Stablecoins backed by fiat currency are the most well-known and widespread type on the market. These are digital assets possessing financial reserves in fiat currency, held by a regulated institution such as a bank. They keep reserves in a bank vault or at a trusted financial depository.
Centralized entities operating this stablecoin type have to generate revenue through the proceeds from their cash equivalents. The two largest stablecoins by market capitalization fall into this category: Tether USD ($USDT) and USD Coin ($USDC).
These stablecoins are centralized, yet stable and capital efficient. Their stability is dependent on the maintenance of the reserve by the covering entity and the supervision of auditors and regulators to demonstrate the transparency of the reserve.
Definition of fiat-backed stablecoins
The importance of these stablecoins comes from their advantages. At the same time, it is important to be aware of their limitations, such as regulation and intervention by centralized institutions. Owners of these stablecoins have to trust that the institution has safely deposited the reserves backing the stablecoins.
Compared to other stablecoins types, they have the advantage of being backed by real fiat currencies. Users can buy products and services online using fiat-backed stablecoins, as well as buy other cryptocurrencies on exchanges such as Binance.
Fiat-backed stablecoins in practice
Stablecoins backed by fiat currency are pegged to a fiat value, most commonly the USD. Fiat collateral remains in reserve with a central issuer, such as a bank, and has to match stablecoins in circulation.
Not all fiat-backed stablecoins are equally secure. Some stablecoin issuers are more transparent about regulation, such as where the funds used to back the stablecoins are kept.
Some issuers publish third-party audit reports to publicly demonstrate collateral fidelity. If the issuer only holds, e.g., 1000 USD in reserve, only 1000 stablecoins worth 1 USD can be in circulation.
Examples of fiat-backed stablecoins
Gemini Dollar (GUSD)
The first regulated stablecoin built to achieve scalability and usability. $GUSD has a 1:1 peg to the USD and is backed by funds at State Street Bank. The BPM accounting company conducts regular audits to confirm that the USD reserves are equal to the GUSD tokens in circulation.
USD Coin (USDC)
A stablecoin fully backed by assets in reserve, also exchangeable for USD at a ratio of 1:1. USDC is managed by a community-based issuer known as the Centre. This body sets the technical, financial, and political standards for the stablecoin.
Binance USD (BUSD)
Binance USD was created by the Binance exchange in collaboration with Paxos Trust Company. This company is also responsible for holding the USD collateral that backs the $BUSD.
Tether USD (USDT)
USDT was founded by Tether from Hong-Kong in 2014. It is the world's first fiat-backed stablecoin. It is currently the most widespread and used stablecoin on the market.
Unlike other cryptocurrencies, the value of a fiat-backed stablecoin is tied to the underlying asset price, not supply and demand. E.g., 1 $USDT should always be worth 1 USD, although market conditions may fluctuate slightly. This makes them a more reliable form of payment currency than other cryptocurrency forms.