What To Know About Fiat-Backed Stablecoins

Understanding Tether, Circle, CBDCs, and more

Pop quiz: what’s the third biggest cryptocurrency by market cap? Bitcoin is number one, Ethereum is second, but what’s next?

The answer is Tether, the largest fiat-backed dollar stablecoin.

Does it surprise you that the third biggest cryptocurrency is essentially the US dollar? And the fifth largest, Circle USD (USDC), is a dollar stablecoin as well. Though we often talk about crypto as an autonomous system separate from traditional centralized finance, an immense amount of money moves between those two systems every day. Much of that occurs through stablecoins: cryptocurrency tokens whose prices are pegged to a fiat currency, such as the US dollar or Euro.

What is a fiat-backed stablecoin?

Stablecoins must always maintain their peg. That is, the value of one token must constantly remain within an extremely tight range of the target currency. If they lose that peg by rising or falling against the value of the currency, the consequences are often dramatic. (More on that later.)

In this article, we’re focusing on fiat-backed stablecoins, which maintain a supply of cash and cash equivalents (such as government bonds or money market funds), so that one stablecoin can always be exchanged one for one with its target currency. However, most users simply exchange their stablecoins for cash on the open market, rather than with the issuer directly.

Tether (USDT) can be redeemed for USD, but you need a verified account and at least $100,000

Other types of stablecoin exist, such as algorithmic and crypto-backed stablecoins. For more on these, check out our in-depth comparison of the three types of stablecoin.

Fiat reserves should provide constant liquidity between the stablecoin and its fiat equivalent, in theory. This is why fiat-backed stablecoins are often considered the most reliable type of stablecoin, and explains why Tether (USDT) and Circle USD (USDC) have grown to such heights.

What are fiat-backed stablecoins used for?

Due to their stability, (It’s in the name, after all) fiat-backed stablecoins are used as a bridge between crypto and traditional finance, as a medium of exchange, and as a safe harbor from volatility. (It should be noted that all types of stablecoins are used for these purposes, though fiat-backed stablecoins are the most popular and time-tested as we said.)

Many large exchanges allow customers to purchase and withdraw fiat-backed stablecoins with no fees, making them a seamless method for moving money in and out of the crypto ecosystem. However, some customers avoid this type of centralized exchanges for a truly decentralized experience (Not your keys, not your crypto, as we’ve written many times.)

For that reason, fiat-backed stablecoins are often used as a safe harbor against volatility within crypto. While subject to some changes in price, major fiat currencies are generally extremely stable in comparison to cryptocurrencies. Holding some portion of your portfolio in fiat-backed stablecoins allows you to hedge against the volatility of your other assets, while still keeping that wealth on the blockchain.

Fiat-backed stablecoins allow you to make crypto transactions, with their speed, 24-hour availability, anonymity, and trustlessness, without the volatility of most cryptocurrencies. This makes them a reliable medium of exchange: an asset with agreed-upon, stable value that is used to settle debts.

For example, suppose you’re making a payment to someone for $100 of work. You send them $100 worth of Bitcoin. But, Bitcoin is a volatile asset, so the price drops while the transaction is being confirmed and your recipient only receives $97 in effect. Using a dollar-pegged stablecoin avoids this.

Major fiat-backed stablecoins

Tether

Tether’s USDT is the largest stablecoin, largest fiat-backed stablecoin, and third largest cryptocurrency. Tether also offers fiat-backed stablecoins for the euro, yuan, and Mexican peso, which are available on most major blockchains. At time of writing, USDT had a total supply of $83 billion with 24-hour volume of $20 billion.

Founded in 2014 by Brock Pierce, Reeve Collins, and Craig Sellars as Realcoin, Tether was one of the first attempts to build a stablecoin on Bitcoin. Since, Tether has grown at a rapid pace, at times the largest and most traded cryptocurrency in the world. Tether’s peg has generally been extremely stable; it slipped a few percentage points in November 2022 during the FTX collapse, but eventually recovered.

In their most recent audit report, Tether’s reserve assets were listed as 84% cash and cash equivalents, of which 76% were Treasury bills and only .69% were actual cash dollars. The remaining 16% is held  in precious metals, Bitcoin, secured loans, corporate bonds, and other investments.

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However, Tether has been marked by controversy and criticism throughout the last decade:

• In 2017, the U.S. Commodity Futures Trading Commission (CFTC) subpoenaed Tether in relation to circulating suspicions that their claim that “Every tether is always backed 1-to-1, by traditional currency held in our reserves” was untrue. At numerous points throughout those years, an independent audit could not be obtained. In 2021, Tether paid a $41.6 million fine and revised their claim to say Tether is “pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether’s reserves.” A US court now requires them to produce regular audit reports.
• In 2017, the Paradise Papers revealed that Tether and the Bitfinex exchange may be co-owned or more closely linked than previously disclosed. This led to allegations of price manipulation and collusion. The corporate structure of Tether is still somewhat opaque and a source of speculation.
• In 2019, the New York Attorney General sued iFinex (the holding company for both Tether and Bitfinex), alleging that Tether was used to cover up a $400 million loss for Bitfinex involving a Panamanian payment processing firm. The case was settled for $18.5 million.  

Circle

USD Coin, or USDC, is a dollar-pegged ERC-20 token on Ethereum. Created in 2018, USDC is issued by Centre: a consortium formed by the financial technology company Circle and Coinbase. The stablecoin runs on Ethereum, Tron, Avalanche, Solana, Arbitrum, Flow, Stellar, Algorand, and Hedera blockchains.

At time of writing, USDC had $23 billion in circulation and 24-hour volumes of $4 billion. Circle also issues a euro stablecoin.

Circle is licensed as a Money Transmitter in New York State, which makes USDC an attractive option for many corporate and institutional clients. They also issue monthly attestations and complete SEC filings. The most recent report shows $31.8 billion in USDC reserves, with $26.6 billion in Treasury bills and $5.5 billion in cash.

In March 2023, USDC suffered a temporary depeg due to the collapse of Silicon Valley Bank, which held $3.3 billion in USDC cash reserves. USDC fell as low as 87 cents, but regained its peg after Circle was eventually made whole by the FDIC and the market regained confidence in the stablecoin and its issuer.

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Binance USD

Binance USD (BUSD) was a dollar stablecoin created by Binance and Paxos. It supposedly adhered to the New York State Department of Financial Services (NYDFS) rules and was backed by reserves. However, in February 2023, the NYDFS ordered Paxos to stop issuing new tokens and it was reported the SEC intended to sue them for issuing an unregulated security.

Coinbase delisted BUSD at this time as well. Nonetheless, BUSD has retained its peg and is still the 14th largest cryptocurrency, with $5 billion in supply and $1.4 billion 24-hour volumes.

Binance CEO CZ acknowledged himself that BUSD market cap will go down over time, since no new minting will take place. Indeed, the market cap is down over 75% from its $23.5 billion peak in November 2022.

Why aren’t fiat-backed stablecoins always stable?

As these three most prominent examples show, fiat-back stablecoins are not necessarily all that stable. These three major stablecoins have all suffered dramatic challenges on various fronts. Nonetheless, they have retained their market dominance and are staggeringly crucial to the healthy function of the crypto ecosystem. Note that the most dramatic stablecoin collapses, such as Terra Luna, were not fiat-backed.  

Let’s take a look at some of the major risks faced by fiat-backed stablecoins:

1. They require huge reserves.

In order to issue billions in stablecoins, the issuer needs billions of dollars. Such a large sum is difficult to acquire in and of itself. Beyond that, maintaining these reserves requires finesse and careful risk management. Since these reserves must be held in diversified portfolios, counterparty risk is introduced at various stages.

Just look at Circle, which produced careful reports on its portfolio and relatively conservative asset mix, but was nearly a casualty of Silicon Valley Bank’s own collapse. Tether has also faced constant public and regulatory scrutiny over the makeup of its reserves, which at times have snowballed into crisis.

2. There is a lot of regulatory uncertainty.

Tether and BUSD have both been challenged repeatedly by regulators in the United States, with Paxos even forced to stop issuing new BUSD tokens. Until there is clear guidance from American lawmakers about stablecoins, there is a risk of regulatory action leading to runs and depegs.

This is especially problematic for stablecoins, as they are highly integrated with traditional finance, which attracts more scrutiny, and whose institutions have far lower tolerance for potential illegality. In 2021, the International Organization of Securities Commissions (IOSCO, an international gathering of national regulators), said stablecoins should be regulated “as financial market infrastructure alongside payment systems and clearinghouses,” though that statement has not translated into real clarity yet. And since stablecoins are commonly used to transact across borders, there is the immense challenge of maintaining compliance within each country.

3. They are not decentralized.

Fiat-backed stablecoins are, by their very nature, centralized. In order to maintain their reserves, a centralized organization is required, and those reserves themselves are held in and issued by other centralized institutions. This contributes to the previous two risks, as well as possible ripple effects from any number of global events that impact the financial sector.

Fiat-backed stablecoins on Aptos

You’ll find both USDT and USDC on Aptos; in fact, the USDT-USDC pool is the largest on Liquidswap, with over $4 million in liquidity. However, neither are natively issued on Aptos. Instead, they are bridged from other chains using bridging protocols like LayerZero.

Aptos does have a native stablecoin, $MOD, issued by Thala Labs. However, it’s backed by decentralized assets and not fiat. Perhaps we’ll see native fiat-backed stablecoins issued on Aptos in the near future. After all, Aptos’s DeFi TVL is much larger than that of other blockchains where Circle already issues  native USDC, such as Flow.

Central Bank Digital Currencies

One of the most intriguing aspects of the fiat-backed stablecoin discussion is that of Central Bank Digital Currencies (CBDCs). CBDCs are a “digital liability of a central bank that is widely available to the general public.” In other words, digital money that is issued directly by the government.

While digital payments are already the norm, CBDCs would complement or replace physical money; instead of digits on a screen representing “real” money, the money itself would be digital. Note, though, that a CBDC doesn’t have to use blockchain.

The best-known CBDC project is the “digital yuan” in China, which is actually being used. By 2022, the associated wallet already had 260 million users, and the transaction volume reached $13 billion. For the latest experiment, government workers in the city of Changshu will soon be paid in it.

Another well-known initiative is the Eastern Caribbean Central Bank (ECCB). Its CBDC has been officially adopted by Antigua and Barbuda, St. Kitts and Nevis, Montserrat, Dominica, Saint Lucia, St. Vincent and the Grenadines, and Grenada. However, the experiment hasn’t really taken off,  and the supporting DCash network even went down for a month in 2022. Nigeria’s “e-Naira” hasn’t reached real adoption, either.

Many more countries have launched pilot projects that are testing the idea, including South Korea, Japan, India, Saudi Arabia, Australia, South Africa, Malaysia, Singapore, Thailand, Ghana, Sweden, etc. Several of these have been developed as partnerships between multiple countries, and the Bank for International Settlements (BIS), the international organization for central banks.

The United States Federal Reserve is publicly exploring the idea, but has not launched a pilot yet. In March 2022, President Biden placed “the highest urgency on research and development efforts into the potential design and deployment options of a United States CBDC.”

Non-blockchain-based CBDCs aren’t stablecoins, though they will obviously compete with them. In fact, CBDCs could upend the existing crypto ecosystem and stablecoins, perhaps eliminating them altogether. Circle has responded to the Fed’s CBDC proposals, saying they would worsen financial exclusion and privacy concerns, increase costs, destabilize the banking system, and function worse than existing options.

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