Stablecoin

Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

A stablecoin is a crypto-asset built to keep a stable value by pegging (fixing) it to a reference asset, usually the US dollar (1 coin = US$1). The peg is held up by reserves of safe assets, by other crypto locked up as security, or by computer code that changes the supply.

It matters because dollar stablecoins can pull savings out of the rupee. That weakens the RBI's control over money and can lead to capital flight. This is why the RBI prefers its own digital currency (CBDC) to private stablecoins [4].

Explanation

How the peg works

• Ordinary crypto such as Bitcoin (2009) has a price that swings sharply within days. It has no fixed anchor.
• A stablecoin tries to fix its price by promising that one coin can always be swapped for one unit of the reference asset.
• The promise holds only while people trust that the issuer can pay. That trust depends on what backs the coin.
• Every transfer is recorded on a blockchain (a shared digital record that is very hard to change once written).

Three types of stablecoin

Type	How the peg is held	Example	Weak point
Fiat-backed	Reserves of cash and US Treasury bills	USDT, USDC	Are the reserves real, safe and easy to sell?
Crypto-collateralised	Over-collateralised (more crypto is locked up than the value of stablecoin created)	—	The collateral itself is volatile
Algorithmic	Code expands or shrinks the supply	TerraUSD, which collapsed in May 2022	No real assets back it, so trust can vanish

• Worked example (over-collateralisation):
• To create $100 of stablecoin, a user locks $150 of Ether. This is 150% collateral.
• Ether falls by 30%. The locked Ether is now worth $105.
• The system sells the Ether before its value drops below $100. This keeps every stablecoin fully covered.

What makes a stablecoin lose its peg

• Runs:
• Holders start to doubt the reserves.
• Many holders ask for their money back at once (redemption).
• The issuer sells reserves in a hurry, so the prices of those reserves fall.
• The coin can no longer be swapped at 1:1, and the peg breaks.

• The RBI's Financial Stability Report notes that stablecoins have seen collapses and redemption pressures [4].

• No real backing: algorithmic coins like TerraUSD depend only on confidence. When confidence goes, there is nothing to sell to defend the peg.

• Volatile collateral: crypto-collateralised coins can fail if the locked crypto crashes faster than the system can sell it.

Wider risks to an economy

• Dollarisation and loss of monetary sovereignty:
• People move savings from rupees into dollar stablecoins.
• Rupee deposits with banks shrink.

• Changes in the repo rate (the rate at which the RBI lends money to banks) reach fewer people, so monetary policy works less well.

• Capital flight: money can leave the country without passing through banks. This gets around capital controls (limits a country places on money moving in and out).

• The RBI's FSR (December 2025) says stablecoins add new layers of risk to the global financial system. Demand for them is strongest in economies with weaker institutions and little access to dollar assets [4].

In India

• Not legal tender: like all crypto, stablecoins are not legal tender in India (money the law says must be accepted to settle a debt). No one is forced to accept them.
• Taxed as a VDA: the Income-tax Act uses the term Virtual Digital Asset (VDA). VDAs include crypto-assets but exclude Indian currency, foreign currency and CBDC [2].
• s.115BBH (Budget 2022-23): flat 30% tax on income from transferring a VDA. No set-off of losses is allowed [1].

• s.194S: 1% TDS (tax deducted at source, meaning the buyer or exchange cuts the tax before paying the seller) on transfers to residents [2].

• Anti-money-laundering: since March 2023, VDA service providers must register with FIU-IND (Financial Intelligence Unit-India, under the Finance Ministry) as Reporting Entities under the PMLA, 2002. The duty is based on activity, so offshore exchanges that serve Indian users must also comply [3].

• RBI stance: countries should prefer CBDCs over private stablecoins, to protect trust in money and financial stability [4].
• India's CBDC is the e-rupee (e₹). The wholesale pilot e₹-W began in November 2022 and the retail pilot e₹-R in December 2022 [7].
• A CBDC is a liability of the central bank itself, so it carries no credit risk (no risk that the issuer fails to pay).

• Some argue for a regulated rupee stablecoin (verify current).

• G20 role: the IMF-FSB Synthesis Paper (7 September 2023) was prepared at the request of India's G20 Presidency. It covers the risks from crypto, stablecoins and DeFi [5]. A G20 roadmap status report (22 October 2024) found that nearly all FSB member jurisdictions have stablecoin and crypto rules in place or plan to make them [6].

Don't confuse with

• Cryptocurrency (e.g. Bitcoin): its price floats freely and swings sharply. A stablecoin is pegged to a reference asset to keep its price steady.
• CBDC (e₹): issued by the RBI, it is legal tender and carries no credit risk. A stablecoin is issued by a private party and is not legal tender. The CBDC is also excluded from the VDA definition, while stablecoins fall inside it [2].
• Fiat-backed vs algorithmic stablecoin: fiat-backed coins (USDT, USDC) hold real reserves such as cash and T-bills. Algorithmic coins (TerraUSD) rely only on code and have no real assets behind them.
• Asset tokenisation: turns ownership of real-world assets (bonds, property, invoices) into digital tokens. A stablecoin is a token meant to work like money, not a claim on a specific asset.

Prelims Hooks

• Fiat-backed stablecoin examples are USDT and USDC. The algorithmic example is TerraUSD, which collapsed in May 2022.
• US GENIUS Act (July 2025) legitimised payment stablecoins. EU MiCA (Markets in Crypto-Assets Regulation), applicable from 2024, is a single crypto rulebook for the EU.
• Trap: "The digital rupee is a VDA" is false. CBDC is excluded, but crypto-assets such as stablecoins are included [2].
• The IMF-FSB Synthesis Paper (7 September 2023) covers stablecoins and advises that crypto-assets should not get legal tender status. It favours comprehensive regulation over a blanket ban [5].
• The RBI FSR (December 2025) calls stablecoins a new layer of risk and prefers CBDCs over them [4].
• A crypto-collateralised stablecoin is over-collateralised: more crypto is locked up than the value of stablecoins issued.

Mains Points

• Stablecoins and monetary sovereignty:
• Dollar stablecoins can cause dollarisation, capital flight and weaker transmission of the repo rate.
• The risk is highest in economies with weak institutions [4].

• The RBI's answer is the e₹ CBDC. A regulated rupee stablecoin is being debated as an alternative (verify current).

• Regulate, don't ban:

• Stablecoins cross borders, so a national ban just pushes users to offshore platforms.
• India uses tax (30% + 1% TDS) and PMLA/FIU-IND reporting to regulate VDAs without recognising them as money [1][3].

• Global coordination through the FSB and FATF, and models such as MiCA and the GENIUS Act, show that rules for reserves and redemption are the way forward [5][6].

• Stability vs innovation trade-off:

• Stablecoins promise cheaper and faster cross-border payments and remittances.
• They also carry run risk, as the TerraUSD collapse (2022) showed.
• Any Indian framework must demand reserves that are real, safe and easy to sell, and must keep the central bank as the anchor of trust.

Related concepts

• Cryptocurrency
• Decentralised finance
• Non-Fungible Token
• Asset tokenisation

Read more

• Crypto-assets, stablecoins and tokenisation: the regulatory frontier