The technical principles and trust logic of stablecoins

Author: Han Weili, Vice Dean of the Software College, Fudan University Source: "Study Times", September 10, 2025, Issue 6

Introduction: Currently, the total market value of global stablecoins has exceeded $280 billion, widely used in trading settlements, cross-border payments, asset tokenization, and other scenarios. Its development not only affects the digital financial ecosystem but also poses new challenges for financial risk prevention and control. The application of stablecoins relies on market trust in them, which stems from the transparent and verifiable mechanisms built by the underlying technology and is also dependent on the reliability of the anchoring mechanism and regulatory guarantees. To this end, a deep understanding of the technical principles and trust logic behind their "stability" is a necessary prerequisite for grasping future digital financial innovation opportunities and potential regulatory risks.

Against the backdrop of digital finance rapidly penetrating the global trade system, cryptocurrencies represented by Bitcoin and Ethereum have attracted widespread attention, but their extreme price volatility makes them difficult to adopt as mainstream payment methods. Stablecoins represented by Tether (USDT) and USD Coin (USDC) establish peg mechanisms with fiat currencies, preserving the advantages of efficient circulation and low costs based on blockchain payments while avoiding the disadvantages of instability associated with traditional cryptocurrencies. As a result, stablecoins have become a hot topic in current digital financial innovation. Recently, relevant bills and regulations introduced in the United States, the European Union, and Hong Kong have laid a compliance foundation for the development of stablecoins, which are favored by global compliant investors and are gradually integrating into the mainstream financial system.

Currently, the total market value of global stablecoins has surpassed 280 billion USD, and they are widely used in transaction settlement, cross-border payments, asset tokenization, and other scenarios. Their development not only impacts the digital financial ecosystem but also poses new challenges for financial risk prevention and control. The application of stablecoins relies on the market's trust in them, which stems from the transparent and verifiable mechanisms built by the underlying technology, as well as the reliability of the anchoring mechanism and regulatory safeguards. Therefore, a deep understanding of the technological principles and trust logic behind their "stability" is a necessary prerequisite for grasping future opportunities for digital financial innovation and potential regulatory risks.

Main Features and Current Status of Stablecoins

Stablecoins are digital assets issued based on blockchain technology, maintaining their price stability relative to fiat currency through an "anchoring mechanism." They were initially used as a medium for direct exchange of cryptocurrencies in cryptocurrency trading, and later evolved into the underlying asset for participating in financial activities such as lending and staking in the decentralized finance ecosystem. Outside of cryptocurrency trading scenarios, stablecoins have gradually been applied in areas such as cross-border payments and trade settlement due to their advantages of near real-time settlement speed, low transaction costs, and 24/7 borderless circulation.

The development of stablecoins has gone through an evolution from "exploration" to "regulation": In 2014, Tether officially launched USDT, a stablecoin aimed at a 1:1 fiat currency collateralization, bringing the value of the US dollar into the cryptocurrency market. With its intuitive anchoring model, USDT quickly achieved widespread application, becoming the main value stabilization tool in the crypto ecosystem. In 2017, MakerDAO issued DAI, pioneering the "over-collateralized crypto asset + smart contract liquidation" model, promoting the development of decentralized stablecoins. In 2020, the boom in decentralized finance led to a surge in demand for stablecoins, introducing the concept of "stability" into the high-risk crypto market, allowing these complex financial activities to be conducted relatively safely and efficiently. In 2022, the algorithmic stablecoin UST collapsed due to algorithm failure, raising global regulatory concerns. In 2025, regulatory frameworks such as the U.S. "Guidance and Establishment of a National Innovation Act for Stablecoins" (the "GENIUS Act") and Hong Kong's "Stablecoin Regulation" were introduced, laying a compliance foundation for the stablecoin industry, while also providing clearer expectations for the development direction among market participants. Since then, stablecoins have entered a new stage of "compliance development."

The current stablecoin market presents two distinct characteristics: first, concentration at the top; as of August 2025, the total market value of stablecoins exceeds $280 billion, with USDT holding an absolute dominant position with about 60% market share, followed closely by other stablecoins like USDC, reflecting the market's deep trust in off-chain assets such as fiat collateral models; second, reliance on mainstream public chain ecosystems; the three major public chains, Ethereum, Tron, and Solana, carry most of the market's stablecoin value and trading volume, with stablecoin market value on Ethereum exceeding $137 billion as of August 2025. Furthermore, the accelerated entry of traditional financial institutions and the improvement of regulatory frameworks are driving stablecoins to expand into scenarios such as cross-border payments and the tokenization of real-world assets (RWA).

Technical Principles of Stablecoins

The value stability and secure operation of stablecoins rely on the support of underlying technologies such as blockchain and smart contracts. Although the technical implementation paths of different types of stablecoins vary, the core logic remains "anchored reliability, transparent mechanisms, and secure transactions."

First, the technical implementation differences of different types of stablecoins. Based on the differences in anchoring mechanisms, stablecoins can be divided into three main categories: off-chain asset-backed, on-chain asset-backed, and algorithmic stablecoins.

Firstly, off-chain asset collateralized stablecoins are the most common type of stablecoins, supported by off-chain reserves of equivalent fiat currency or equivalent assets (such as short-term bonds, gold) to stabilize the value of the stablecoins. The technical implementation mainly includes three aspects: asset custody, audit verification, and redemption mechanisms. USDT and USDC are representatives of this type of stablecoin.

Secondly, on-chain asset-collateralized stablecoins support the value of the stablecoin through over-collateralization of on-chain assets (such as Ether). Taking MakerDAO's DAI as an example, users need to collateralize Ethereum and other crypto assets into a smart contract, and the system generates a corresponding amount of stablecoins based on the collateralization ratio requirement (e.g., 150%). When the value of the collateralized assets drops, causing the collateralization ratio to become too low, the system will automatically trigger a liquidation mechanism to sell some of the collateralized assets to maintain the value support of the stablecoin. The purpose of over-collateralization here is to address the risks brought by the volatility of on-chain assets.

Thirdly, algorithmic stablecoins support the value of the stablecoin through an algorithm-driven supply and demand adjustment mechanism. The core principle is to automatically adjust the supply of stablecoins via smart contracts: when the price is above the pegged value, the protocol increases the supply through methods such as issuance; when the price is below the pegged value, the protocol reduces the supply through buybacks, issuing bonds, etc., to guide the price back.

Second, blockchain provides a trust infrastructure for stablecoin operations. Blockchain is a distributed ledger technology where each newly generated block is tightly linked to the previous block through cryptographic hashing (a unique digital fingerprint), forming a chain of interconnected data. Any slight modification to historical data will cause a chain reaction of "fingerprint" changes in all subsequent blocks, making such tampering easily identifiable and rejectable. At the same time, the integrity of the data is ensured by having multiple or all nodes hold the same copy of the ledger, allowing participants to trust the data recorded on the blockchain. Blockchain can issue its native coins, such as Ether, which is the native currency of the Ethereum blockchain. Stablecoins are usually issued and managed based on smart contracts on specific blockchains, and native coins are often required to pay transaction fees on the blockchain in transactions involving stablecoins.

Consensus mechanism is the core mechanism of blockchain, through a decentralized consensus mechanism, multiple or all nodes can participate in the generation of data on the blockchain. For example, Ethereum adopts the "Proof of Stake (PoS)" mechanism, which determines the transaction verification authority based on the scale of compliant assets and credit status held by the nodes; TRON and Solana adopt the "Delegated Proof of Stake (DPoS)" mechanism, where trusted verification groups are elected through node voting, responsible for transaction verification and block generation. Because the process and results of data generation on the blockchain are transparent and verifiable, it can be summarized as "full participation, transparent process," thus gaining the high trust of all parties involved in the blockchain ecosystem.

Thirdly, smart contracts are the "automation hub" for stablecoin operations. Smart contracts are automated execution codes deployed on the blockchain that can perform operations such as asset issuance, transfer, and destruction according to preset rules. Stablecoin providers have automated the minting and burning functions through smart contracts, ensuring the alignment between the supply of stablecoins and the collateral assets. At the same time, smart contracts are also responsible for managing the locking and liquidation of collateral assets; when the market experiences significant volatility, they can promptly trigger liquidation processes to mitigate systemic risks. Different types of stablecoins have varying focuses in the application of smart contracts: in off-chain asset collateralized stablecoins, smart contracts are mainly used for on-chain issuance, redemption, and audit records; in on-chain asset collateralized stablecoins, smart contracts take on the core functions of collateral management and risk control; in algorithmic stablecoins, smart contracts are responsible for automatically adjusting the supply based on market price changes to achieve price anchoring. The transparency and multi-centered execution of smart contracts not only enhance user trust but also reduce the risks of human intervention, achieving the security and efficiency of stablecoin issuance and management.

The Trust Logic of Stablecoins

The core competitive advantage of stablecoins lies in "trust," meaning that users believe they can exchange it for fiat currency at its pegged price at any time.

First, the Anchor and Reserve Mechanism:** The Value Foundation of Trust.** In terms of the reliability of the anchor and reserve mechanism, the three types of stablecoins exhibit different characteristics.

Off-chain asset-backed stablecoins rely on the authenticity and liquidity of reserve assets, as well as the compliance operations and transparent audits of the issuing institution. Taking USDC as an example, its reserves mainly consist of cash and short-term U.S. Treasury bonds, which are verified by a third party on a monthly basis, thus making it relatively trustworthy. Factors such as the scope of verification, audit frequency, institutional independence, and the proportion of highly liquid assets in the reserves are key to risk control for this type of stablecoin.

On-chain asset-backed stablecoins rely on a dual protection system of over-collateralization and automated liquidation. Coins like DAI set a collateralization ratio of no less than 150% to provide a buffer for price fluctuations, while the smart contract-driven liquidation mechanism ensures that when the price of the collateralized assets hits the liquidation threshold, the automatically triggered auction process can quickly recover funds. The diversification of collateral assets (to avoid excessive concentration of a single asset), the accuracy of price feeds from oracles, and the emergency response capability of the governance mechanism are key to risk control for such stablecoins.

The price stabilization mechanism of algorithmic stablecoins has structural flaws. Its design, which lacks actual asset collateral, makes its stability entirely dependent on the effectiveness of supply and demand adjustment algorithms and market arbitrage activities.

Second, the verifiability of technical assurance: Transparent support for trust. **Technology is not the only source of trust, but it provides tools that are 'verifiable and traceable' for trust. On one hand, the transparency of blockchain allows the 'key data of stablecoins to be checked', eliminating the need to rely on the issuing organization’s 'unilateral statements'; on the other hand, the open-source nature of smart contracts enables 'mechanism rules to be audited', allowing global developers to collectively audit code vulnerabilities and propose solutions for issues found through community governance (such as DAI optimizing its liquidation mechanism through community voting), forming 'technical consensus supervision' to reduce the risk of 'opaque operations'. Furthermore, compliance rules can be embedded within smart contracts, allowing for timely regulation of stablecoin activities directly at the contract level.

Third, the constraints of regulatory laws: institutional guarantee of trust. While technology and reserves represent "intrinsic trust," regulation serves as an "external trust supplement." The trust in stablecoins cannot be constructed without clear and robust regulatory constraints. By clarifying rules to reduce market chaos, users can have more confidence in the compliance and safety of stablecoins.

Currently, major jurisdictions around the world are actively exploring the incorporation of stablecoins into effective regulatory frameworks to maintain financial stability, protect user rights, and provide clear normative expectations for healthy market development. Whether it is the U.S. "GENIUS Act", the European Union's "Markets in Crypto-Assets Regulation" (MiCA), or Hong Kong's "Stablecoin Regulation" which will take effect on August 1, 2025, they all essentially construct a rigorous rule framework from aspects such as issuer licensing, reserve asset management, user rights protection, and comprehensive information disclosure, implementing the principle of "same activities, same risks, same regulations". These regulatory measures not only prevent "issuer violations" (such as excessive issuance and misappropriation of reserves), but also provide a "systemic safety net" for user rights, allowing stablecoins to transition from "unregulated innovative attempts" to "compliant financial instruments."

Challenges and Prospects

From a practical perspective, the development of stablecoins faces severe challenges in three areas: regulatory technology, currency value stability, and institutional governance.

First, the challenge of regulatory technology. Many stablecoin transactions occur between decentralized platforms or individual wallets, bypassing compliance procedures such as KYC (Know Your Customer) required by traditional financial industries. Currently, there is still a lack of large-scale regulatory infrastructure for stablecoins and on-chain blockchain transactions globally, making it difficult to trace and handle funds entering the stablecoin and blockchain ecosystem. This situation effectively facilitates illegal activities such as extortion, money laundering, and fraud within the stablecoin and blockchain ecosystem.

Second, the challenge of stable value. For fiat-collateralized stablecoins, the stability of their value heavily relies on the transparency of reserve assets and regular audits. However, there have been multiple instances in the past market where the reserve information was opaque, and stablecoin prices became unpegged, triggering widespread market panic.

Thirdly, the challenges of systems and governance. The global operational characteristics of stablecoins sharply contradict the fragmented regulatory situation in various countries, and an effective international regulatory coordination mechanism is still lacking, making it difficult to address the cross-border risks they pose. In addition, stablecoins are a completely new concept for the majority of the domestic population, and the public is easily susceptible to various scams, thus there is an urgent need to strengthen knowledge dissemination and risk warning publicity at the social level.

Looking to the future, thanks to the expansion of cross-border payment scenarios, the supply of stablecoins may continue to rise sharply from the current scale of hundreds of billions of dollars to several trillion dollars. Firstly, stablecoins are expected to gradually penetrate fields such as supply chain finance and real estate tokenization, transforming from a single payment tool into mainstream financial infrastructure; Secondly, the regulatory environment is becoming increasingly mature, with the regulatory frameworks of major economies such as the United States, the European Union, and Hong Kong providing clear compliance guidance for stablecoin issuers, further attracting various institutions to participate in market layout; Thirdly, technological innovation is accelerating breakthroughs, and some solutions that effectively enhance the scalability of underlying networks while balancing regulatory privacy protection capabilities are expected to be implemented.

To address the various challenges in the development of stablecoins, it is necessary to construct a multi-dimensional comprehensive response strategy: In terms of regulatory technology, greater investment in research and development should be made to promote the construction of regulatory infrastructure aimed at the global blockchain ecosystem, ensuring orderly and compliant innovation in the stablecoin ecosystem through big data and artificial intelligence technologies. The development system for the standardization of smart contracts should be advanced, introducing AI-driven auditing tools to achieve automated detection of code vulnerabilities, while integrating regulatory rules more significantly into contracts to effectively reduce systemic risks. In terms of enhancing the reliability of the anchoring mechanism and reserve management, measures such as establishing a real-time reserve proof system and engaging independent third-party auditing institutions should be taken to urge issuers to proactively and transparently disclose asset details and operating data, thereby strengthening user trust in stablecoins and consensus within the market ecosystem. In terms of systems and governance, international cooperation should be promoted to establish consistent regulatory collaboration processes and reduce cross-border compliance barriers; at the same time, domestic user education should be strengthened to enhance public digital financial literacy, increase user awareness of risk prevention, and curb fraud and other illegal activities.