, algorithmic stablecoins operate on smart contracts and protocols, reducing the need for trust in a central party. On the one hand, this makes them more censorship-resistant, as there’s no single entity that regulators can easily target or shut down. On the other hand, algorithmic stablecoins may be increasingly vulnerable to smart contract errors, hacks, and similar issues without a central authority to oversee the system.
By leveraging innovative economic models, game theory, and automated code, these systems aim to create stable values without the backing of traditional finance (TradFi) — attempting to push the boundaries of what’s possible in decentralized finance (DeFi).
Through experimentation with elastic supply algorithms, algorithmic stablecoins represent a creative, albeit experimental, approach to stable onchain value. And if history tells us anything, it’s that algorithmic stablecoins still have work to do to get the formula right.
A risk analysis of fiat-backed vs algorithmic stablecoins
As a quick recap, we’ve discussed fiat-backed stablecoins and algorithmic stablecoins.
Algorithmic stablecoins are pegged to USD or another fiat currency but they aren’t usually supported by actual cash collateral. The algorithm does all the work, or at least is designed to do the work. If you’re into decentralization and bleeding-edge innovation — and you understand the very serious risks — algorithmic stablecoins might pique your interest.
Fiat-backed stablecoins are pegged to fiat currencies and backed by them (including cash-equivalent assets). These stablecoins offer stability through reserves and have a much stronger track record of stability, though you must trust the company managing those reserves. For those looking for proven stability, fiat-backed stablecoins are the much safer approach — and USDC stands in a class of its own being fully backed with transparent reserve attestations, and a regulation-first approach.
The truth is that every stablecoin model requires you to place trust in someone, something, or some entity. With fiat-backed stablecoins, you’re trusting the stablecoin issuer. In the case of USDC, specifically, that means Circle as the issuer of USDC, and the manner in which it operates its business, which includes providing monthly third party assurances regarding the value of USDC reserve holdings, and its regulatory-first approach. With algorithmic stablecoins, you have to trust the smart contracts, the developers, and the algorithm that is adjusting the supply and demand in an effort to keep a close fiat peg. That choice depends on what you value — transparency and compliance, or decentralization and code-based trust — and your risk tolerance.
While that’s up to you, it’s important to state that fiat-backed stablecoins make up over 90% of the total stablecoin market cap.
Final thoughts on your stablecoin options
Stablecoin use cases go beyond trading — they power onchain payments, decentralized autonomous organizations (DAOs), and more. Whether you're looking for regulation-friendly options or more decentralized stablecoins, understanding the differences helps you align with your values and needs and gives you a much stronger grasp of how this ecosystem works.
Stablecoins are the glue holding much of the digital asset universe together. So next time you use one, take a moment to think: What’s backing this stablecoin, and who or what controls it?
If you’re looking for stability, fiat-backed stablecoins like USDC and EURC can be powerful tools. You can use USDC in DeFi protocols, send instant cross-border payments with relatively low fees, or even fund a global project. EURC brings similar benefits to those transacting in euros, opening doors for European businesses and freelancers to participate in the digital economy without currency headaches.
On the other hand, algorithmic stablecoins represent an experiment in creating decentralized and stable onchain value. Just bear in mind that algorithmic stablecoins come with significant risks and aren't issued or supported by Circle. It's important to do your own research before using them.
Stablecoins aren’t just about holding value — they’re about unlocking new ways to interact with money, finance, and technology. The choice is yours.
