Full Reserve Backing vs Fractional Reserve Backing

Specific advantage: Requires $1 in reserve for every $1 issued. This matters for risk-averse institutions and regulatory compliance, as seen with USDC (Circle) and USDT (Tether) holding direct cash & treasuries. It eliminates bank-run risk but ties up significant capital.

Specific advantage: Can issue >$1 in stablecoins for every $1 in collateral. This matters for DeFi protocols seeking high capital efficiency and users chasing native yield. Examples include MakerDAO's DAI (over-collateralized) and older models like Terra's UST (algorithmic). Enables lending and leverage but introduces liquidation and depeg risks.

Specific advantage: Counterparty risk is centralized but transparent (e.g., monthly attestations). This matters for payment processors and treasuries where predictability trumps yield. The primary failure mode is issuer insolvency or regulatory seizure, not a protocol hack.

Specific advantage: Risk is decentralized into the protocol's economic design. This matters for decentralized purists and systems valuing censorship resistance. Failure modes are complex: collateral volatility (e.g., ETH drops causing DAI liquidations) or death spirals (algorithmic models). Requires active governance and risk parameters.

On/Off Ramps, Corporate Treasury, Regulatory Compliance.

• Use Case: Holding funds for short periods, paying vendors.
• Protocols: Circle's USDC, Paxos' USDP.
• Key Metric: Backed by $100B+ in cash-equivalents across major issuers.

DeFi Native Applications, Leveraged Strategies, Censorship-Resistant Money.

• Use Case: Earning yield via lending protocols like Aave or Compound.
• Protocols: MakerDAO's DAI, Liquity's LUSD.
• Key Metric: DAI's ~$5B TVL demonstrates sustained demand for decentralized stable assets.

100% asset-backed: Every issued token is directly collateralized by a verifiable, liquid reserve (e.g., USDC, Treasury bills). This eliminates counterparty risk from lending activities, making it the gold standard for institutional custody and regulatory compliance. Protocols like MakerDAO's PSM and Paxos Standard (PAX) exemplify this model.

Instant, guaranteed liquidity: Users can redeem tokens for underlying assets at any time without affecting the system's solvency. This structure prevents bank run scenarios and contagion, as seen in the stability of Tether's reserves for USDT (post-transparency) during market stress versus the collapse of fractional algorithmic models like TerraUSD (UST).

Higher leverage on assets: By lending out a portion of deposits, the system can generate yield (e.g., through DeFi protocols like Aave or Compound) and support more circulating supply than its base collateral. This is critical for scaling lending markets and providing competitive returns, as utilized by mountain protocol's USDM.

Enables sustainable business models: Interest earned on lent assets creates a native revenue stream for the protocol (e.g., fee distribution to governance token holders). This economic model supports protocol-owned liquidity and developer grants, fueling ecosystem growth beyond simple asset custody.

Opportunity cost: Capital sits idle in low-yield reserves (e.g., short-term treasuries yielding ~5%). Holders bear this cost, as seen with USDC, which offers no native yield, pushing users towards wrapped yield-bearing versions like cUSDC on Compound.

Vulnerable to mass withdrawals: If redemption requests exceed liquid reserves, the protocol must liquidate loans, potentially at a loss, risking insolvency. This requires robust risk parameters, oracle reliability, and over-collateralization, adding operational complexity and points of failure.

100% asset-backed: Every issued token is backed 1:1 by a verifiable reserve asset (e.g., US Treasuries, cash). This eliminates insolvency risk from the backing model itself, as seen with USDC (Circle) and USDT (Tether). This matters for institutional custody and regulatory compliance, providing clear audit trails via attestations from firms like Grant Thornton.

Higher yield potential: Only a portion of deposits are held in liquid reserves, freeing capital for lending and investment activities (e.g., MakerDAO's DAI with RWA collateral, or traditional banking models). This can generate revenue to fund protocol incentives or insurance funds. This matters for protocol sustainability and offering competitive yields to holders.

Opportunity cost: Idle capital in low-yield, high-liquidity assets (like cash) generates minimal revenue, placing burden on other fee models (e.g., mint/redemption fees). This can make it harder to bootstrap network effects against yield-bearing competitors in a high-interest-rate environment.

Bank run vulnerability: If confidence wanes, a rush to redeem can deplete the fractional liquid reserves, potentially causing insolvency. This requires robust risk management (e.g., MakerDAO's Stability Fee, PSM) and liquidity backstops. This matters for protocol resilience and is a primary concern for regulators like the SEC.