Fiat-Collateralized Stablecoins: A Quick Rundown
Fiat-collateralized stablecoins are different from other stablecoins. Learn the differences and the pros and cons of fiat-collateralized stablecoins here.
Published August 1, 2022.
Stablecoins provide a solution to bridge the gap between fiat currency like the Chinese Yuan and cryptocurrencies like Bitcoin. Since they are price-stable cryptocurrencies that function essentially like fiat but facilitate the transfer and use of digital assets, stablecoins are undeniably an innovative solution to cryptocurrency volatility.
Basically, stablecoins are cryptocurrencies issued on the blockchain and are distinguishable by their underlying collateral assets: fiat-collateralized, crypto-collateralized, commodity-collateralized, and algorithmic-based. Though the underlying collaterals differ, stablecoins always strive to offer stability. This article takes a deeper dive into fiat-collateralized stablecoins.
What Are Fiat-Collateralized Stablecoins?
Among the four types of stablecoins, fiat-collateralized stablecoins are the most popular.
Fiat-collateralized stablecoins have fiat currencies, like the US dollar, as the underlying assets to their value. While there are other forms of collateral, such as commodities and precious metals, most fiat-backed stablecoins maintain reserves of US dollars.
These stablecoins maintain their 1:1 peg through trusted custodians that hold the same amount of legal tender in reserves. As such, new coins are issued when someone deposits USD into the custodian’s reserve. Likewise, when a redemption bid is sent, the custodian releases USD and burns the redeemed stablecoin.
Pros & Cons of Fiat-Collateralized Stablecoins
These are the pros and cons of fiat-collateralized stablecoins:
Pros
- Their 1:1 collateralization structure minimizes the chances of extreme volatility
- They are simple and easy to understand
- Fiat-collateralized stablecoins are not easily vulnerable to hacks as their reserves are stored off-chain
- They bridge the gap between standard crypto and fiat efficiently
- Are highly scalable since their structure can be expanded to back an extensive ecosystem
Cons
- They are centralized in nature
- Highly regulated as they are bound to a central bank issuing the underlying asset
- Little to no transparency due to lack of regular audits on their reserves
- They require a custodian to store reserves, presenting custodial solvency and legitimacy risks
- Little innovation to what traditional banks do
Popular Fiat-Backed Stablecoins
These are the top five popular fiat-collateralized stablecoins:
- Tether (USDT) The biggest fiat-backed stablecoin by market cap that runs on the Bitcoin network through the Omni Layer Protocol.
- USD Coin A completely collateralized USD ERC-20 token issued by CENTRE–a joint organization of Circle and Coinbase.
- Binance USD (BUSD) Collateralized by reserves kept in fiat currency in omnibus accounts at various US banks and /or treasury bills.
- Paxos Standard (PAX) Backed 1:1 by USD reserves and available via Paxos.
- TrueUSD (TUSD) An ERC-20 stablecoin that’s backed, secured, and verified by third-party agencies.
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