The Most Used Stablecoin Category

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Fiat-backed Stablecoins

Fiat-backed stablecoins have been the first stablecoins to emerge and have become the most prominent and used form of stablecoins over the last eight years. Fiat-backed stablecoins have the characteristic that each USD-pegged token issued is backed 1:1 by real USD. Therefore, fiat-backed stablecoins require bank accounts to hold USD to back the stablecoin issuing. The most prominent fiat-backed stablecoin is USDT from Tether Holdings. USDT is mainly used for trading on centralized and decentralized exchanges as well as a store of value to hedge the high volatility in the crypto markets. The direct backing with Fiat currency has made USDT one of the most stable and long-lasting stablecoins in the market. Many other fiat-backed stablecoins have entered the market based on the success of USDT such as USDC from Circle or BUSD from Binance. However, the high stability of fiat-backed stablecoins comes with trade-offs in decentralization and capital efficiency.

The challenges of Centralization

The requirement to hold actual Fiat currency such as USD can only be met with the existence of Fiat-based bank accounts. Thus, fiat-backed stablecoin issuers rely on a centralized structure with a regulated entity. Customers who want to borrow stablecoins against USD will have to go through a KYC and an AML process. However, the practice of issuing stablecoins has no specific regulation by any financial authority yet. This leads to low transparency and a high need for trust by investors for the stablecoin issuer. Regular attestation reports and actual audits of the balance sheets of centralized stablecoin providers remain voluntarily. Tether and its stablecoin USDT have been subject to endless rumors about having large parts of its USDT supply outstanding unbacked or only partially backed by assets that are substantially more volatile and risky than cash and cash equivalents.

Maintaining Dominant Position

Due to the ability to create stablecoins based on real USD, Fiat-backed stablecoin providers are the preferred issuer for large and institutional investors who want to enter the crypto markets. Thereby, they are the entry-gate for professional capital and contribute to further growth of the entire market. As of May 2022, Fiat-backed stablecoins accounted for over 95% of the entire stablecoin supply in the market. However, the lack of transparency and accountability of centralized stablecoin providers constitutes a known systematic risk for the crypto market.