The technical principles and trust logic of stablecoins

# The Development, Technical Principles, Trust Logic, and Outlook of Stablecoins  

Against the backdrop of the accelerated integration of digital finance into the global trade system, cryptocurrencies represented by Bitcoin and Ethereum have attracted widespread attention. However, their extreme price volatility makes them unfit to serve as mainstream payment tools. In contrast, stablecoins—typified by Tether (USDT) and USD Coin (USDC)—establish pegging mechanisms to fiat currencies. This design not only retains the advantages of blockchain-based payments, such as efficient circulation and low costs but also avoids the instability of traditional cryptocurrencies, making stablecoins a focal point of current digital financial innovation. Recently, relevant bills and regulations introduced in the United States, the European Union, and Hong Kong (China) have laid a compliance foundation for the development of stablecoins. As a result, stablecoins are gaining favor among compliant investors worldwide and gradually integrating into the mainstream financial system.  

Currently, the total market capitalization of global stablecoins has exceeded $280 billion, with wide applications in scenarios such as transaction settlement, cross-border payments, and asset tokenization. Their development not only impacts the digital financial ecosystem but also poses new challenges to financial risk prevention and control. The adoption of stablecoins relies on market trust, which stems not only from the transparent and verifiable mechanisms built by underlying technologies but also from the reliability of pegging mechanisms and regulatory safeguards. Therefore, gaining an in-depth understanding of the technical principles and trust logic behind their "stability" is a prerequisite for seizing opportunities in future digital financial innovation and addressing potential regulatory risks.  

## Key Characteristics and Current Status of Stablecoins  

Stablecoins are digital assets issued based on blockchain technology, maintaining price stability relative to fiat currencies through "pegging mechanisms." Initially, they served as intermediaries for direct cryptocurrency exchange in crypto trading. Later, within the decentralized finance (DeFi) ecosystem, they evolved into foundational assets for participating in financial-like activities such as lending and staking. Beyond crypto trading scenarios, stablecoins are increasingly used in cross-border payments and trade settlement, thanks to their near-instant settlement speeds, low transaction costs, and 24/7 borderless circulation.  

The development of stablecoins has evolved from an "exploratory phase" to a "standardized phase":  

- In 2014, Tether officially launched USDT, a stablecoin designed to be 1:1 backed by fiat currency, introducing U.S. dollar value into the crypto market. With its intuitive pegging model, USDT quickly achieved large-scale adoption and became the primary stability tool in the crypto ecosystem.  

- In 2017, MakerDAO issued DAI, pioneering the "over-collateralization with crypto assets + smart contract liquidation" model and advancing the development of decentralized stablecoins.  

- In 2020, the DeFi boom drove a surge in demand for stablecoins. By introducing the concept of "stability" to the high-risk crypto market, stablecoins enabled relatively safe and efficient execution of complex financial activities.  

- In 2022, the algorithmic stablecoin UST collapsed due to algorithmic failure, attracting global regulatory attention.  

- In 2025, the U.S. *Guiding and Establishing America’s Stablecoin National Innovation Act* (GENIUS Act) and Hong Kong’s (China) *Stablecoin Ordinance* were enacted, laying a compliance foundation for the stablecoin industry. These regulations also clarified market expectations for stablecoins’ development direction, marking their entry into a "compliant development" phase.  

The current stablecoin market exhibits two distinct characteristics:  

1. **Concentration among leading players**: As of August 2025, the total market capitalization of stablecoins exceeded $280 billion. USDT dominates with approximately 60% market share, followed by USDC and other stablecoins. This reflects deep market trust in off-chain asset-backed models (e.g., fiat collateral).  

2. **Dependence on mainstream public chain ecosystems**: Three major public chains—Ethereum, TRON, and Solana—host most of the market’s stablecoin market capitalization and transaction volume. As of August 2025, the market capitalization of stablecoins on Ethereum alone exceeded $137 billion.  

Additionally, the accelerated entry of traditional financial institutions and improved regulatory frameworks are driving stablecoins to expand into scenarios such as cross-border payments and real-world asset (RWA) tokenization.  

## Technical Principles of Stablecoins  

The stable value and secure operation of stablecoins depend on underlying technologies such as blockchain and smart contracts. While technical implementation paths vary across stablecoin types, their core logic revolves around "reliable pegging, transparent mechanisms, and secure transactions."  

### 1. Technical Implementation Differences Across Stablecoin Types  

Based on their pegging mechanisms, stablecoins are categorized into three types: off-chain asset-backed, on-chain asset-backed, and algorithmic stablecoins.  

#### (1) Off-Chain Asset-Backed Stablecoins  

The most common type, these stablecoins maintain their value through off-chain reserves of equivalent fiat currency or assets (e.g., short-term bonds, gold). Their technical implementation involves three key links: asset custody, audit verification, and redemption mechanisms. USDT and USDC are typical examples.  

#### (2) On-Chain Asset-Backed Stablecoins  

These stablecoins are backed by over-collateralized on-chain assets (e.g., Ethereum). For instance, MakerDAO’s DAI requires users to collateralize crypto assets (such as Ethereum) into smart contracts. The system generates a corresponding amount of stablecoins based on collateralization ratio requirements (e.g., 150%). If the value of collateralized assets drops below the required ratio, the system automatically triggers a liquidation mechanism—selling part of the collateral to maintain the stablecoin’s value backing. Over-collateralization is intended to mitigate risks from extreme volatility of on-chain assets.  

#### (3) Algorithmic Stablecoins  

These stablecoins rely on algorithm-driven supply-demand adjustment mechanisms to maintain value. Their core principle is to use smart contracts to automatically regulate stablecoin supply: when the price exceeds the peg, the protocol increases supply (e.g., through issuance); when the price falls below the peg, it reduces supply (e.g., through buybacks or bond issuances) to guide the price back to the target.  

### 2. Blockchain: Trust Infrastructure for Stablecoin Operations  

Blockchain is a distributed ledger technology. Each newly created block is tightly linked to the previous block via a cryptographic hash (a unique digital fingerprint), forming an interconnected chain of data. Any minor modification to historical data would cause a cascading change in the "fingerprints" of all subsequent blocks—an act that would be easily identified and rejected. Meanwhile, data integrity is ensured by having multiple (or all) nodes hold identical copies of the ledger, allowing participants to trust the data recorded on the blockchain.  

Blockchains can issue native tokens (e.g., Ethereum’s Ether is the native token of the Ethereum blockchain). Stablecoins are typically issued and managed via smart contracts on specific blockchains. Transactions involving stablecoins often require native tokens to pay on-chain transaction fees.  

**Consensus mechanisms** are the core of blockchains, enabling multiple (or all) nodes to participate in generating on-chain data through decentralized means. For example:  

- Ethereum uses a "Proof of Stake (PoS)" mechanism, determining transaction verification rights based on the scale of compliant assets held by nodes and their credit status.  

- TRON and Solana adopt a "Delegated Proof of Stake (DPoS)" mechanism, where trusted verification groups are elected via node voting to handle transaction verification and block creation.  

Since the process and results of on-chain data generation are transparent and verifiable—summarized as "full participation, transparent process"—blockchains earn high trust from all participants in their ecosystem.  

### 3. Smart Contracts: The "Automated Core" of Stablecoin Operations  

Smart contracts are self-executing code deployed on blockchains, capable of automating asset issuance, transfer, and destruction based on pre-defined rules. Stablecoin providers use smart contracts to automate minting (creation) and burning (destruction) functions, ensuring that stablecoin supply matches the value of collateral assets. Additionally, smart contracts manage the locking and liquidation of collateral: during extreme market volatility, they can trigger liquidation processes promptly to mitigate systemic risks.  

The focus of smart contract applications varies by stablecoin type:  

- For off-chain asset-backed stablecoins, smart contracts are primarily used for on-chain issuance, redemption, and audit recording.  

- For on-chain asset-backed stablecoins, smart contracts play a core role in collateral management and risk control.  

- For algorithmic stablecoins, smart contracts automatically adjust supply based on market price changes to maintain the price peg.  

The transparency and decentralized execution of smart contracts not only enhance user trust but also reduce the risk of human error, enabling secure and efficient stablecoin issuance and management.  

## Trust Logic of Stablecoins  

The core competitiveness of stablecoins lies in "trust"—i.e., users believe they can redeem stablecoins for fiat currency at the pegged price at any time.  

### 1. Pegging and Reserve Mechanisms: The Value Foundation of Trust  

The three types of stablecoins differ in the reliability of their pegging and reserve mechanisms:  

- **Off-chain asset-backed stablecoins** depend on the authenticity and liquidity of reserve assets, as well as the compliant operation and transparent auditing of issuers. For example, USDC’s reserves primarily consist of cash and short-term U.S. Treasury securities, with monthly third-party verification—ensuring high credibility. Key risk control factors for this type include the scope of verification, audit frequency, auditor independence, and the proportion of highly liquid assets in reserves.  

- **On-chain asset-backed stablecoins** rely on dual safeguards: over-collateralization and automated liquidation. Stablecoins like DAI require a minimum 150% collateralization ratio, providing a buffer against price volatility. Smart contract-driven liquidation mechanisms ensure that when collateral prices hit the liquidation threshold, an automated auction process quickly recovers funds. Key risk control factors include collateral diversification (avoiding over-reliance on a single asset), the accuracy of oracle price feeds, and the emergency response capability of governance mechanisms.  

- **Algorithmic stablecoins** have structural flaws in their price stability mechanisms. Without backing by real assets, their stability relies entirely on the effectiveness of supply-demand adjustment algorithms and market arbitrage—making them inherently risky.  

### 2. Technical Verifiability: Transparent Support for Trust  

Technology is not the sole source of trust, but it provides tools for "verifiability and traceability":  

- Blockchain transparency ensures that "key stablecoin data is auditable," eliminating reliance on issuers’ "one-sided claims."  

- The open-source nature of smart contracts allows "mechanism rules to be reviewed": developers worldwide can collectively audit code for vulnerabilities. If issues are identified, community governance can propose fixes (e.g., DAI once optimized its liquidation mechanism via community voting). This "technical consensus supervision" reduces the risk of "black-box operations."  

- Additionally, compliance rules can be embedded in smart contracts to enable real-time regulatory oversight of stablecoin activities at the contract level.  

### 3. Regulatory Constraints: Institutional Guarantees for Trust  

If technology and reserves represent "intrinsic trust," regulation serves as "extrinsic trust supplementation." Building trust in stablecoins requires clear, robust regulatory frameworks. By clarifying rules to curb market misconduct, regulators enhance user confidence in the compliance and security of stablecoins.  

Currently, major global jurisdictions are actively exploring ways to bring stablecoins under effective regulation—aiming to safeguard financial stability, protect user rights, and provide clear regulatory expectations for market development. Whether it is the U.S. GENIUS Act, the EU’s Markets in Crypto-Assets Regulation (MiCA), or Hong Kong’s (China) *Stablecoin Ordinance* (effective August 1, 2025), all establish rigorous rule frameworks covering issuer licensing, reserve asset management, user protection, and comprehensive information disclosure. These frameworks implement the principle of "same activity, same risk, same regulation": they prevent "illegal operations by issuers" (e.g., over-issuance or misappropriation of reserves) and provide "institutional safeguards" for user rights, transforming stablecoins from "unregulated innovative experiments" into "compliant financial tools."  

## Challenges and Outlook  

In practice, stablecoin development faces significant challenges in three areas: regulatory technology, price stability, and institutional governance.  

### 1. Challenges in Regulatory Technology  

Many stablecoin transactions occur on decentralized platforms or between personal wallets, bypassing compliance procedures such as KYC (Know Your Customer) required in traditional finance. Currently, there is a lack of large-scale global regulatory infrastructure for stablecoins and on-chain blockchain transactions. This makes it difficult to track and regulate funds entering the stablecoin and blockchain ecosystem, inadvertently facilitating illegal activities such as ransomware attacks, money laundering, and fraud.  

### 2. Challenges in Price Stability  

For fiat-backed stablecoins, price stability depends heavily on the transparency of reserve assets and regular audits. However, past incidents—such as opaque reserve information and stablecoin depegging—have triggered widespread market panic.  

### 3. Challenges in Institutional Governance  

The global operation of stablecoins conflicts sharply with the fragmented regulatory landscape of individual countries. Effective international regulatory coordination mechanisms are still lacking, making it difficult to address cross-border risks. Additionally, stablecoins remain a new concept for most people, leaving the public vulnerable to scams—highlighting the urgent need for public education on stablecoins and risk awareness campaigns.  

### Outlook for the Future  

Driven by the expansion of cross-border payment scenarios, the supply of stablecoins is expected to grow significantly from the current hundreds of billions of U.S. dollars to trillions:  

1. Stablecoins are likely to penetrate supply chain finance, real estate tokenization, and other fields—evolving from single payment tools to mainstream financial infrastructure.  

2. The regulatory environment will mature further: frameworks in major economies (the U.S., EU, Hong Kong (China)) will provide clear compliance guidance for stablecoin issuers, attracting more institutions to enter the market.  

3. Technological innovation will accelerate: Solutions to enhance the scalability of underlying networks and balance regulatory needs with privacy protection are expected to be implemented.  

### Comprehensive Strategies to Address Challenges  

To tackle the challenges in stablecoin development, a multi-dimensional strategy is needed:  

- **Regulatory Technology**: Increase investment in R&D to build global regulatory infrastructure for the blockchain ecosystem. Leverage big data and AI to ensure orderly, compliant innovation in the stablecoin ecosystem. Promote the development of standardized smart contract systems, introduce AI-driven audit tools for automated vulnerability detection, and integrate regulatory rules more deeply into contracts to reduce systemic risks.  

- **Reliability of Pegging Mechanisms and Reserve Management**: Establish real-time reserve verification systems and engage independent third-party auditors to urge issuers to proactively disclose asset details and operational data transparently—strengthening user trust and market consensus.  

- **Institutional Governance**: Promote international collaboration to establish consistent regulatory coordination processes and reduce cross-border compliance barriers. Simultaneously, enhance domestic user education to improve public digital financial literacy, strengthen risk prevention awareness, and curb illegal activities such as fraud.  

*(Author: Vice Dean, School of Software Engineering, Fudan University)*  

*Source: Study Times, September 10, 2025, Issue 6*  

*Editor: Ji Sihan*  

### Disclaimer  

The views expressed in this article are solely those of the author and do not constitute investment advice for this platform. This platform makes no guarantees regarding the accuracy, completeness, originality, or timeliness of the information in the article, nor does it assume any liability for any losses arising from the use of or reliance on the information contained herein.