Welcome to Part 2 of our 3-part stablecoin article series. In Part 1 of this series, we explored why stablecoins matter: how they solve the volatility problem that has limited cryptocurrencies from functioning as practical money, and how they bridge blockchain’s efficiency with the predictability that institutions require. But knowing why stablecoins exist is only the starting point. To fully understand their impact, we must turn to the how of it all.
Stablecoins all aim to provide stability, yet the way they achieve it varies significantly. Fiat-backed stablecoins rely on traditional reserves, crypto-backed versions lean on smart contract collateral, algorithmic models attempt to regulate supply dynamically, and commodity-backed tokens link value to tangible assets like gold. Each approach carries distinct strengths and weaknesses, shaping their relevance across retail, institutional, and regulatory landscapes.
As regulators roll out dedicated frameworks and banks assess integration pathways, these distinctions are no longer technical details. They determine which models can scale into global finance and which remain confined to niche ecosystems. This article unpacks the major models of stablecoins, why they matter, and how they set the stage for the institutional use cases we’ll explore in Part 3.
I. Stablecoins and Why They Matter
When stablecoins first appeared in the crypto markets, they seemed like a niche solution: a digital asset designed to smooth out volatility by pegging the tokens to the U.S. dollar. Fast forward to 2025, and stablecoins have grown into one of the most consequential innovations in financial services. With more than $150 billion in circulation and annual transfer volumes that have already surpassed Visa and Mastercard combined, stablecoins are no longer a speculative experiment. They are now firmly part of the conversation about the future of money in banking and capital markets.
For financial institutions, the key question has shifted. It’s not whether stablecoins will play a role, but rather which models will meet regulatory, compliance, and operational standards and how they can complement or even transform existing payment and settlement rails.
Fiat-Backed Stablecoins: The Core Model
Fiat-backed stablecoins are the most widely adopted model, and for good reason. Everyone can get their head around the concept, and it is a close mirror to fixed exchange policies that many countries operate within. Today, they account for more than 90 percent of circulating stablecoins and are typically backed one-to-one by reserves held in cash or high-quality liquid assets. Popular examples include USDC, USDT, and PayPal’s PYUSD.
What has changed in recent years is the regulatory environment. In the United States, the GENIUS Act (July 2025) established a long-awaited federal framework, requiring licensing for issuers, clear rules on the composition of reserves, and redemption rights for holders. In Hong Kong, the Stablecoin Bill passed in May 2025 and took effect in August, mandating licenses, audited reserve reporting, and strict capital requirements. Meanwhile, the Monetary Authority of Singapore (MAS) expanded its Project Guardian framework in late 2024 to formally cover stablecoins and tokenized deposits side by side.
For banks, this wave of regulatory clarity has profound implications. Stablecoins that once operated in a gray zone are now entering the domain of regulated finance. This opens the door for financial institutions to use them in settlements, treasury operations, and cross-border payments and fx operations with far greater confidence.
Crypto-Backed Stablecoins: Transparency Meets Limits
A smaller but important segment of the market is crypto-collateralized stablecoins. These are backed not by fiat reserves in bank accounts, but by digital assets locked in smart contracts. DAI, the most prominent example, relies on overcollateralization with cryptocurrencies such as ETH.
The benefit of this model is transparency. Anyone can verify reserves on-chain in real time, a level of visibility that traditional fiat-backed issuers are only beginning to provide. Yet the drawback is volatility. If crypto collateral assets exhibit high fluctuations in value, stability mechanisms can break down, forcing liquidations or endangering the peg.
For banks and regulated financial institutions, this model is less relevant as a settlement instrument. However, crypto-backed stablecoins remain influential in decentralized finance (DeFi), where they serve as collateral primitives in liquidity pools and lending markets. Their lessons on transparency may also inform the design of future bank-issued stablecoins.
Algorithmic Stablecoins: Fragility Exposed
Few developments have done more to shape regulatory caution than the high profile collapse of algorithmic stablecoins. These designs attempted to maintain a peg through supply adjustments, without holding reserves in fiat or crypto. The most notorious, Terra/UST, imploded in 2022, erasing $40 billion in value and striking a blow to public trust.
Since then, regulators have signaled consistently that unbacked, algorithmic models are unacceptable for systemic use. For banks, the message is clear: algorithmic stablecoins are a cautionary tale, not a blueprint. They serve as a reminder that stability requires tangible backing, transparency, and accountability; attributes that align with regulatory expectations.
Commodity-Backed Stablecoins: Niche but Useful
Beyond fiat and crypto, there is a smaller market for commodity-backed stablecoins. These tokens are pegged to assets like gold or oil. Pax Gold (PAXG) is one example, offering investors fractionalized ownership of gold stored in professional vaults.
For banks, commodity-backed stablecoins are less about mainstream settlement and more about specialized use cases. They may serve as tools for hedging, commodity-linked structured products, or as components in exchange-traded funds. While not as central as fiat-backed models, they illustrate the flexibility of tokenization and the potential for banks to diversify the instruments they offer.
II. Stablecoins vs. Tokenized Deposits
One of the most important distinctions for banks is the difference between stablecoins and tokenized deposits. At first glance, they appear similar: both are digital tokens pegged to fiat currency. But their issuance, lifecycle management and regulatory treatment diverge significantly.
Stablecoins are typically issued by fintechs or specialized providers. They sit off the balance sheet of banks, although regulation is moving them closer to bank-like oversight. Tokenized deposits, on the other hand, are typically issued directly by regulated banks and recorded on their balance sheets like traditional deposits. They often come under deposit insurance schemes, making them familiar territory for supervisors.
For the Bank for International Settlements (BIS) and for regulators such as MAS, tokenized deposits represent the preferred model for interbank settlement, since they integrate seamlessly with existing supervisory frameworks. Stablecoins, however, play a complementary role by extending programmability and accessibility beyond the boundaries of a single bank or jurisdiction.
Together, fiat-backed stablecoins and tokenized deposits are poised to form the backbone of digital settlement systems in the years ahead.
III. Stablecoins vs. Traditional Payment Rails
To understand the significance of stablecoins, it’s essential to compare them to the legacy payment rails they complement (or may replace).
Consider SWIFT, the backbone of cross-border banking for decades. Banks transmit SWIFT payment messages between themselves rapidly, but actual settlement typically takes one to three days, depending on time zones and compliance checks. In correspondent banking, where several banks and intermediaries are involved in moving funds across borders, these timelines can extend further and usually, the banks involved have a difficult time providing up front clarity about the time or cost required to execute and settle transactions. Stablecoins collapse this into seconds with cost clarity up front by combining message and settlement in a single atomic transaction.
Next, look at credit card networks. They excel at rapid authorization, giving merchants immediate confirmation that a transaction is valid. But behind the scenes, settlement takes days, and merchants pay fees of 2-3 percent for the privilege. Stablecoin payments provide the same instant confirmation while settling in real time and at a fraction of the cost to the merchant. From there, it is up to the merchant if the reduced cost is passed on to customers but in a competitive market where stablecoin payments are commonplace, these savings will certainly be passed on to consumers in the form of reduced prices.
Finally, systems like ACH or SEPA remain batch-based and limited to certain hours. By contrast, stablecoins are continuous and global, unconstrained by national clearing windows.
For banks, the implication is not that stablecoins will immediately displace SWIFT, Visa, or ACH. Rather, they introduce programmable, low-cost alternatives which benefit merchants and consumers that can run alongside these systems. Over time, this alternative will reshape customer expectations about how money should move. The reality is that today, customers generally have no insight into how their money moves. Stablecoins, in contrast to the black-box current status quo, illuminate the journey.
Stablecoins have evolved far beyond their origins as crypto-market stabilizers. Today, they represent a spectrum of models, each reflecting a different philosophy of stability. Fiat-backed stablecoins and tokenized deposits are emerging as the most institution-ready, aligning with regulatory standards and operational demands. Crypto-backed versions continue to pioneer transparency, algorithmic designs serve as cautionary tales, and commodity-backed tokens demonstrate the flexibility of tokenization in specialized markets.
The key insight is that stablecoins are not competing solely with one another, they are redefining expectations for money movement itself. By enabling settlement that is instantaneous, programmable, and transparent, stablecoins highlight the limitations of legacy systems like SWIFT, ACH, and card networks.
Yet models alone don’t define the future. What truly matters is how these tokens are being deployed in practice, whether in payments, treasury management, securities settlement, or new forms of programmable finance. That’s where we turn next. In Part 3, we’ll explore the real-world use cases of stablecoins in banking and capital markets, the risks that must be managed, and the infrastructure decisions institutions need to make today to stay competitive in the decade ahead.
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