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Stablecoins have a market cap of around $170 billion, making them a relatively small part of the overall cryptocurrency market, which is currently worth around $1.2 trillion, according to CoinMarketCap data. But they have surged in popularity in recent years. The largest stablecoin, Tether, has a market cap of around $80 billion, having surged from just $4.1 billion at the start of 2020. The No.2 stablecoin, USD Coin, has a market cap of $49 billion, according to CoinMarketCap data. While data on the specific uses of stablecoins is hard to come by, they play a crucial role for cryptocurrency traders, allowing them to hedge against spikes in bitcoin's price or to store idle cash without transferring it back into fiat currency.

There are two main types of stablecoin: those which are backed by reserves comprising assets, such as fiat currency, bonds, commercial paper, or even other crypto tokens, and those which are algorithmic, or "decentralised". Major stablecoins such as Tether, USD Coin and Binance USD are reserve-backed: they say that they hold enough dollar-denominated assets to maintain an exchange rate of 1:1. Asset-backed stablecoins have come under pressure in recent years to be transparent about what is in their reserves and whether they have sufficient dollars to back up all the digital coins in circulation.

TerraUSD's stability mechanism stopped working this week when investors lost faith in Luna, amid a broader downturn in cryptocurrency markets. TerraUSD's price crashed to as low as 30 cents. In theory, asset-backed stablecoins should hold firm despite this. But Tether also broke away from its dollar peg for the first time since 2020 on Thursday, dropping to as low as 95 cents. Tether sought to reassure investors, saying on its website that holders were still able to redeem their tokens at the 1:1 rate.

While regulators globally are trying to establish rules for the cryptocurrency market, some have highlighted stablecoins as a particular risk to financial stability - for example, if too many people tried to cash out their stablecoins at once. In its stability report, the Fed warned that stablecoins are vulnerable to investor runs because they are backed by assets that can lose value or become illiquid in times of market stress.